Investors shouldn’t let enticing payouts blind them to property trusts’ risks
Reits or Real Estate Investment Trusts are now the flavour in Singapore and the region. Governments are offering tax incentives for Reits and there is talk of several billion-dollar Reits being floated in Singapore and other regional markets, including Hong Kong.
Reits invest in a portfolio of properties and manage them. Each year, they share the earnings — after deducting costs — with their shareholders. They are being touted as the ideal investment, offering high dividends, low taxation and possible capital appreciation. In fact, Reits are revolutionising the whole property investment sector.
Investors in Reits listed on the SGX have done very well in the past few years. Given the low interest rate environment, the dividend payouts have been relatively attractive.
The attractive yields from rental of properties have allowed the trusts to add to their property portfolios without diluting dividend payouts.
It has been a virtuous circle. As the unit value of Reits appreciate on the market, their yield drops and that enables the trusts to buy relatively low yielding properties without appearing to dilute dividend yields.
But the truth is that the yields offered by our Reits have been substantially lowered as their share prices rise. They are still above bank deposit rates, but the margins have narrowed. However, investors have tasted profits from Reits and want more. What will it all lead to?
The hunger for Reits is becoming a craze, even if it is not yet a bubble. There are pitfalls ahead and investors should be aware of these.
One major concern is what will happen to the value of Reits when interest rates rise steeply and unexpectedly. Unit prices will drop sharply and those Reits which have high borrowings will be hurt the most.
Even if interest rates rise gradually, investors will sell Reits as their yields will not look as attractive as before.
In Singapore, interest rates are in a gradual multi-year uptrend, as the economy grows and loan demand increases.
Reits will also suffer if the property markets take a downturn. Rentals usually fall in a depressed market and the dividend payouts from Reits will fall in line with lower income from their properties.
Investors are looking at Reits as if they are bonds, but they are not. The dividend payouts on units are not fixed and can decline as property income drops.
Of course, in a rising property market, Reits do very well as they gain from the appreciating values of properties held and rising rental yields. But in a falling property market, Reits suffer a double whammy of falling rental income and property prices.
These cautionary remarks on Reits could jolt some investors into doing their homework before rushing into property trusts, but various investment banks are promoting Reits aggressively.
We have six listed Reits and they are all aggressively buying properties. All of them want to become multi-billion dollar giants: CapitaCommercial Trust, CapitaMall Trust, Suntec REIT and Ascendas or A-REIT as well as Fortune REIT.
But Reit companies have to know when to stop buying properties. If they keep buying in a rising market, they will eventually be caught with high-priced properties yielding low or falling rentals.
The vendor companies are happy now, selling their properties to the Reits at relatively high prices. They often do a sale-and-lease-back deal, as in the case of Hyflux and Armstrong.
These deals look like win-win situations. The Reit gets an accretive rental yield and the vendor gets a large amount of cash in hand, on sale of the long-held property.
But the lease-back period may be for a few years only and when that ends, the property-owner-turned-lessee will want to pay a lower rental. That is when the Reit and its shareholders will face uncertainty and possible capital losses.
The bottomline is that Reits have inherent risks like any investment and their current attractive dividend payouts are blinding investors to their downside risks. As Reits go on a property grab, they are issuing more shares and passing the risks onto investors.
When the music stops — as when interest rates rise and the property market drops — all will suffer. We will then have another sorry tale of a popular investment gone sour.
By Mano Sabnani
Source: Today Online
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