07 July 2014

Things To Note When Investing in REITs - July 2014

Real Estate Investment Trust (REIT) is a hybrid product that combines features of real estate and securities in the market and normally listed in stock exchange. For some investors whose risk and return profile is moderate, this is a good investment vehicle to them. Why do I say so? Let's look at the benefits of REITs:

  1. It allows you to purchase a piece of real estate in prime location and proven passive income in the market. There are existing tenants in the piece that you own through REITs.
  2. It is managed by professionals via two main categories: managing the shareholder funds & managing the properties for you. By allocating the cash (whether from borrowings or from shareholder funds) to more than 1 property under management, it requires certain skills to do so. Of course, the most important part is the capital relocation by disposing properties or acquiring new properties. By recruiting correct tenants or managing a pool of tenants is not a simple job to individuals as well. It requires a team of people in doing so. And of course, the cost to this is that you have to pay for the management fees and/or performance fees to these group of people, which is deducted from the passive income received from the tenants or active income via capital relocation method. 
  3. You can acquire and liquidate the piece of properties you have in the open stock market much faster than property market. It reduces the risk of having difficulty in finding buyers as compared to property market.  
  4. You do not need to pay for the income tax for the dividends you received as individual, which is slightly different from the real estate rental income to be taxed accordingly. In Singapore, it is stated that the dividend income from REITs and shares are tax-exempted. It is a good investment tool for rich individuals.  
Since there are so many benefits of investing in REITs, what is the weakness over REITS investing? 
  1. Similar to shares investing, the price movement is influenced by both short term and long term linked to the macro-economic condition as well as business risk involved. For example, the REITs managing oversea properties might face currency risks and oversea market risk. The management would manage the risk via currency hedging or receive the rental income in Singapore dollar denominated. 
  2. The investors might not be able to ride on the leveraging similar to real estate investing, and hence they also cannot report the loan interest paid in income tax for tax rebate purpose. For example, if you have S$100K in cash, you can only invest the S$100K in REITs but you cannot borrow up to S$900K and use S$100K as down payment which is quite common in real estate investing. 
  3. As you leave it to professionals to manage the real estates for you, you might also need to monitor the management fees and performance fees to see whether it is justifiable. You may also need to have certain knowledge in selecting the correct REIT that suitable in your risk & return profile. 
  4. The dividend payout that you receive is also not as certain as bond coupon payment. It means that the dividend could increase or reduce over year, as similar to the rental income in real estate market. 
In summary, this investment asset class is suitable for those who wish to invest in real estate but with the mind to let professionals running for them. Over the long run, the dividend payout could be increased due to the excellence management by professionals or due to the inflated environment. It is good for long term investment for a moderate risk profile. 

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