The Pros and Cons With Real Estate Investment Trusts: The Negatives

There are over 30 real estate investment trusts in Singapore’s stock market and these REITs either focus on one real estate sector or are invested across a few. Some of the real estate sectors include healthcare, industrial, commercial, retail, and hospitality.

Just like every other kind of investment vehicle, there are pros and cons for investors when it comes to REITs. In this article, I will be taking a look at the negative aspects of REITs. For the benefits that REITs can bring to investors, you can check out here.

1. Slower growth

As I mentioned in my take on the benefits that come with REITs, they are required to pay out 90% of their taxable income. This result in REITs having high distribution yields.

But there is a drawback here: The requirement to distribute nearly all of their income mean that REITs have very little profits to reinvest into their core business. This in turn lead to REIT’s distributions on a per-unit basis generally growing at a slower pace as compared to a company’s earnings.

2. The presence of debt

The fact that REITs are able to retain only a small portion of their earnings mean that they have to constantly take on new borrowings or raise capital from investors in order to pay down existing debt.

The presence of debt creates financial risks. Meanwhile, REITs can raise capital from investors either through private placements or rights issues. Private placements will dilute existing unitholders’ stakes in the REIT while rights issues can also result in dilution if the REIT’s existing unitholders are unable to take up the rights units on offer.

At the moment, the level of debt allowed for REITs in Singapore is capped at 45% of their assets. This also brings me to the third negative thing about REITs – sensitivity to interest rates.

3. Exposure to interest rate risk

Due to a REIT’s need for debt to run its business model, it is susceptible to interest rate risk. When interest rates rise, debt becomes more expensive for REITs and this could ding their bottom-line and thus, distributions.

This is a worthwhile risk to consider given that interest rates in Singapore are currently near generational lows.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.