Are REITs really a 'smarter pick' than property?

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With Real Estate Investment Trusts (REITs) in Singapore now looking good value for money after an initial Covid-19 drop in March 2020, investors have started putting money into them again. And they would be encouraged by measures in place to help locally-listed REITs ride the storm.

In contrast, actual property prices in Singapore has only dipped slightly, and the ABSD looks like it is here to stay.

But it’s not the first time that sentiments have tipped towards REITs. REITs also trended for awhile in 2019 and as recently as 2022. In fact, REITs seems to be a “go to” for investors whenever the government pokes the real estate market.

But are they really better than investing in actual real estate?

Firstly, REITs and real estate aren’t considered an either/or choice by serious investors.

In our experience, investors have both REITs and real estate investments. You’ll find many investors, for example, who own a condo to rent out, while also owning REITs as part of their investment portfolio.

That’s because REITs allow them to diversify into other types of properties (e.g. industrial), which are a whole different ball game and best left to the experts (i.e. those managing the REITs).

No matter how deep their pockets, typically retail investors are more comfortable with directly putting money in residential properties than, say, factory space.

But the retail investor knows that industrial yields can be good, so makes perfect sense for he/she to buy industrial REITs and let a professional manager run the show, while directly handling residential properties he/she owns.

To use an analogy, you should think of REITs and properties as being different tools in an investor’s toolbox. A hammer may be appropriate than a drill for some situations, but it’s not reasonable to say that a hammer is objectively better than a drill, or vice versa.

In the same way, it doesn’t make sense to declare whether REITs or actual properties are “objectively” better.

A better question to ask is WHEN you should invest in REITs, versus properties.

At the time of writing, more investors are turning to REITs. This is not surprising, as many are adopting a “wait and see” approach to gauge the full effect of the Covid-19 recession on property prices.

In fact, according to a poll we did on 450 likely condo buyers in April 2020, 65per cent of respondents are waiting for property prices to fall further before buying.

Falling rental demand (and rent) is also a worry, whenever there’s an economic contraction.

The other factor is that many REITs are looking good value right now. Industrial, logistics and warehousing properties, as well as healthcare facilities and data centres, are some of the real estate assets that are expected to escape the worst of the Covid-19 recession, and some of these REITs have even returned to their pre-Covid-19 prices.

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In fact, SPH Reit posted a 5.1 per cent increase in distribution per unit to 1.45 cents for the Q3 2022, from 1.38 cents a year ago, rising 0.9 per cent year on year to $211.6 million.

Investors who, for instance, want to ride the wave of data centres will have little choice but to seek exposure to the market through REITs. Because again, residential investors may lack the specialised knowledge to directly buy and manage other types of properties.

It’s NOT that REITs are safer now (or even), as they are equity assets with much higher volatility and risk then a condo unit, which enjoy a certain degree of price stability because of measures put in place by the government like Seller Stamp Duty and the Additional Buyer’s Stamp Duty (ABSD).

It’s just that, at this point in time, REITs appear to hold better value, are seen as potentially yielding greater returns, and involve a far, far lower capital outlay.

That being said, there are also many investors who still prefer physical properties over REITs, with good reason.

There are 5 key advantages that real properties have over REITs

  1. Potentially better returns
  2. Direct management
  3. Better leveraging
  4. Reassurance from direct ownership
  5. You can use real property as something other than a financial asset

1. Potentially better returns

Some investors believe they can still find good properties, even during a downturn (sometimes, especially during a downturn.)

These investors continue to trawl the residential markets, for properties with unrecognised value, or hidden fire sale opportunities. If they’re able to find any, their returns will probably be higher than what they get from investing in any REIT.

One assertion among these investors is that it’s easier to find an undervalued property than to find an undervalued REIT. Because REITs are monitored by so many investors, it’s highly improbable that a REIT will ever sell for cheaper than its actual value.

In fact, if you’re reading this, you’d probably have missed the boat for 90per cent of the rights trading out there on the SGX.

With individual houses however, value appears all the time in unexpected places. This is simply because there is no perfect availability of information for every home out there all at once, unlike REITs or stocks.

For example, buyers may miss the fact that a unit has a better view than others in the same block, or there’s a buyer wanting to sell but hasn’t listed.

REIT investors, on the other hand, can just assemble a trading terminal and fit everything they need to know on four LCD monitors.

Of course, the real estate investor still has to put in a lot of effort and footwork. They also needs to be experienced enough to identify properties or great value. A data-centric property portal like 99.co can help you here, as you can compare prices easily across different units and even districts in Singapore.

2. Direct management

There is a general divide between investors here. Some prefer the fact that REITs are managed by a full time professional, as they have no expertise in that REIT’s particular market. This may be the entire reason they invest in a REIT instead of directly in the property.

On the other hand, there are property investors who hate paying REIT managers (and you do pay them, their fees come out of your returns). Some investors see an inherent problem here, as REIT managers are effectively paid based on the number of properties managed.

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The higher the value of the REIT’s assets, the more the manager gets paid.

This can be problematic, such as if the REIT manager starts buying up properties for the sole purpose of charging higher fees instead of generating better returns for the investors. Suspicious investors point out that, if a REIT crashes and burns, the people running it won’t have to pay back a single cent of their fees and bonuses. Eagle Hospitality Trust is a recent cautionary tale for REIT investors.

Of course, not all REITs are run this way, and if they were no one would be investing in them right now. But it comes down to individual investor mindsets: if you’re okay with how REITs charge you, then this is a non-issue. But if you don’t trust managers/other landlords, then investing in physical property will set your mind at ease.

Direct management: one of the key factors why certain demographics choose property over REITs as investment assets.

3. Better leveraging

When you buy actual property, you’re able to borrow a lot of money at a rock-bottom interest rate. For the average Singaporean, buying a property is the only time we’re able to borrow more than a million dollars to invest.

Try asking your bank for a S$1 million loan at 1.6per cent interest to invest in REITs or other stocks—they’ll probably kick you out before even offering the free mineral water.

Read this: Loan-to-value (LTV) limit: a Quick Guide for Property Buyers

4. Reassurance from direct ownership

Singapore has very low corruption rates, but REITs still require a higher level of trust than owning the actual property.

Embezzlement, fake assets, kickbacks from developers, creative accounting… all the white-collar crimes that can suddenly bring down a company can also happen to a REIT. And when that happens, investors are usually lucky to get back even a fraction of their money.

Again, the recent case of Eagle Hospitality Trust comes to mind.

When you buy the actual property, you’re in full control. You have the actual title deed, you know all about the relevant debts, and you have a physical structure that you can claim to own.

Some investors prefer property investment for precisely this reason, and REITs doesn’t appeal to them one bit.

5. You can use real property as something other than a financial asset

This is not really an investment factor, but we include it just because many property investors raise this point.

When you own a house, you can use it for purposes other than money. You can choose to forego a few years of rent, to let your newly married child raise a family in it. You can choose to use it a vacation home for a long sabbatical (if it’s overseas), or you can choose to move into it and rent out your current home instead.

On the other hand, until you choose to sell it, REITs are just numbers on screens. Catch the drift?

What if the market is bearish? Are REITs a safer option?

There are a variety of REITs, most of which specialise in different types of property. In the context of this article, we refer to residential REITs. Local examples are Ascott Residence Trust and Saizen REIT.

As such, REITs are an alternative way to be a landlord. Investors who buy units in REITs will reap returns from rising rental rates, or when the REIT sells assets at a profit. This has led to some investors wondering if – perhaps instead of the hassle of getting another property – they should consider REITs instead.

However, this may be an “apples and oranges” comparison, given how different the two truly are. While they are both tied to the same market, they do not provide the same degree of risk and return for investors.

REITs vs Property: Pros & cons

The are six main differences between buying a REIT, and buying another property. These are:

  • The psychological impact
  • Initial capital
  • Diversification and risk
  • Time and effort committed
  • Tax issues
  • More leverage

1. Psychological impact

It has been said that personal finance is 20 per cent maths, and 80 per cent psychology. This is most apparent when it comes to owning properties “on paper”, versus owning the actual house. All numbers aside, this is the deciding factor:

Are you happy putting your money into something intangible?

If you buy the actual property, you can see it and point to something you own. You can renovate it to try and raise its value, you decide who lives in it, and there are no hiding any facts from you (while most REITs are honest, you cannot assume the REIT’s property managers will be open about defects or maintenance issues.)

With a REIT, there is a diminished sense of ownership. Having the actual house can be psychologically more comforting and secure, especially for a long term investment of over 15 or 20 years.

2. Initial capital

There’s no denying that REITs win this category hands down. At the time of writing (May 2016), one unit of Ascott Residence Trust is S$1.14. In fact, REITs are the go-to investment for many people who want exposure to the property market, but do not have the capital to buy an actual house.

Some investors may also be nervous about the prospect of using loans – this is especially true for property loans, with their large quantum and long loan tenures. REITs provide access to property markets while sidestepping the need for that.

3. Diversification and liquidity

A REIT does not invest in a single property. A REIT may invest in dozens of different properties, often in more than one country. This provides greater diversification for investors – even if one property does not do well, the performance of the others can make up for it.

When you buy a house for investment, you are dependent on that single house to attract tenants, and sell for a profit. If it fails to do either, your investment could turn into a liability. In the eyes of some investors, this makes REITs a less risky prospect.

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The other advantage of a REIT is that your assets are easier to liquidate. If you ever need cash in a hurry, it is not easy to sell your house to obtain it. Apart from getting a proper valuation, there has to be showings, negotiations with potential buyers, waiting for the buyers to settle their loans, etc.

For REITs, it is relatively easier to convert your assets into cold-hard cash. Since REITs are listed on the stock exchange, you have the freedom to trade a REIT throughout the trading day if you do not like the direction your REIT is heading.

(This is the reason we emphasise the need for holding power for property investors – houses are excellent long term property investments, if you have the finances to outlast property downturns.)

4. Time and effort committed

If you are renting out your property, you will have to commit a little more time and effort. This is because you have to handle maintenance or asset enhancement (e.g. Installing new air-conditioning, improving airflow by repositioning partitions, and so on.) You are also responsible for checking on the tenant, and ensuring rules are followed.

REITs have their own property managers, so you don’t need to deal with any of this. You just buy the REIT, and then sit back and wait for the dividends.

This is both a pro and a con. The upside is convenience. The downside is that you have little control, or understanding, of what’s really going on with the property. All you will see are the REIT’s dividends rising or falling, and you’ll have to take their word when the property manager(s) explains why.

Moreover, because REITs are traded on the stock market, it tends to be volatile. For example, if there are external shocks to the stock market which cause it to do badly, REITs may follow suit and perform poorly. even though the property market is largely unaffected.

5. Tax issues

It is often argued that there is no capital gains tax in Singapore, but there are taxes on property and rental income. Therefore, REITs are always cheaper. This view is somewhat imbalanced.

Tax deductibles for landlords are generous. In Singapore, you can claim the interest paid on a mortgage as a tax deductible. In addition, you can also claim tax deductions for maintenance costs, if they are used just for repairs and not to enhance the house.

It’s not time consuming to make these claims either – if keeping receipts is not your thing, there is a default 15 percent option. That is, a landlord can claim a flat tax deduction of mortgage interest, plus 15 percent of rental income.

It’s easy to overrate the impact of property taxes in the “REITs versus real house” argument. Don’t forget that Singapore is one of the lowest tax environments in the world.

6. More leverage

Singapore banks can provide a Loan-to-Value (LTV) ratio of 80 percent for properties. Of the remaining 20 percent, up to 15 percent can be paid using your CPF*. This means that, in terms of hard cash, it is possible to fork out just $40,000 to purchase an $800,000 condo.

(*Assuming you have no outstanding property loan already. In addition, banks may lower the LTV in the event of factors such as a high debt servicing ratio.)

This frees up a significant portion of your wealth to be invested elsewhere, while your house pays for itself through capital appreciation and/or rental income.

So what’s the solution? (Hint: Use both)

As most successful investors have learned, there doesn’t have to be an “either/or” solution of REITs versus property.

REITs can be a good investment early on, when you’re working to build up sufficient capital to buy a house. The low capital means you can start investing early. Given that most S-REITs have delivered returns of around five to six per cent per annum, this will grow your cash much faster than a fixed deposit.

ALSO READ: 3 REITs that are giving investors bigger angbaos this Ox Year

Actual property, with its potentially higher gains from rental income and resale, is better suited for longer term investments. As always, the more money and effort you put into something, the more you’ll get out of it.

As an aside, you may not want to have them both at once – it may be excessive to hold both REITs, and actual properties. They are both tied to the same market, so a downturn would affect both. For example, the rising interest rates on property loans have had a negative impact on both property prices, as well as the dividends and prices of REITs. Speak to a qualified wealth manager for more details.

This article was first published in 99.co.