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by Shrikant Bhat 04:45 AM Feb 18, 2012
Real estate as an asset class is hardly a new concept. People have viewed property as an investment long before the advent of stock exchanges and other capital markets.
The URA Private Property Index jumped from 33.3 points in 1980 to 202.8 points in 2010. This is a 500-per-cent increase over 30 years, signifying the surge in the value of real estate, which has outpaced the rate of inflation.
Real estate investments are a good way to diversify your portfolio. Given the large transaction sizes of properties, most retail investors face a difficult choice - either commit a large amount of capital or exclude exposure to an asset class that can diversify their investment portfolio.
REITS IN SINGAPORE
One way to achieve property diversification is to invest in real estate investment trusts (REITs). REITs are tax-advantaged corporate vehicles that provide a real estate investment structure to accommodate a wide variety of investors, much like what mutual funds do with stock or bonds. Since the listing of the first REIT in Singapore in July 2002 (CapitalMall Trust), the sector has grown exponentially. There are now about 27 REITs with underlying properties from the retail, corporate, industrial, hospitality and healthcare sectors.
For investors, the biggest advantage of REITs is the opportunity to participate in the performance of a wide variety of properties. The exposure to commercial properties also offers investors diversification, as retail investors are likely to hold only residential properties in their personal portfolio. REITs also allow investors to benefit from the professional expertise and research resources of the asset managers overseeing the fund.
In addition, REITs offer investors greater liquidity and transparency. Unlike physical real estate, REITs are traded on major stock exchanges, providing price transparency for investors and allowing them to enter or exit a REIT position based on published quotes. REITs also allow investors to liquidate their positions quickly for purposes of taking profit, managing loss or even to meet emergency needs. This is unlike physical property transactions, which usually take months as price is privately negotiated between the buyer and seller.
Another distinct advantage is the small capital required for participating in REITs, as opposed to physical real estate investment. This implies that investors need not take a loan to participate. Among other risks, the use of loans exposes the investor directly to interest rate risk.
High-dividend yield is another main attraction of REITs. REITs pay at least 90 per cent of their income available for distribution as dividends. Based on FSTE ST REIT Index, the dividend yield as of November last year is at an attractive 6.64 per cent compared to fixed-deposit rates. With the interest rate environment likely to remain low over the next two years, and Singapore headline inflation hovering at 5 per cent, investing in REITs can be a viable alternative to holding cash. Such steady dividends can also partially soothe out the volatility in one's portfolio.
Because of its low correlation with large-cap stocks, treasury bonds and inflation, REITs offer diversification benefits for a portfolio of traditional assets. Studies have shown that by adding REITs to a portfolio of stocks and bonds, it can potentially improve the efficient frontier by providing an upward parallel shift of the frontier. Simply put, this means that REITs can potentially increase the portfolio returns at any given risk levels.
CONSIDER THE FLIPSIDE: RISKS
Like all investments, REITs have their fair share of risks. As REITs are listed on public stock exchanges, prices are susceptible to investors' sentiments, therefore making them more volatile when compared to real estate investing.
It is also essential to note that the REITs business model relies significantly on the availability of credit since they do not retain much of their incomes. Thus, they need to periodically tap the banks or the capital markets to refinance their debt. In times when credit gets frozen, the inability to refinance becomes a real risk for some REITs. This is what happened during the recent global financial crisis, when a number of small, highly-leveraged REITs (both local and foreign) came close to defaulting on their debts.
All in all however, the balance sheets of REITs today is nowhere near that of 2008/09. REITs have emerged from the financial crisis in a stronger condition and are now able to better weather any potential economic downturn. Debt maturity profiles have also improved, with annual maturities backed by stable annual cash flows from rental income.
CONSIDER SINGAPORE AND HONG KONG REITS
Stock markets have recently been hit by concerns over the euro debt crisis, the risk of a hard landing in China and a potential double-dip recession in the United States. Amid these worries, REITS offer a compelling investment proposition for income investors. Citi analysts see good opportunities in the REITs sector, specifically in the commercial REITs in Hong Kong and Singapore where the dividend yield is averaging at 6.1 per cent.
Shrikant Bhat is head of wealth management at Citibank Singapore.
Publish date: 18/02/12