What is REITs and Can I Live on REITs Dividend?

As investors, we are always looking for opportunities to expand our investment portfolio and REIT does just that. It exposes us, investors to real estate properties without having to experience the high levels of risks that come with direct ownership.

As you might know, direct ownership requires various upfront and ongoing resources from an investor, such as the large sum of capital for a down payment, insurance fees, maintenance fees, etc. in which for many, we do have the means to own and manage multiple properties simultaneously.

REITs generally hold a portfolio of real estate assets, providing shareholders (investors) with inherent diversification across the real estate industry. In return, it reduces the risk of any single investment and improves the portfolio’s total risk-adjusted potential. REITs are also suitable as long-term investments where returns are highly reliant on dividends and capital appreciation.

In Malaysia, REIT first began as a “property trust” with its first listing in 1989 by Amanah Harta Tanah PNB 2 and the Arab Malaysia First Property Trust (AMFPT). However, it never took off in the Malaysian market until its rebranding in 2005 to “REIT” together with the introduction of a guideline by the Malaysian Securities Commission (SC) to provide a legal framework for better monitoring of REITs.

With the re-branding, Malaysian REITs grew with an average growth rate of 34% per annum in market capitalisation from less than RM 500mil in 2005 to RM 40bil in 2020 (TheStar, 2021). Now, there are 17 listed Malaysian REITs that owns and manages 10% of retail mall space and 5% of office space in Malaysia.

What is REIT?

Generally, REIT is a company that owns, finance, and operates various income-generating real estate properties in which 90% of the income generated will be paid out to the shareholders (also known as unitholders) in the form of dividends.

This is very much similar to a mutual fund whereby when you invest in REIT, you are contributing to a pool of investment funds which is then used to invest in various real estate ventures such as commercial buildings, office buildings, warehouses, residential complexes, hospitals, etc.

A little bit of fun fact, Real Estate Investment Trust (REITs) was first introduced in the 1960s by the US Congress with the intention of providing the public with the opportunity to invest in large income-producing commercial real estate without going through the hassles that come with owning the properties.

Since the establishment of REIT, many retail investors have benefited from commercial real estate investing, which was previously only privy to groups of wealthy individuals and large financial intermediaries.

How does REIT operate?

REITs rely on external fundings as an important source of capital to invest and operate various real estate assets. Hence, REITs are required by law to distribute 90% of their taxable income to unitholders.

Generally, REITs uses the investment funds contributed by unitholders to purchase, develop, and manage a pool of real estate properties. These properties are then sold or leased out to tenants to generate income which is then directly distributed to the unitholders on a quarterly basis.

Dividends are paid directly to the unitholder in accordance with their contribution to the pool. However, do note that most REITs have various fees covering the trustees, property managers and fund managers which will be deducted from the profits before any distributions are made. Furthermore, REITs that own foreign properties may also be subjected to taxation by the relevant jurisdictions and may result in a further deduction.

What are the requisites of REIT?

When the US congress started REIT, it was designed to be similar to a mutual fund. Although many years have passed since the first REIT was created, the system and ideology behind it are still the same. Nevertheless, all legitimate REITs must abide by these requirements,

1. Have a longterm outlook;
2. Have a min. of 100 unitholders (investors) where none of them can hold more 50% of the shares;
3. Invest at least 75% of their asset in real estate;
4. Obtain 75% of its gross income from the real estate investments;
5. Must pay out dividends to unitholders which are equivalent to at least 90% of their taxable income (REITs are not allowed to retain earnings);
6. Must be managed by a Board of Directors or Trustees.

How many types of REITs are there?

Generally, REIT investing will fall into one of the 3 categories: Equity REITs, Mortgage REITs (mREITs) and hybrid REITs. The 3 different categories of REITs are identified based on the financial structures of their underlying holdings.

Equity REIT

Equity REITs owns, develops and manages income-producing real estate assets. The income is generated from rents, mainly through the leasing of properties, which are then distributed as dividends to the unitholders. In some cases, equity REITs do generate income through the sales of properties.

For equity REITs, the typical investment strategy depends on the amount of capitalisation and physical labour necessary to improve the property’s value and rental yield. Typically, if the property can be purchased at a lower price, fixed up with reasonable labour cost, the expected return on the investment will be higher. In contrast, there are some equity REITS that only acquire properties that are fully occupied and is a stable income-producing asset. In such cases, there is less hands-on work and capital needed to get the business running.

Mortgage REIT

Mortgage REIT (also known as mREIT) provides financing for income-generating real estate. This is typically done by providing mortgages to real estate owners or purchase existing mortgage-backed securities. The main source of income is from the interest charged on these mortgages .

In other words, mREITs provide mortgage loans to real estate investors and collects an interest on the capital provided. The margin between the interest earned on mortgage loans and the cost of funding is the income generated.

Hybrid REIT

Hybrid REIT is a mixture of both equity and mortgage investments in which it owns properties and at the same time, also extends mortgage loans to real estate investors. Thus, hybrid REITs earn their income from both rent and interest.

Are REITs typically publicly traded?

In reality, not all REIT is available to the public and can be traded through the stock market. REITs that are registered with the SEC and are traded on the stock market are known as Publicly Traded REITs. In contrast, Private REITs are not registered with the SEC and is not traded on the stock exchange.

Investing in a private REIT can be highly risky when information is not readily available for audit. Hence, it is important for you to do your own homework before investing in any REITs.

Public Traded REITS

Public traded REITs are registered with the US Securities and Exchange Commission (SEC) and are listed on the national securities exchange/public stock exchange, where they are bought and sold by individual investors.

Public traded REITs are required by SEC regulations to report on their financials and portfolio, providing transparency to the investors. At the same time, investors should take advantage of the no minimum holding period for the highly liquid public traded REITs.

One particular downside to public traded REITs is that their performance is highly related to the public market. Hence, public traded REIT’ share prices are susceptible to the rise and fall of the stock market. With this, a public traded REIT offers little in regards to diversification that is beyond the standard public market assets.

Public Non-traded REITs

Public non-traded REITs are registered with the SEC but not listed on a public stock exchange. While they still provide considerable transparency such as public reporting, public non-traded REITs are less liquid as compared to public traded REITs because it is not conveniently available to investors.

Because public non-traded REITs are not publicly available, their performance is not affected by the market performance and is fairly stable during market fluctuations.

To invest in public non-traded REITs, you will need to purchase shares through a broker or financial advisor who participates in non-traded REITs trading.

Private REITs

Private REITs are not registered with the SEC and are also not listed on any exchange for trading. Hence, private REITs typically only offered to institutional investors and is not commonly available for the public.

Private REITs are not required to provide any public on their financial statements and portfolio, allowing for potential investor abuse. Because of this, the risk of investing in private REITs are much higher.

Private REITs are generally favored by institutional investors because of the high dividend yield and low compliance cost, making it a highly profitable return.

What types of properties does REIT invest in?

REIT invests in a wide range of commercial real estate properties, typically offices, retail buildings, tourism facilities, medical facilities and industrial buildings. While most REITs will focus their investment in a particular niche, some REITs will choose to divest into multiple types of properties.

• Retail REITs – Retail units and independent retail blocks
• Commercial REITs – Office buildings and shopping complexes
• Hospitality REITs – Hotels, motels and apartment buildings
• Healthcare REITs – Hospitals, medical facilities and nursing homes
• Industrial REITs – Data centers, warehouses, logistics facilities and self-storage facilities

What are the benefits and risks to REITs investing?

REITs are good investment vehicle to consider, especially when you wish you diversify your investment portfolio. However, it is always best to understand the benefits and risk in REITs investing before you decide to dive into them.

Benefits of investing in Public Traded REITs

1. Low minimum investment.
   With a small capital, you are able to purchase REIT shares and partake in the investment of a wide variety of properties. Every quarter, the income earned on these properties are returned to you in the form of dividend. In some cases, when the property appreciates in value and is sold for a profit, you are also entitled to a portion those profits.
2. High liquidity.
   Since public traded REITs are traded in the national securities exchange, it is fairly easy to sell off your shares and get your money back in a short amount of time. In contrast to traditional real estate ownership, it is not easy to liquidate your properties in a short time.
3. Passive Investment.
   In REITs investing, the real estate assets are managed by REIT managers and professional property managers. Hence, all you need to do is sit back and relax, unlike traditional real estate ownership.
4. Diversification.
   REIT generally owns multiple properties that varies from the type, location and industry. So, instead of concentrating your investment into a single rental property, you are diversifying your investments into numerous properties by investing in REITs.
5. Consistent, recurring high yield dividends.
   This is possible thanks to a few tax advantages. First, REITs are not required to pay stamp duty on a property’s purchasing price. They are also exempted from paying property gain tax when they sell off the asset. Lastly, REITs are given a special corporate tax exemption if they choose to give out 90% of their income as dividends to the unitholders.
6. Attractive risk-adjusted returns.
   REITs carry a relatively low risk profile as compared to normal stocks since they are bound to the rules and regulations that protects the interest of small shareholders. These rules are set in place to ensure the capital preservation and a consistent return on investment.

Disadvantages of REITs

1. Low growth, limited capital gains.
   Due to the governing rules, many REITs find it difficult to grow their portfolio over time. The minimum 90% payout which allows unitholders to higher dividends have left REIT company with little money to grow.
2. Subjected to real estate related risks such as interest rate, oversupply, economic, tenant risks, etc.
   For example, if interest rates on mortgage loans increases, the cost to operate will increase and in turn, reduces profitability. On the other hand, REITs return may be badly hammered when there is an oversupply of commercial properties. Taking COVID-19 pandemic as an example, we saw many businesses wind up due to the extended locked down. This forces tenants to terminate on their lease, leaving REITs in a difficult position with their investments.
3. Potential for high management and transaction fees.
   Some REITs charge high transaction and administrative fees. As a result, this reduces the final divided payout to investors.
4. Minimal control.
   As an investor, you are not in control of any operational decisions as well as the strategies applied to market trading.

How much money do I need to invest in REITs to sustain an average lifestyle?

As mentioned, REITs are long-term investment vehicle whereby you cannot expect an immediate return of investment. It is basically a passive way to invest in real estate if you are looking to get a steady income for retirement. Simply, REITs do not offer explosive returns to make you a millionaire.

Looking at the statistics, according to the National Association of Real Estate Investment Trusts (Nareit) 2020, REITs have been reported to outperform the S&P 500 over the past decades and has an average dividend yield of 4.33% as of June 2020, which is double the average dividend yield of stocks (1.83%) in the S&P 500.

However, for Malaysian REITs, the average dividend yield varies between 1% to 12%. General, you would expect a dividend yield of 4%-7%. So, assuming that you are investing in Malaysian REITs such as the Atrium REIT, you can expect an annualized dividend yield of 6.21%.

With the statistics we have in hand, let us do a reverse calculation to determine how much money do we need invested to live a regular life in Malaysia,

• Monthly expenses needed to survive: $4,000
• Yearly expenses needed to survive: $48,000
• Assumed annualized return over a 10-year period: 6.21%
• Required capital invested in REITs: $772,946.86

From the reverse calculation above, we know that $772,946.86 is the needed capital invested in RETIs in order to live a regular life in Malaysia. You should also take note that this calculation does not take into consideration room for compounding effect.

Like any other investment performance, I must warn you that past performance is not reflective of future performance. If you are looking to invest in REITs with extended returns, you may want to think twice on the risk factor. Since REITs is affected by the overall market performance, it is really difficult to predict the future performance.

Therefore, it is my advice that you do not go “all in” into REITs and expect them to outperform all other asset classes.

What should I consider when investing in REITs?

1. Type of Industry

Mentioned previously, REITs are categorised into various industries such as hospitality, healthcare, retail, commercial, and industrial. Each of these sectors has its own characteristics which will ultimately affect the growth, risk profile, and performance of REITs.

For instance, during recessions, businesses may face bankruptcy, the demand tumbles and office rents fall. The economic cycle will greatly affect the performance of office REITs. On the other hand, retail REITs are able to maintain their profit as shopping malls are still packed with customers even in times of recessions. Hence, the high demand for retail spaces enables retail REITs to generate income as usual.

2. Dividend Yield

Dividend yield is the financial ratio that measures the quantum of cash dividends paid out to shareholders relative to the market value per share. While, we typically enjoy a good REIT that pays out a high dividend yield, it is to consider a REIT’s dividend track record. For example, is the dividend yield of a REIT stable? Does the dividend yield fluctuate from year to year?

In such situations, it is best to consider REITs that grow steadily. At the same time, a higher dividend yield does not mean it is a better investment since you would also have to look at the type of industry the REIT invests in. Office REITs may have higher dividend yields but can be less resilient towards economy crisis.

In addition, distribution yield will also change when the share prices change. Thus, you should be cautious of REITs that have unreasonable high distribution yields as they might be traps (a.k.a. value traps) that are intended to lure in ill-advised investors.

3. Property Yield

Property yield is the total annual rental income of the rental properties and dividing it with the properties’ total value. In short, it is the amount of income a REIT is able to generate from the properties they own.

When it comes to investing in REITs, it is important to observe the property yield of a REIT over a period of time. A stable or rising property yield tends to indicate that it is a well-managed REIT. It also assures investors that there is a demand for the assets managed by the REIT whereby if a tenant has decided to terminate their lease, the REIT will have less of an issue in finding another tenant to fill up the vacancy.

4. Gearing Ratio

Gearing ratio refers to a REIT’s debt over its total assets in which the higher the ratio, the greater the debt. Generally, a more conservative REIT will have a lower gearing ratio. REITs with a high gearing ratio do not mean that the REIT is a poor investment. It simply means that the REIT is willing to take on more risks and debts for growth.

Nonetheless, if you want to be on the safe side, then you can choose to invest in REITs that have a gearing ratio of less than 40%. This is to ensure that the REIT is able to withstand the borrowings and can pay off the debts slowly. With this said, if a REIT could not earn enough profits to pay off its debt interest, the gearing ratio will increase at an alarming rate.

#5 Price-to-Book (P/B) Ratio

P/B ratio measures a REIT’s share price against its net asset value (NAV) per share. Theoretically, if the P/B ratio is above 1, it means that the REIT is overvalued while a ratio below 1 means the opposite. Hence, to have a fair valuation, the REIT should have a P/B ratio of 1.

As investors, you might want to consider REITs that have a P/B ratio of less than 1 since it indicates that you will be paying a share price that is lower than the REIT’s asset value. Nonetheless, it is still crucial for you to look at the other metrics as well instead of relying solely on the P/B ratio when making an investment decision.

What are the best performing REITs in Malaysia?

If you are looking to invest in Malaysian REITs, here are some of the better REITs registered locally with BURSA Malaysia.

Final Words

Through REITs, everyone have an equal opportunity of building their through the real estate industry. Nonetheless, just like any other investment vehicles, it is best to look at both the quantitative and qualitative sides of REIT before making an investment decision.

Hence, my advise to you is to always do your own due diligence and develop a personal system to analyse investment opportunities.

On a side note, comprehending financial reports may be confusing especially if you are a new investor, nonetheless, it is a skill that is worth learning.

Until then, take care.