Your Investment Options: A Breakdown of REITs
With such a wide array of investment options, new investors might not know where to start. With that in mind, I have written a series of articles that breaks down the most common investment options for new investors. In the first part of this series, I looked at the pros and cons of investing in stocks. Over here, I will focus on Real Estate Investment Trusts, commonly referred to as REITs.
So, what are REITs?
Real Estate Investment Trusts are a class of securities listed on the stock exchange. Like stocks, you can buy a unit of a REIT through your broker or online brokerage. When you buy a unit of a REIT, you become a part owner of the trust and are entitled to distributions. You can also sell the unit to another buyer in the future.
Just like stocks, REIT investors earn money in two ways. First, unitholders of REITs are entitled to distributions (similar to dividends) that are paid out periodically. Second, REIT investors can earn capital appreciation gains when the price of the REIT’s units increases in value. Investors can therefore sell the units at a profit when the price goes up.
But here is how REITs differ from stocks. REITs invests primarily in income-producing real estate. These properties are rented out to earn rental income, which is then distributed back to unitholders as distributions. Unlike stocks, which are not required to pay out profits to shareholders, REITs must pay at least 90% of their distributable income back to unitholders each year. This provides investors of REITs stable and consistent cash flow from distributions each year.
Since REITs debuted in Singapore in 2002, it has grown in popularity, with more REITs choosing to list here. There are now around 40 different REITs and stapled trusts (stapled trusts are similar to REITs, but with slight differences as explained here) in Singapore. They boast distribution yields of between 4.8% and 10.2%.
Types of REITs
REITs have different sub-types. They can invest in either retail, commercial, residential, logistics, industrial, healthcare or even data centre properties.
Each REIT has its own specialty, with some diversifying across multiple sub-types. For instance, CapitaLand Mall Trust (SGX: C38U) invests primarily in shopping malls in Singapore. Most Singaporeans would be familiar with some properties in their portfolio, which includes Plaza Singapura and Raffles City Singapore.
On the other hand, Keppel DC REIT (SGX:AJBU) invests in data centres. It owns 15 data centres located in eight countries in Asia and Europe.
As unitholders of these REITs, you become a part owner of the REITs and essentially, through your stake in the REIT, own a small stake of their portfolio. Income earned from rent is then filtered down to the unitholder either quarterly or half-yearly.
Benefits of REITs
- Exposure to wide range of properties: Investors in REITs become part owners of a large portfolio of properties. Unlike buying your own investment property, REITs provide greater diversity and even geographical exposure outside of Singapore.
- Reliable and consistent distributions: As mentioned earlier, unlike stocks, REITs are bound to pay out at least 90% of their distributable income to unitholders. This provides REIT investors stable and consistent cash flow from their investments.
- Capital appreciation potential: Contrary to popular belief, REITs are not merely a tool for distributions. Capital appreciation is common in REITs too. For instance, Ascendas Real Estate Investment Trust (SGX: A17U) first went public back in 2002 at just S$0.88 per unit. The REIT now trades at S$2.74 per piece. Investors who invested since then would have made huge capital gains plus collected distributions paid out during that time.
Risks and downsides
- Harder to grow: As illustrated by Ascendas REIT, REITs have the ability to grow its book value over time. However, book value may not grow as fast as some growth stocks. This is because REITs are obligated to pay 90% of their distributable income to unitholders. As such, it can only make use of 10% of retained income each year for growth.
- Capital risk: Like any investment, your capital is at risk. Prices of REITs can fall unpredictably. For instance, earlier this year, REIT prices fell dramatically due to fears that interest rate hikes could affect the profitability of REITs.
The Foolish bottom line
REITs have become one of the most popular investment vehicles in Singapore. In fact, I have included four REITs in my own investment portfolio. REITs provide stable cash flow and are usually less volatile and risky than stocks. REITs are also easy to analyse and require less tedious research, while providing good returns at the same time.