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Saturday, 26 December 2009

Investing in REITs - Really for the yield?

Business model of typical REIT

People invest in Real Estate Investment Trust (REIT) primarily for the stable dividend yield. REITs are supposed to provide good source of passive income for those with neither the cash nor the leverage capacity to invest in typical properties for passive rental income. Is this really so?

Before answering that question, let's look at the business model of a typical REIT. In layman terms, REIT acquire properties and lease them out for rental income. The funds for acquisition comes either from shareholders (share issue), banks (loans) or both. REIT is supposed to pay out ALL profit from rental income less all other business expenses (including bank loan interest) required to keep the REIT alive.

During Good Times

When the economy is booming, demand for factory, office and retail space pushed up rents and hence the record rental income for REITs, pushing up the dividend per unit (DPU) of these REITs. However, the prices of these REIT surge even higher, and hence the yield is actually very low. For blue chip REIT like the Capitalmall Trust, yield got as low as mere 3 to 4% in 2007. At such yield, I am quite puzzled whether the investor are indeed after the dividend yield.

During such time when demand for practically everything is high, profit is easy to come by and credit is even easier. DPU accretive property acquisitions continue to be made even when property bubbles seem to form. Perhaps the REIT management think no matter how much they pay for the properties, with easy credit, they can always milk much more from the tenants. Perhaps investor think the same way too, and look pass the current depressed yields for brighter future returns.

During Bad Times

Unfortunately, all good things must come to an end one day, especially those built on excesses. The subprime crisis put an end to the easy credit and the ensuing recession saw demand for factory, office and retail space plunge, driving down rents and rental income for REITs. Since REITs pay out all their profit, little is left to repay debts and when the loan are due, some faced problem refinancing their debt. Investor confidence in such REITs sunk like a rock in water. For example, Cambridge Industrial Trust, without a strong sponsor and concern was material that it might not survive, its annualised yield at one point went above 25%!

Inherent to the REIT's business model of growth by debt and paying out every cent less all expenses, continual injection of funds is their sole source of life sustaining blood. Thus capital call in form of debt refinancing (at prevailing interest rate) or equity raising exercise via rights or placement is inevitable.

For debt refinancing, the consequent is dip in DPU if interest rate is much higher than before.

But for equity raising exercise, dilution becomes a significant concern for those who do not have the funds to subscribe to rights entitled to them or left out cold in an event of private placement to new shareholders. The latter is especially unfair to current shareholders and normally met with angry shareholders like the recent case of MacAuthurCook Industrial REIT's dilutive recapitalisation plan.

Whichever route the REIT take, by virtue of their business model, high DPUs or high dividend yields are never sustainable.


If high yields or high DPU is not sustainable, is REIT never a worthwhile investment? I don't think so. Like all businesses, each have their intrinsic business cycles and one can benefit by exploiting the ups and down. For REIT, during recession, rents are low, property valuation are low, credit are difficult to come by and share prices depressed. At this juncture, the moment they can sort out their outstanding debt issues (i.e. refinancing, rights, placements), there is no better time to buy them and await the eventual economic recovery.

Thus in my opinion, REIT is better as a one-off capital appreciation investment than long term passive income generator.



Anonymous phantasia said...

Actually i think it depends on the entry price. If entered at an attractive price, the reit presents opportunities for decent price appreciation, at the same time offering a good annual dividend yield.

Effectively, it functions similar to a dividend stock, although the internal workings is somewhat different.

At the end of the day, i think a reit is just another investment vehicle, like equities, bonds, unit trust, properties etc. And whether is it a good investment depends on whether you can get it at an attractive enough entry price.

26 December 2009 at 22:12  
Anonymous Anonymous said...

For REIT almost all earning are paid out as dividend.

Effectively your earning yield will be your dividend yield.

It will be possible to get a higher earning yield with a lower leverage.

27 December 2009 at 08:28  
Blogger Musicwhiz said...

I always feel you should get into something when it is still new and there is little competition. Once everyone starts entering the fray then returns get diluted and when the masses start moving in that direction, most of the potential gains are lost.

When A-REIT, CMT, CCT and Suntec first came out, they were the first 4 REITS and had strong backing and asset portfolios. Subsequently, some of the REITS which came onto the market were sub-standard and didn't address issues of debt and growing their portfolio adequately, resulting in them becoming "bad eggs". Also, the concept of REITs had caught on like a frenzy and almost everyone started "securitizing" property assets into REITs or Trusts.

For myself, I bought into Suntec REIT during IPO and have enjoyed nearly 5 full years of very good yield, plus capital appreciation to boot at today's market price. I agree it's the price you buy in which determines if you can have a sustainable long-term decent yield, and it also depends on the timing.

For example, buying into cash-rich companies while their share prices are depressed will give you very good yields for many, many years to come, without undue risk.


27 December 2009 at 19:19  
Blogger Market Uncle said...

Hi all,

I'll just talk about DPU as yield is determine by price paid.

What I'm trying to say was that the perpetual-debt-driven business model of REIT does not really allow for a growing DPU for sustained periods. It can be high for the first few years but as DPU accretive deals get scarce (from competition or ppty bubble) or refinancing draws near, DPU correction occurs.

Thus, if one is savvy or fortunate enough to get into a REIT at a cheap price, assuming the average forward DPU is more or less sustainable without growth, the resulting yield thus 'locked' in already proof the investment worthwhile and expected capital appreciation a good bonus.

28 December 2009 at 10:15  
Anonymous BlackCat said...

Agreed, better to view REITS as cyclicals, rather than as long term investments.

28 December 2009 at 22:43  
Anonymous financialfreedom said...

Can clarify when you say that REITs are only repaying the interest payments and not the loan itself?

From what I understand, Suntec REITs issue rights to repay their debts too correct?

5 January 2010 at 12:23  
Blogger Market Uncle said...

Hi financialfreedom,
You are right, technically these REITs don't just pay interest but most (if not all) have no intention to pay off their loan. They only start to reduce their loan to keep within comfortable debt-to-equity or any similar ratio in order to get a good credit rating. Hope this clears.

10 January 2010 at 17:40  
Blogger dsea said...

But why would we expect REITS to be fully funded by equity? Why not add some debt to improve the ROE?

Of course, I know that some mgt would over do it by overgear.....

10 January 2010 at 22:39  
Anonymous Anonymous said...

If a business can only improve their ROE by leverage, then is that a good business to be in?

11 January 2010 at 21:53  
Anonymous Anonymous said...

Hi market uncle

I am a vistor who happened to chance upon ur blog and took the liberty of pasting ur article onto an investing forum for others to share.

Hope you dun mind.

Many thanks


The forum thread is as such:

10 February 2010 at 22:04  
Anonymous Anonymous said...

Hi market uncle

I am a vistor who happened to chance upon ur blog and took the liberty of pasting ur article onto an investing forum for others to share.

Hope you dun mind.

Many thanks


The forum thread is as such:

10 February 2010 at 22:08  
Anonymous Anonymous said...

Hi Why so quiet for so long? Too busy making money to blog? Looking to hear from you soon.

2 March 2010 at 22:41  
Blogger Market Uncle said...

Yes, have been very busy taking care of my baby girl. Hope to find time soon.

2 March 2010 at 23:00  
Anonymous Anonymous said...

price is the most important factor
in investing whether it is reit,
bond, commodity, foreign currency.
just make sure all are not value

30 November 2010 at 20:33  

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