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The Truth About REITs

The recent successful listing of Mapletree Greater China Commercial Trust further cemented Singapore as a dominant hub for Real Estate Investment Trusts (REITs) in Asia. The returns on REITs range from 4-8% and Singapore investors have developed a preference for REITs with their stable income streams. Adding to current market buoyancy, a recent article by Dow Jones Newswires said that Singapore REITs were still seen offering attractive yields despite the rally in the past few months.

However. while REITs may provide stable income for investors, they are by no means safe haven. In a broad market correction or crash, REITs trade like equities. During the financial crisis, REITs had not been spared as they plunged 65% over the period, giving no comfort to investors desiring stability (see chart below).

FTSE Chart

SOURCE: FTSE GROUP

 

Investors have to take note of several risks with REITs.

    • The stock price of a REIT is sensitive to interest rate movements as the assets are purchased using leverage. If interest rates go up, REIT prices will usually fall because their costs of financing or refinancing will rise.
    • Having a strong sponsor is also important. During the financial crisis, some of the REITs almost collapsed as they were not able to refinance the loans with banks and their sponsors lacked the capacity to support them with loan or equity injection. That is why REITs with strong sponsor-backing such as Ascendas and Mapletree are seen as relatively safer bets.
    • In “The Reit Myth busted”, the author pointed out that REITs as good income-yielding instruments may be anything but a myth. This is because although REITs pay out good distributions, they frequently claw them back in the form of new units issue.

 

With interest rates at or near bottoms, I think the risks of REITs investments are further heightened and will unravel when expectations of future rate hikes begin to set in and materialize.

While REITs can be a component in an investment portfolio, a portfolio that is skewed towards REITs and bonds for income generation does not make a good strategy. When interest rates go up, prices of both REITs and bonds are likely to fall and thus consideration needs to be given to whether the distributions or coupons will be sufficient to cover the resulting losses.

A potential new asset class to consider could be peer-to-peer loans. It is an asset class that can provide stable income streams similar to REITs and bonds but perhaps without the price volatility. I will provide more details on peer-to-peer loans in my next article.