Thoughts on Investing in REITs

Real Estate Investment Trusts (REITs) seem popular among investors as they generally have high dividend yields and sell at a discount to the book value. They also pay out quarterly dividends, which is especially good for dividend investors who can quickly reinvest the dividends and compound their returns at a more frequent rate. I have not really covered REITs in my blog post so to start I'll just post some of my thoughts on investing REITs, then (maybe) I'll cover some of the REITs, but I've personally not invested in them before.

(Image source: http://realtybiznews.com)

I do not think that REITs make very good investments for the time being due to 3 reasons:

Rentals in Singapore are starting to stagnate or decline

Refer to
http://www.channelnewsasia.com/news/business/singapore/singapore-retail-rents/1772026.html
http://www.commercialguru.com.sg/property-management-news/2015/2/83595/orchard-road-retail-rents-down-5-in-q4-to-decline-
https://www.ura.gov.sg/uol/media-room/news/2015/apr/pr15-18.aspx

Retail rents are starting to decrease while office rents are starting to stagnate. There are also several new shopping centres expected to open up, which would increase vacancy rates unless demand increases, which seems unlikely due to the stagnating or decreasing rents. REITs would be greatly affected by any increase or decrease in the rental yields of their properties as this is their main source of revenue.

Unless the REIT you are looking at invests primarily in properties overseas, its income is likely to decrease as the rental rates in Singapore decline. That being said, some other countries are also facing the same problems as Singapore.

Interest rate hikes

Interest rates may increase with the Fed likely to increase short-term interest rates by the end of this year. This would affect the price of REITs as they are usually valued based on their dividend yield, which would decrease when compared to interest rates (after the increase) The interest rate hikes would also increase the cost of debt for the REITs, debt incurred while funding their acquisitions.

An increase in interest rates may make some of the purchases that the REITs have made recently, under the pretext of low interest rates, unprofitable. This would reduce their income and their yield as well, so interest rate hikes will affect REITs in two negative ways.

Little product differentiation

This leads to low Return on Equities (ROEs) as one rental space may not be very different from another rental space in a competing REIT's property. While REITs usually trade below their book value, their return on equity would be considerably low as it is hard to differentiate their product (rental space) from that offered by their competitors.

But then again, every cloud has a silver lining

While I do not think that REITs would make good investments due to the reasons mentioend above, I have to mention that they appeal to a certain type of investor: The dividend investor. (You can read m thoughts on dividend investing at Thoughts on Investing for Dividend Yields)They are good as they are likely to provide stable dividend income (which may decrease due to reasons mentioned above in the long-term) which are paid out quarterly and can be used for reinvestment or personal expenses. This is good for people after retiring as they provide a higher return that government bonds or fixed deposits, however, the income that they provide is not as stable as the two mentioned.

REITs are also a good way to invest in property without having to get into the nitty-gritties of managing the property, dealing with tenants, etc. So I guess they still have a place in the investment portfolios of certain groups of people, however, I think that I am unlikely to invest in REITs unless their price decreases to make the returns that it offers more attractive.

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