This post is a 101 dissection of real estate investment trusts, REITs or Reits in short. As the full content of this topic is pretty long and I will try to make this 101 comprehensive, touching on the following:
- What are Reits
- What makes Reits different from other investment vehicles
- Why invest in Reits
- What are the different types of Reits
- How to evaluate a Reit
As you can see, there’s plenty to talk about even in a 101 piece, so let’s get straight to it.
1. What are Reits?
Reits, by virtue of their long form name, are essentially instruments that allow investors to get exposure to the real estate market, be it locally, regionally, or globally. The easiest way to give an explanation of what is a Reit is to take on the perspective of the Reit manager. As the Reit manager, to start an investment trust on real estate, you would first need to secure financing from, say a bank, to finance your portfolio of properties. That’s one portion of the financing. The other portion comes from listing the Reit in an exchange through an IPO, and get investors to invest in your Reit as a unitholder.
From there, your entire portfolio of properties are financed from these two parties and your Reit is established. Afterwhich, you would do whatever that is required to rent these properties out on a lease, and start to collect rental income.
Reits as a passive income stream
And here’s where plenty of retails investors, especially those in Singapore, have came to love Reits - Reits are obligated to pay out a minimum of 90% of its income as distributions (i.e. dividends) to enjoy tax exemptions. Suffice to say that the math works out for the Reit manager to indeed to pay at least 90%. This obligation is often viewed favorably by investors as a means to achieve consistent passive income stream - it has been suggested that Reits can be used as a supplement or even alternative to a retiree’s annuity.
The different parties within a Reit
Following illustrates clearly how each party in a Reit interacts with another. Let’s take a brief look at each of them.
- The Trustee: the trustee, as the name suggests, is responsible for the holding of the Reit units for investors. The trustee may also ensure compliance on the Reit on behalf of unitholders, and in gist, act in all manners in the interest of unitholders.
- The Reit manager: the Reit manager is the one or the team that manages the strategic oversight of the Reit and its investment strategies. A Reit manager, may for instance, decide to expand out of Singapore real estate and venture into say, the Australian market.
- The Property manager: on the other hand, the property manager is in charge of the actual management of the properties, e.g. running marketing campaigns or strategizing to maximise rental income.
- The Sponsor: the sponsor is basically the “big boss” in the Reit. They are usually big developers like CapitaLand or Mapletree. They may be the ones who initially developed the properties and assets in the Reit. A sponsor, especially a larger one, would typically run and manage several Reits at once with different Reit manager teams - e.g. CapitaLand with CapitaLand Mall Trust, CapitaLand Commercial Trust, Ascott Residence Trust, CapitaLand Retail China Trust, and CapitaLand Malaysia Trust (listed on the Kuala Lumpur Stock Exchange).
2. Why makes Reits different from other investment vehicles?
- Fundamentally, Reits have no relations with stocks, bonds or commodities, only real estate. Therefore Reits are often thought of as an alternative asset class.
- Public companies operate in accordance to typical business regulations set out by e.g. SEC in the US, and different companies operate under different guidelines for different industries, e.g. a medical devices company with the FDA. On the other hand, Reits are more strictly regulated and more homogeneous. In Singapore,
- Reits cannot undertake any development activities (e.g. asset enhancement initiatives or AEI) directly or indirectly, when the value of these activities are in excess of 10% of the Reit’s portfolio value.
- Reits can have a maximum leverage (i.e. gearing ratio) of 45%.
- As mentioned above, Reits are obligated to pay out a minimum of 90% of its income as distributions (i.e. dividends) to enjoy tax exemptions.
Unlike Reits, these or equivalent measures on leverage and distributions are not applicable in public stocks or companies.
What about Reits vs physical property?
Well that’s all good, but what about having real estate exposure by simply owning a property? How does that match up? In Singapore,
- Investing in a Reit requires a brokerage account, a CDP account, and the transaction fees in buying and selling. There is no capital gain tax nor dividend tax in Singapore. For a physical property, there’s the following to think about, on top of time and money spent in e.g. sourcing for tenants:
- 3-4% Buyer Stamp Duty
- 12-25% Additional Buyer Stamp Duty
- legal fees
- property tax of ~10% Annual Value
- rental income tax
- maintenance cost
- 4-12% Seller Stamp Duty
- agent commission
- Physical properties are more illquid that the exchange-traded Reit unit
- Due to the price of physical properties, it is unlikely for a retail investor to have say more than 5 or 10 properties, thus incurring concentration risk in location. A well diversified Reit would have no such issues.
- Yield of a Reit is typically in the 4-8% range, while it could be challenging to replicate or better this yield from a physical property.
(Good to know) Reits versus Business trusts, stapled securities
Not all the counters you see on SGX that seem like Reits, are actually Reits. For example, Ascendas Reit (A17U.SI) is a Reit, while Ascendas Htrust (Q1P.SI) is a stapled security, i.e. one unit of Q1P constitutes buying into the Ascendas Hospitality Real Estate Trust plus the Ascendas Hospitality Business Trust. Think of it as stapling two pieces of paper together.
From a regulatory standpoint, there are significant differences between a Reit and a business trust. This REITAS page (REITAS is short for REIT Association of Singapore) is clear on the differences. For retail investors, it would be good to be cognizant of the following (lifted from the same page):
Reit Business Trust Distribution Reits must distribute at least 90% of their specified income to their unitholders to enjoy tax transparency under the Income Tax Act. There is no statutory requirement to distribute a certain percentage of its income, but business trusts may pledge to distribute a certain percentage of income to their unitholders. Gearing The Code on Collective Investment Schemes sets a 45% cap on gearing. There is no statutory gearing limit, but business trusts may commit to a self-imposed borrowing limit.
In a stapled security, all Reits regulation (e.g. the Income Tax Act and the Code on Collective Investment Schemes) apply to the Reit portion only. The business trust is nothing but a company, regulated under typical public company regulations.
3. Why invest in Reits?
- Reits allow for property exposure without the significant hassle of property ownership.
- Reits are most commonly thought of as a source of passive income stream, and rightfully so. As we pointed out earlier in this 101, Reits are obligated to pay out a minimum of 90% of its income as distributions to enjoy tax exemptions. Suffice to say that the math works out for the Reit manager to indeed pay out at least 90%. This obligation is viewed as a plus point for retail investors as a consistent passive income. This is in addition to the fact that most Reits distribute on a quarterly basis.
- Because the relatively high yields (~6-8%), Reits can play a part in a retiree’s holdings, where passive income and/or principal drawback kicks in. Instead of selling of units, Reits function as a perpetual income stream, of course provided that you have accumulated enough units during your career years.
- Unlike evaluating companies coming from a variety of industries, from e-commerce to shipping, Reits are relatively homogeneous and easier to understand. The notion of buying and managing a property, then collect rental income is much easier to grasp than e.g. how Medicare and Medicaid policy changes will affect the outlook of pharmaceutical companies. This relative ease makes it more straightforward to evaluate Reits, and act on your decision.
- In addition to high yields, Reits also avail themselves to capital gains and losses. Reits have been performing well since the second half of 2018 and continues to do so. Make of that what you will.
4. What are the different types of Reits?
Reits are typically thought of as coming under these five categories:
- Retail Reits are those comprising of shopping malls, focusing on the retail sector. Example Reit: CapitaMall Trust.
- Commercial Reits go for commercial properties, such as office buildings. Example Reit: Suntect Reit.
- Industrial Reits consist of properties like factories, warehouses and other specialized facilities. Example Reit: Mapletree Industrial Trust.
- Hospitality Reits are the ones with hotels and serviced apartments. Example Reit: Ascendas hTrust (a stapled security).
- Healthcare Reits are, well, hospitals and other healthcare facilities like medical centers or nursing homes. Example Reit: First Reit.
As you can imagine, each category of Reits would flourish or suffer under whichever prevailing economic conditions. The clearest example would be that hospitality Reits would typically suffer during economic downturns, where consumers are less likely to travel (discretionary spending). High unemployment numbers could mean lower occupancy in commercial Reits, while a boost from the government to transform the country into a medical tourism hub would do well for healthcare Reits. As such, these broad economic and policy changes plays significant role in Reit evaluation.
There is also a bunch of Reit-ETFs, such as the Lion-Phillip S-Reit ETF, which I personally don’t fancy - it’s kind of “fee-on-top-of-fee”. Using regular saving plans products like the POEMS Shares Builder Plans can allow us to assemble a diverse portfolio of Reits without the ETF expense ratio.
5. How to evaluate a Reit
Due to their homogeneity, there are a number of standardized ways of Reit evaluation, with the use of a number of metrics that capture different aspects of a Reit. I wouldn’t be going too in-depth here as I would like to explore this topic in greater detail in the future.
Here are some ways in which Reits are evaluated:
- Distribution per Unit (DPU). The DPU is simply the distributed amount to unitholders during e.g. quarterly distributions. For example, the most recent distribution from CapitaMall Trust (C38U) in May 2019 was 0.0444 per unit, which is a quarterly yield (see 2. below) and yield-to-date of 1.83%.
- Distribution Yield. Slightly different from DPU is the yield. The yield is simply your dividends divided by your principal, i.e. instead of having units as a denominator in DPU, we are talking here about the price of the Reit. More important than maximizing yield (the so-called dividend trap) is to look for stable and growing distributions. An increasing yield over time could mean that the Reit is stable, and is able to attract tenants. For example, the yield of C38U grew from 3.44% in 2013 to 7.68% in 2018 full year.
- Price-to-NAV. The price-to-NAV ratio, also known as book value, compares the market valuation of the Reit to the value of the Reit in its books. NAV stands for net asset value, which captures the amount of money, in principle, that the Reit would have if the Reit manager liquidates all assets and returns the money back to investors. We would consider any price-to-NAV ratio of less than 1 to signal undervaluation by the market. Following are some examples (as of May 2019):
- Suntec Reit - 0.87
- Keppel Reit - 0.85
- Mapletree Industrial Trust - 1.39
- Gearing Ratio. Also known as leverage, the gearing ratio is the ratio between the amount of debt divided by the Reit’s total assets. Recall we talked about the maximum gearing ratio of a Reit in Singapore has to be less than 45%. Generally, we are seeing an average of < 40% amongst our S-Reits.
- Weighted Lease Average Expiry (WALE). As the name suggests, WALE is simply the mean remaining lease duration, weighted by the rental income, in the Reit’s portfolio. Needless to say, a WALE of 10 years is better than that of 5 years. WALE typically differs depending on the type of Reit - for example, industrial Reits tend to have longer leases than a retail Reit.
- Capitalization Rate. Also know as property yield, the cap rate simply captures the income derived from the properties (net operating income) to the value of the properties.
And there’s more. Some of these metrics, like WALE, are obviously Reit-specific, while others apply to most if not all listed company stocks. I will go over more of these metrics, as well as viewing Reits under a fundamental analysis lens, in a later, post-101 series of posts.
That’s all for now - thank you for reading! :)