Debate rages over popular S-Reits
Endowus Insights

Debate rages over popular S-Reits

Updated
June 7, 2022
published
March 8, 2022
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S-REITs have been sold down in recent weeks, with many of them hitting their 52-week lows.

Such securities have been offloaded at such speed and magnitude that some brokerages now think investors have sold too much, and too quickly.

Let's explain why the headlines are flashing over this popular asset class in Singapore. We also unpack how you can gain exposure to them, and why you should not be limited to exposure to Reits in Singapore.

What are S-REITs?

S-REIT, which is the short form for Singapore Real Estate Investment Trust, is a Singapore-listed trust structure that holds real estate investments. This trust structure is managed by a professional REIT manager that is in charge of property and facilities management, lease management and acquisition of properties. 

S-REITs enjoy tax benefits from IRAS when they distribute at least 90% of their taxable income each year. As a result, S-REITs by default try to distribute 90%, if not all of their income as distributions. As most operating cash flow is paid out as distributions, this makes S-REITs an attractive way to build a high income portfolio. The average distribution yield of a S-REIT could range anything between 3% to 9% per annum.

Why do Singaporeans invest in S-REITs?

High distribution yield

The high distribution yield, as seen in the chart below, is the key reason that Singaporeans largely favour S-REITs. 

Studies show that retail investors in general prefer getting their investment returns through dividend over capital gains. One key reason is that receiving dividends from SGX-listed companies does not incur any transaction costs, compared with liquidating your capital gains from selling stocks through a brokerage. REITs make it cheaper for investors to generate cash flows from their investments, which is especially important for retirement income. 

iedge-sreit-index-comparison-st-reit-index

Preference for real estate investments

Real estate ownership is a huge part of Singaporean’s net worth. Data from SingStat Household Balance Sheet 3Q 2021 shows that 42% of assets owned in a household is in residential property assets. Property investments have worked well for earlier generations of Singaporeans, and it is natural for younger Singaporeans to want to invest in real estate as the country becomes more developed.

Familiarity bias

It is seemingly easier for new investors to understand the business model of REITs, as visiting a shopping mall or using healthcare services in a hospital are activities that are highly relatable. For Singaporeans who are risk-averse, investing in real estate where they can experience the operating performance of the REIT first hand is almost a no-brainer.

Many of these REITs are also operated by brands that many Singaporeans grew up with, such as CapitaLand, Fraser Property and Lendlease. This makes investing in these sponsors’ REITs less intimidating. It also helps that many S-REITs are listed and pay out dividends in Singapore dollars, which makes investing easier to manage.

Here are more examples of S-REITs you can buy.

What’s the current debate over S-REITs?

If S-REITs are so popular, why have some investors dumped them in recent times? 

That’s because S-REITs are sensitive to changes in interest rates. 

The US Federal Reserve has signalled that it will hike rates in 2022 to temper inflation amid a strong US labour market. Deciding how aggressively to raise rates is a high-wire act for central bankers: if overdone, the sharply higher financing costs — in the form of sharply higher interest rates — can undermine growth.

At the same time, central banks must also cool inflation where it can, so that purchasing power is still in relative control of ordinary consumers buying their daily essentials.

There are concerns that the Fed has been too late in reining in inflation; the ongoing Russia-Ukraine war has also meant more uncertainty in the number of rate hikes the Fed will undertake this year. 

Such volatility has scared off uneasy investors of S-REITs. Some fear that REITs will be caught off-guard by more expensive debt that they typically use to acquire properties from which they extract rental income. Higher debt would make their purchases less lucrative. Since property income is passed on to S-Reit investors via distributions, some S-REITs investors think that their distributions will be less appealing than before. 

Yet, brokerages such as DBS think that refinancing rates should be manageable. DBS has estimated that a 1% rate hike would only bring headline distribution yields down by at most 20 bps (0.2%) from the current 6% yield. To add, a 1% hike in interest costs only shows up in a Reit’s performance after 3 years. 

Investors also need to review if S-REITs have been prepared for higher interest costs. REITs may, for example, have most of their debt cost fixed at a certain interest rate. This eliminates the risk of them servicing debt priced on floating rates in a rising rate environment. 

Data from the Singapore Exchange showed that institutional investors have accumulated S$30.4 million in net inflows into the S-Reit sector from February 25, 2022 to March 3, 2022. Conversely, retail investors have cut their S-Reit exposure by a net S$42.6 million in the same period. 

Between Jan 1, 2022 and March 6, 2022, S-Reits underperformed the benchmark index. The sector lost 2% in that period, while the Straits Times Index gained 4.4% in total returns.

To be clear, Singapore has been an attractive listing location for REITs, and investors who think S-REITs are attractive now can buy them easily as they are traded on the Singapore Exchange.

But beyond the market volatility, there are broader limitations for investors to note.

Lack of Diversification 

It is critical for new investors to not just diversify across different properties, which they may be able to get through a REIT investment, but also to diversify across different asset classes, sectors and geographies.

Investors should consider investing in equities and fixed income, not just REITs to build a more balanced portfolio. Also, the S-REITs market, despite its strong growth, is significantly smaller than other markets. It would be prudent for investors to also invest in other real estate markets such as the US, Japan, and Australia.

size of sreit relative to other global reit markets

Distribution limitations 

Not all REITs investors are looking for immediate payouts. Many investors are working adults with a steady stream of income that can support their expenses. It can be inefficient to receive distributions that they do not have immediate use of. REITs investors can opt to receive their distributions in the form of REITs units, but such odd lots are harder to sell. 

REITs also distribute most of their income to investors, rather than investing the income in capital, technology or business acquisition. This curbs the opportunities that REITs can capitalise on to improve their bottom line in the future. They also may not be able to charge higher rental rates if the rental market is competitive.

Looking beyond S-REITs for better investment opportunities

Familiarity can breed complacency. S-REITs investors should be mindful of the risk involved with investing solely in the sector. With more diversified and fuss-free investment options, investors do not need to limit themselves to S-REITs to get passive income or real estate exposure. 

A portfolio of real estate unit trusts such as those from Endowus Global Real Estate Satellite Portfolio, with global exposure and distributions reinvested automatically might be the investment alternative that Singaporeans can consider. Endowus also offers its Income Portfolios, where investors get monthly passive income from funds paying out dividends.

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