Real Estate Investment Trust, a.k.a. REIT, is a popular income-generating investment nowadays. It is also one of the 5 core Income Generating Assets that I recommend for retirement planning. But the risks of investing in REITs are not well understood.

In the course of my work, I realize many people have these common misconceptions:

• I don’t want to take the risk of investing in stocks, I will just buy REITs
• REITs are safe
• It is ok even if the REIT price drops, I can still collect dividends
• The lower a REIT’s price is, the better, so my dividend yield is higher

Like most investment thesis online, these claims are half-true. Can you really rely on REITs for your retirement income?

REIT investing was not always a common topic. But people are buying REITs today as if it is a risk-free asset. It is understandable because Singaporeans value property investment and always consider owning a property a safety net.

However, most people have no idea what they are getting into. If you think because REITs are backed by physical properties and you have little downside risks, you can’t be more wrong.

REIT volatility affects your holding power in a down market

If you have invested for a while, you know that volatility reduces your ability to hold an investment for long term. Unlike Physical property, a REIT has a market price in every trading day. And these prices can make you very nervous sometimes.

If you refer to the chart below, you can see that during the 2008 Global Financial Crisis, Singapore’s REITs market (represented by FTSE ST Real Estate Investment Trusts Index), dropped 70%. Yes, you hear that correctly, it dropped that much. And till today, it has not fully recovered.

Even a moderate correction is probably hard to stomach. Singapore REITs dropped 19% in 2015 and 12% in 2017.

It is not that REITs, like any other stock investment, will not recover from a market downturn. The issue is that if you are not mentally or strategically prepared for such risk, you will likely suffer a great loss by selling at the right bottom.

Additional Reading: Why long-term investment is a bad investment strategy.

What are REITs

REITs are essentially a collective investment scheme. You can think about it as a group of investors pooling money together and invest in a portfolio of income-generating real estate assets such as:

• Shopping Center – Retail REITs
• Hotel – Hospitality REITs
• Factories – Industrial REITs
• Hospital – Healthcare REITs
• Office – Office REITs

The benefit of REIT investing is that with a small capital, you can enjoy the rental income as if you were the landlord of multi-million dollar commercial properties.

Unlikely investing in private properties, you don’t even have to collect rental or fix the light bulb for your tenants. REITs are managed by professionals, all you need to do is to buy the shares and wait to collect dividends.

The good news is that REITs in Singapore are well-regulated. The REIT manager cannot bully you just because you are a small-time investor. They also have to distribute at least 90% of the rental income to you as dividends.

If you just started, MoneySense has an introduction article about investing in REIT.

REITs are not new

Sometimes people talk about REITs as if it is a new discovery. REITs investing has a long history and what we are familiar with is just the tip of an iceberg.

The US had legislated REITs since the 1960s to give small investors access to income-producing real estate. The chart below shows that there are all sorts of REITs other than the one we see here in Singapore.

• Railroad REITs
• Racetracks REITs
• Movie theatres REITs
• Gas stations REITs
• Even prisons REITs

Singaporeans are over-relying on REITs for retirement income

The first REIT listed on the Singapore stock exchange was CapitaMall Trust in July 2002. But the industry was only flourished in the past decade. Singapore now has the most vibrant REITs market in Asia after Japan REITs (J REITs).

If you google, you will see more praise of Singapore REITs over Singapore stocks. You are told that

• Singapore REITs outperformed Straits Times Index
• Whenever the REIT’s share price drops, you should buy more
• You should dollar-cost-averaging the purchase of REITs to build a retirement portfolio

I reviewed many clients’ own stock holdings, many people have 80% of their holdings in REITs.

I am not saying REITs is no good, but the overwhelming worship of this asset class made me worried. You should not over-rely REITs for income, especially retirement income. I will explain to you why.

Additional Reading: Why investing STI ETF investing is not what it looks like.

The popularity of REITs is a product of Financial Repression

REITs investing is popular simply because it made money in the recent past. But we need to understand the reason before jumping in. It was in the backdrop of a decade of declining interest rate environment globally.

In the financial world, there is a term called “Financial Repression”. To put it simply, Financial Repression means the government’s policy forced the investor to take unnecessary risks by buying riskier investment to achieve the same return.

Finding low risked income was more challenging than ever. The chart below shows that before 2009, you can easily find 4% income from high-grade government or corporate bonds. But in the past 10 years, if you want any bonds with more than 4% interest, you have to buy high yield bond (a.k.a. junk bonds with higher risks).

Thanks to Uncle Sam’s unprecedented Quantitative Easing.

If you are someone who needs to invest for retirement income but is not comfortable to buy traditional stocks, you had no choice but to find alternative solutions.

At the same time, a lower interest rate reduces the cost of borrowing, which is in favour of fixed assets such as property investments. Real Estate Investment Trusts were the perfect instruments at the right time.

This is also the exact reason why Bitcoin had an eye-popping run last year, because the world was flooded with money but the financial market ran out of assets to buy.

But when you look forward to the future, the global macro environment has radically changed. The interest rate hike is inevitable (even though it may be delayed) and property valuations are at a historically high level. You need to start pondering how much of the runway for REITs is left.

I am not saying that REITs and property markets are at the verge of a crash. But the past stellar performance may not be repeated in the coming few years.

REITs face a double whammy in a downturn economy

If you own private property and paying mortgage loans, you can use other sources of income (such as your salary) to continue servicing the loan even if your property is vacant. But it is not so simple for REITs.

Since a REIT’s only source of income is rental and they have to pay at least 90% of their income to unitholders (some even pay 100%), it has a very little buffer in bad times (no emergency cash).

When the market is good, everything looks ok. But when the economy is bad, the rental income of REITs can be severely affected (will reduction of tourists cause loss of income for hospitality REITs? Of course). At the same time, a higher interest rate means higher expenses. It is a double whammy to a REIT.

When the rental income is not sufficient to cover the expenses and loan payment, REITs managers may have to do a few things which may be detrimental to you as a unitholder.

• Issue rights: dilute share price
• Issue new bond or perpetual securities: increase the debt
• Sell assets: potential at a distressed price

These phenomena are either already happening or will happen in the near future.

In Summary…

I was always puzzled by the fact that Singapore’s REITs were consistently paying an average 5% yield while the yield is only 3% in other developed REITs markets. I have asked many REITs gurus but none of them can give me a satisfying answer.

So my guess is that Singapore REITs with greater systematic risk and S-REITs have to compensate the investors with a higher return.

In a nutshell, REITs can perform very well in an environment with a super low-interest rate and flood of liquidities. But it will face great challenges when the situation is reversed.

REIT is an important component of your retirement portfolio but you should not over-rely on it just because it has performed well. You have many years to come in your retirement, but the return of REITs is cyclical and depends on the global macro environment.

If you read my book “FIRE Your Retirement”, you know that I advocate a safety-first Kueh Lapis income approach for your retirement. You can click here to find out more about how I help my clients manage their investment portfolios.

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