In my last article, “Popular Investing: Invest in unit trusts” in the link below, I received a comment form my friend below,

[Sslee Dear kcchongnz,
The other way of passive investment is in REIT. Should give return better than bank FD rate. This is where I first start my investment in Bursa. It is a bit boring not much movement on price but just waiting for dividend every quarter that is why I started to buy other share get myself burnt and start to do some study on FA, joining i3 and attending AGM to get to know the board, management team and asking hard questions to understand how the business is runned and managed.
Thank you.]

Here, I will write something about what I know about it. But one thing you must bear in mind is that investment return includes dividend plus capital gain. None of them should be ignored.

What is REIT?

A real estate investment trust or REIT is a tax designation for a corporate entity investing in real estate which reduces corporate income taxes. The REITs, in return, are required to distribute 90% of their income into the hands of the investors. The structure of the REIT is designed to provide a similar vehicle for investment in real estate as unit trusts provide for investing in stocks.

Listed REITs are traded on Bursa like shares of common stock. This allows investors to become exposed to real estate without having to involve themselves in private investment outfits or direct ownership. Typically, real estate investment trusts own offices, apartments, and other kinds of commercial real estate, including warehouses, shopping malls, hospitals and hotels.

The Pros of REIT

Many rich individuals in Malaysia own a number of properties. Property investment has been a very popular investment in Malaysia, Singapore, New Zealand, Australia, China, Hong Kong and almost everywhere in the world. It is the source of enormous wealth. Unfortunately, it’s not an easy one for most investors to gain access to. Each property is unique, transaction costs are very large, sales occur only occasionally, and market knowledge is often local and restricted, making this an insider’s market.

Many investors want to invest in real estate but do not want to deal with the problems associated with owning property directly such as getting tenants, dealing with tenants who damage your property, managing the properties, chasing monthly payments from tenants, paying quit rents and assessment etc. Real estate is far from passive. Many people, have bought and then subsequently sold their properties because of this.

Real Estate Investment Trusts (REIT) solve those problems. REITs are special investment vehicles that hold real estate and distribute 90% of their income to unit holders as required by the statutory. This often provide a yield of 5%-6% each year, higher than the bank fixed deposit rate. Hence this appeal to investors who are risk averse and retirees who depend on some regular income in retirement.  

Another argument of proponents about REIT, and real properties too, is it is a good hedge against inflation. As inflation rises and things become a lot more expensive, REITs which holds portfolios of properties will rise in price according to the rate of inflation. How about investing in individual property stocks? Don’t property stocks also hedge against inflation, and why must they be Reits?

Financial advisors also work in cohort with unit trust funds promoting investing in Reits claiming that they have little correlation to the stock markets. They claim that when the market goes down, Reits are little affected. That means they are good candidates for diversification and can over time reduce portfolio risk and increase returns in a properly structured portfolio.

With a volatile market now, more people are contemplating to invest in REITs as a safe investment, for a higher dividend yield and hence better and more dependable return from the market, so the story goes.

The Cons of REITs

Nothing in this world is perfect, so is investing, and investing in Reits. The following summarises some of the cons in investing in REITs.

One of the major problems when buying REITs is the lack of control. When buying you make a number of assumptions that you may not be aware of such as the value of the assets they hold and the benefits of professional management. You have to trust that they are doing a good job and are not using Hollywood Accounting.

There are significant problems with the valuation of real estate in today’s market, you also have to consider that REIT’s will also take a severe hit if valuations of real property fall.

As a REIT is bounded by regulation to distribute at least 90% of its taxable annual income to unit-holders, but there is no guarantee that the REITs will be able to continue to rent out its properties. Hence there is no guarantee that you will get that income.

After distributing the bulk of its income, very little is left to engage in expansion programs. Therefore, REITs tend to require the injection of new funds from either its existing owners (in the form of rights issues) or new owners (in the form of private placements; which will dilute the interest of minority shareholders) when it needs to acquire new properties. As an investor, the implication is that investing in a REIT might require you to fork out additional capital once in a while to subscribe for those rights issues. Many investors buy into REITs for their high dividend yields for a potentially large stream of passive income. But, a REIT’s fund-raising exercises might just result in an overall cash inflow that’s tiny, or in the worst-case scenario, even negative.

REITs are like stocks. Their share price fluctuates with the market. When the market drops 30%, it can drop 30% too.  

When looking at real estate investment trusts (REITs), many investors are usually fixated on their financial figures like the growth in their distributions per unit (DPU), distribution yields, gearing ratios and the price-to-book (PB) ratio. However, many may fail to see that there’s another important aspect of a REIT to look out for: The amount of fees paid out to the manager of a REIT.  Generally, there are four main type of fees that the managers would be entitled to. These are the killers. With all these fees, how can shareholders make money?

1. There is a base fee that unit-holders have to pay the managers regardless of the performance of the REIT. This ranges from 0.1% to 0.5% of its total asset.
2. Then, there is a performance fee where the managers are rewarded based on meeting certain targets. However, there is no standard structure for the performance fee and each REIT has its own version of performance fee.
3. Lastly, there are acquisition fees and divestment fees for the managers every time a property is bought or sold. This ranges from 0.5% to 1.5% of the transacted amount. 

The bottom line is; do Reits provide better total return including dividend and capital gain with less risks for investors? What are the evidences for Reits listed in Malaysia?

The total return of Malaysian REITs in the last 5 years

I managed to list out 18 REIT stocks listed in Bursa which have a record of long enough 5 years price history (Excluding ALSreits, 3.5 years, and KipReits, less than 1 year) from 1^st September 2013 to 24^th August 2018 as shown in the chart below.

The share prices of the REITs were obtained from Yahoo Finance website daily prices with the prices adjusted for all dividend distribution. Hence what is shown is the total cumulative return including dividends and capital gain/loss.

During this period, the broad market returned a total of 15.2%. The cumulative average and mean return of the 18 Reits was 12.8% and 11.8% respectively as shown in Table 1 in the Appendix, under-performed the broad market. That could be due to the sluggish property market, as well as the rising interest rate started a year or two ago.

13 out of 18 Reits obtained positive return as shown in Figure 1 above, with the highest in YTL Reits at +51.9% or a CAR of 8.7%, followed by KLCC Reit at +48.1%, IGB Reits at +47.8% and SunReit with cumulative return of 45.8%.

The worst performer was AMFirst Reits which lost 34.1% during the 5-year period. A seeming good Office Reits, Tower Reit, was not spared with a loss of 28.4%. Note this has included all dividends paid every year.

So, are Reits always good investments? You make your judgment.

Should You Invest in REITs?

Go ahead and invest in Reits if you think the Reits provide you with the safety comfort and the real estate market fundamentals are good. However, if you think that current valuations of real property are still high, you may want to reconsider…Reits are just as vulnerable. The values of their assets are linked to the real estate markets.

REITs are not as safe as bonds which bond holders have the first right of the claim of a company’s assets before the equity or Reits shareholders in case of liquidation of the company. If you buy the bond of a company with stable earnings and cash flow, and a healthy balance sheet, it is much safer than a Reit.

Most of all, the Reit management is pressured to buy properties even if they are expensive as they have to prove that they are wisely investing shareholders money. The management can’t sit around with piles of cash even when they should. That won’t be the best interest of shareholders. The management also has their incentives and self-interest, which often are not be the same as yours.

Adios and best of luck. 

K C Chong

Appendix

Table 1: Five-year return of Reits