16 JULY 2013
4 Reasons Why REITs Are Better Investments Than Real Estate
Scottish American industrialist and philanthropist Andrew Carnegie once said that 90 percent of millionaires became so through owning real estate. This wisdom, though dispensed in the 18th century, is a wisdom that has persisted today judging from the popularity of real estate as an investment class.
There is nothing inherently erroneous in this advice despite the carnage that has unfolded in recent years in the real estate market. As an asset class, real estate investments generate a reliable stream of income besides holding the prospect of capital appreciation. And unlike the yesteryears when real estate investments are within reach of only the very wealthy, prospective investors today can participate in real estate investments through a Real Estate Investment Trust (REIT).
But the popularity of REITs in recent years has brought about a perennial debate as to which is a better mode of investment, buying real estate physically or holding it in a REIT? Each method has its own merits but this article we will discuss four advantages that REITs investors have over traditional property investors.
Real estate, be it a single building or an estate, will require constant maintenance and repair. Certain property types such as shopping malls will require even greater maintenance costs as they will need to sustain a decent façade in order to attract shoppers and continue generating income. An investor who puts his money on a single property will need to consider the expenditures on leaking roofs, faulty plumbing or termite infestations as part of his investment costs. In some cases, these costs can be quite hefty and may not be easily recoverable from the tenant.
In REITs, building maintenance costs, or more commonly referred to as capital expenditures (CAPEX), are borne by the REIT managers and are in effect distributed across many shareholders. In some cases, favourable lease terms allow these costs to be passed on to the tenants, practically absolving the REIT investor from any sort of building maintenance costs. As a REITs investor, it is unlikely that you will see CAPEX making significant impact on the returns of your investment. This is the scalability that REITs investors enjoy over property owners.
Owning a single property would usually mean that your fortunes are pretty much tied up in the sector that your property is vested in. For example, if you own a small factory complex, it is unlikely that you will benefit from the surge of tourist arrivals in your country. And should the demand for manufacturing slows, you may be in trouble finding a tenant for the property.
REITs investors are able to expose themselves to several sectors of the economy at any one time by distributing their investments across different REIT categories such as Retail REITs (to benefit from surges in consumer spending), Hospitality REITs (to ride on tourist arrivals) or Healthcare REITs (to benefit from increased spending on medical services). This minimises the risk that an investor is over exposed to just one particular sector of an economy. To achieve the same level of diversity with traditional property holdings would require a very hefty investment.
An investor who decides to buy and manage a property as an investment will usually have to depend upon himself in managing the property including renovations, sourcing for tenants and making sure that the building adheres to local safety regulations. These functions can be outsourced to third parties, but this would severely increase the costs of managing the property and erode the returns on investment.
REITs on the other hand are managed by dedicated teams of REIT managers who make it a daily endeavour to look for growth opportunities while keeping borrowing costs low. REIT managers are also very experienced in financing and asset enhancement strategies, often increasing the value of the properties that they manage over time. This is the advantage of having a professional management that REITs investors enjoy over traditional property investors.
Favourable Tax Rulings
In many economies, building owners are liable to annual property taxes, administration fees and stamp duties, on top of paying personal income taxes as an investor. The combination of these taxes can be very overwhelming.
REITs on the other hand are largely exempt from paying taxes at the REIT level in virtually most economies as long as they distribute at least 90 percent of their income to shareholders. In economies like Singapore, the government has gone even further to exempt REITs investors from paying taxes on capital gains and dividends from REITs. Tax rulings vary across the different economies. But one similarity that these economies have is the markedly favourable tax rulings that REITs investors enjoy over the traditional property investor.