2 Important Things Every REIT Investor Needs To Know

The first ever real estate investment trust (REIT) in Singapore was launched in 2002 and it was none other than CapitaLand Mall Trust (SGX: C38U), then known as CapitaMall Trust.

In the 13 years since, many other REITs have joined the fold and as of 8 May 2015, there are 28 REITs and six stapled trusts in Singapore’s stock market with a collective market capitalisation of S$68 billion.

REITs can be attractive investments for many investors due to their high dividend yields. Data from stock exchange operator Singapore Exchange show that the 28 REITs have an average yield of 6.1% (as of 8 May 2015); this compares with the yield of less than 3% that the SPDR STI ETF (SGX: ES3) – an exchange-traded fund which tracks Singapore’s market barometer the Straits Times Index (SGX: ^STI) – has at the moment.

But despite their high yields, it’s important to know that REITs, like any other investment option out there, do carry risks as well. Here are some important aspects of risk which every REIT investor has to know:

1. Different types of assets can result in different risk profiles

REITs can be broadly categorised into five different groups according to the types of properties they own: Industrial; Commercial; Healthcare; Hospitality; and Retail. Bear in mind though, that there are some REITs with a mixture of different types of properties.

With REITs deriving the bulk of their income from renting out the properties they own, the performance and risks that a REIT has is naturally tethered to that of its underlying properties.

Industrial REITs such as AIMS AMP Capital Industrial REIT (SGX: O5RU) are one good example of REITs which may be more cyclical in nature as compared to say Healthcare REITs.

Industrial REITs also have a greater dependence on the health of the country’s economy in which they operate in; in AIMS AMP Capital Industrial REIT’s case, the ability for Singapore’s economy to grow would be important as most of the 26 properties in the REIT’s portfolio reside here.

This brings me to another point about how the ownership of different assets can bring with them different risks: The risks associated with a REIT can vary greatly based on the geographical location of its investments as well. We can use Saizen Real Estate Investment Trust (SGX: T8JU) and SPH REIT (SGX: SK6U) as illustrative examples here.

Investors in the former would have to be mindful of issues like the fluctuation of the Japanese yen in relation to the Singapore dollar, the aging population in Japan, and Japan’s slow economic growth – that’s because Saizen REIT’s entire portfolio of 136 residential properties are located in Japan.

On the other hand, those factors would have almost no bearing on how the latter would perform. With only two retail malls in Singapore – Paragon and the Clementi Mall – investors in SPH REIT face a completely different set of risks, such as possible shifts in the way people prefer to shop (online versus brick-and-mortar, for instance).

2. The downside of paying out most of their distributable income

REITs in Singapore often carry high yields because they are required – as per regulations set by the Monetary Authority of Singapore – to distribute at least 90% of their taxable income to unitholders in order to enjoy certain tax benefits.

As a result, REITs can’t retain much of their earnings to fund future growth and they have to borrow or issue new units to raise capital. This presents two different types of risk for investors.

The first deals with the perils of having to take on borrowings. Most REITs in Singapore have a gearing ratio (total borrowings over total assets) of 30% or more – that isn’t onerously high, but it isn’t chump change either. If interest rates are to increase in the future, it may ding the bottom-line of REITs and thus lead to lower distribution yields. On an even more bearish scenario, REITs which are unable to secure refinancing at interest rates which make sense may even be required to sell off some assets when loans come due. This brings me to the second risk.

The inability of REITs to retain their earnings also makes it very tough for them to build up cash reserves to repay any loans as they come due. As a result, REITs will usually seek financing by entering into new borrowing agreements or engage in other capitalization measures such as rights issues, private placements, and in worst-case scenarios, the sale of assets. The issue of rights or the undertaking of private placements, may lead to the risk of dilution of existing unitholders’ stake in the REIT.

Foolish Takeaway

REITs do have their benefits – besides offering a high yield, thy also provide investors the ability to diversify their capital across multiple high-grade properties. But, like any other investment instrument, there are still important risks to consider when it comes to a REIT, such as the type of assets it owns, the geographical locations those assets are in, the health of the REIT’s balance sheet, and more.

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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 James Yeo doesn’t own shares in any companies mentioned.