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Why You Shouldn’t Invest in REITs

I had earlier written an article about why you should invest in REITs. In this article, let’s go to the flipside of REITs and talk about the disadvantages of investing in REITs.

As a brief recap: there are 26 REIT listings on the SGX, in addition to six other stapled securities (a stapled security typically consists of a business trust and a REIT). You can see a listing of all the REITs and stapled securities here.

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Once again, we can turn to author Bobby Jayaraman, and his book Building Wealth Through REITs for hints. Here are some of the tips I picked up from his book:

Need for debt and refinancing

The nature of REITs is to retain very little earnings for paying down its loans. This leaves REITs at the mercy of capital markets for refinancing that it needs to do from time to time. The ability and flexibility of a REIT to consistently do so is one thing to watch.

Some will do better than others. For instance, healthcare property owner Parkway Life REIT (SGX: C2PU) boasts an all-in interest rate 1.4% and an interest coverage ratio of 10.1 times. Serviced apartment owner Ascott Residence Trust (SGX: A68U) on the other hand, has an effective borrowing rate of 3.0% and an interest coverage ratio of 4.3 times. The differences in debt profile may lie in the underlying business behind the ticker.

Growth by acquisition with more debt or share dilution

At the moment, the level of debt allowed for REITs is capped at 60% of its assets provided that it has a credit rating. Without a credit rating, the debt to asset ratio is capped at 35%. Foolish investors should also be aware that the new REIT regulations proposed by the Monetary Authority of Singapore is a single-tier cap of 45% – with or without credit rating. It may serve to limit the debt levels taken by REITs.

However, this also would mean that REITs will likely need to issue more units or take on more debt in order to finance any new acquisitions. The astute Foolish investor will have to comb through previous acquisitions to see if historical acquisitions have been accretive.

Track record of management teams

The REIT you pick may be as good as the ability of the management team to generate organic growth from existing properties, and to execute prudent acquisitions for the future.

There is also the matter of management compensation. My colleague Stanley has pointed out differences before:

CapitaCommercial Trust (SGX: C61U) has one of the lowest fees, with only a 0.1% base fee. Most REITs such as Keppel REIT (SGX: K71U) and Ascendas Real Estate Investment Trust (SGX: A17U) have a base fee of 0.5% of the total asset of the REIT.

REITs such as Mapletree Greater China Commercial Trust (SGX: RW0U) and OUE Commercial Real Estate Investment TR (SGX: TS0U) set its performance fee to the increase in DPU from year to year, motivating the managers to focus on growing the DPU for its unit-holders.

Ultimately, the private investor will have to judge the performance of the management team against its compensation.

Foolish summary

The points above are to highlight some of the downsides from investing in REITs. Like any investment vehicle, there will be advantages and disadvantages associated. The points shared should not distract us from the overarching importance to picking good businesses underlying in the REITs.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chin Hui Leong owns shares in Parkway Life REIT.