With a multitude of real estate investment trusts (REITs) in the market, choosing one to invest in may be a daunting task. In this article, I hope to make your life easier by breaking down the pros and cons of each of the four main REIT sub-types.
Retail REITs invest primarily in shopping centres. In Singapore, there are a variety of retail REITs that have portfolios in different countries. For instance, CapitaLand Mall Trust (SGX: C38U), CapitaLand Retail China Trust (SGX: AU8U), and Lippo Malls Indonesia Retail Trust (SGX: D5IU) invest in shopping malls in Singapore, China, and Indonesia respectively.
Each shopping mall usually consists of a variety of tenants that have varying lease terms. Anchor tenants that attract shoppers to the properties can usually negotiate lower rental rates and longer contracts.
Smaller shops, on the other hand, have shorter leases and higher rental rates. It is also common to find that retail REITs charge tenants a minimum rent or a percentage of sales, whichever is higher. Furthermore, retail REITs earn income from car parks. As such, retail REITs are highly dependent on shopper traffic and tenant sales.
Because of the way retail REITs earn their rental income, the capability of management to attract and retain anchor tenants is essential to its success. The key risk factors for retail REITs are a slowing economy and low employment rate, which may lead to lower consumer spending. But on the flip side, there is also potential upside when the economy grows and consumer spending increases.
CapitaLand Commercial Trust (SGX: C61U) and Suntec Real Estate Investment Trust (SGX: T82U) are two examples of office REITs in Singapore. Office REITs own office buildings and lease spaces to business tenants. Contracts tend to be long and lease terms increase over time.
However, because of the time it takes to build an office building, office REITs are susceptible to supply-demand mismatches that can result in variation in office rents.
In Singapore, office space supply far outpaced demand in 2016 and 2017, resulting in lower rental rates. A large supply-demand mismatch may also result in higher vacancy rates. The key risk affecting office REITs is a slowing economy leading to lower job creation.
Industrial REITs focus on investing in warehouses, distribution centres, factories, and other manufacturing-related buildings. The properties are either single-tenanted with long contracts or multi-tenanted leases with shorter but higher rental rates.
Rental prices vary depending on property categories and features. For instance, industrial buildings that have a ramp-up feature can command higher rentals than their older counterparts without it. The performance of an industrial REIT is also highly dependent on the demand and supply of industrial properties.
In addition, the economic growth of a country can have a material impact on rent and occupancy levels. Ascendas Real Estate Investment Trust (SGX: A17U) and Mapletree Industrial Trust (SGX: ME8U) are two examples of industrial REITs listed in Singapore.
Hotel REITs usually lease their properties to management companies. In return, the management companies manage the hotels and pay a master lease rent with a variable component. This provides the hotel REIT with potential upside, should the hotel earn more revenue.
However, hotel REITs are perhaps the most volatile of the four REIT categories listed here. Business and travel leisure volatility, and the sector’s cyclical and seasonal nature can greatly impact a hotel business.
Like office space, the hotel industry is also affected by the supply-demand mismatch. Should new hotel room supply exceed demand growth, there could be a significant drop in revenue per available room and can also lead to lower occupancy rates.
The Foolish bottom line
Investors should consider the unique aspects of each REIT asset class when investing in REITs. Among the four REIT-types listed above, hotel REITs are the riskiest. Because of its variable lease term with its master tenant and susceptibility to volatile market conditions, rental income of hotel REITs can fluctuate wildly. Meanwhile, retail REITs and commercial REITs have more reliable rental income and therefore, are more popular among investors. This, in turn, gives giving rise to lower distribution yields.
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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 Jeremy Chia doesn’t own shares in any companies mentioned. The Motley Fool Singapore recommends CapitaLand Mall Trust, CapitaLand Commercial Trust, CapitaLand Retail China Trust, Ascendas Real Estate Investment Trust and Mapletree Industrial Trust.