The Benefits and Risks of REITs


Reits, in short for Real Estate Investment Trusts, are basically vehicles which investors can buy into to get themselves exposed to a myriad of professionally managed portfolios of real estate.

On the surface, many can see the attractiveness from this kind of investment. The requirement to distribute 90% of taxable income to investors, the affordability, the relatively higher average yield compared to stocks and the liquidity of the units, are just a few obvious benefits that Reits can offer.

However one has to know that reits are not low risk instruments. They are usually driven by high financing, managerial/trustees' fees, low cash, payment of interest on their existing loans, repayment of loans that are maturing and their inverse relation with interest rates. These risks are quite substantial and have to be recognized.

In my view, the requirement to distribute a huge portion of its cash flows from its operation to the unit holders may not be something beneficial. It removes the flexibility of capital allocation for debt repayment, forcing some to issue new loans to pay for their existing loans or to issue new shares via rights issue.

The common mistake people make is to equate Reits with "capital guaranteed" instruments like bonds, fix deposits and treat the distribution as extra passive income or interest. Reits, like stocks fall by the amount of the dividend on ex date and moves accordingly to market sentiments and interest rates. They are of a different paradigm to capital guaranteed investments. That is why I am not a fan of pure Reits/perpetual accumulation in a portfolio.

That being said, it does not imply that reits cannot outperform in a long time frame. Some can and have, but some have not. We just need to keep an eye on their fundamentals(gearing, debt to maturity, price to book, occupancy rate, net debt to equity, p/e ratio, sponsor and macro/Forex risk) if we wish to invest in them.

In my view, Reits make a good defensive growth hybrid, but we cannot judge its attractiveness by just its yield alone as I think that will be very dangerous. Hope this post will be of some help to you.

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