Abstract: Share the benefits of investing in real estate investment trusts (REITs), including providing stable dividends and resisting inflation. It is especially important for investors who want to stably increase their cash flow, such as retirees or investors whose asset value is large enough to be financially free.
What is real estate investment trusts (REITs)?
Real estate investment trust, generally referred to as Reit. Basically, Reit is just like a traditional mutual fund, in which a certain amount of capital is pooled to invest in assets with stable income such as real estate. Principally, the purpose of investing in Reit is to be a landlord and collect rent regularly, but on the good side Reit can save a lot of troubles that traditional landlords always have to deal with, such as finding tenants, maintaining properties, urging tenants to pay rent, paying utility bills and government related taxes and fees. Of course, Reit will hire a professional team to provide related property management services. In addition, Reit can usually be bought and sold on the stock exchange so it can be easily invested in the same way as stocks. The liquidity of Reit is also very good. Therefore, investors do not have to deal with many complicated procedures in buying physical properties. This is certainly one of the benefits of investing in Reit.
Industry categories of Reits
The industry categories or asset classes of Reit has evolved from traditional shopping malls, offices, apartments, houses, hotels, etc., to logistics, storage, power supply facilities, wireless communication base station facilities, data centers, senior citizen nursing homes, hospitals, and even prisons. Of course, these newer Reit categories are mainly concentrated in the United States, while Hong Kong and Singapore Reit are still mainly concentrated in some traditional asset classes.
Reit vs stock
- Dividend payout:
- The general dividend distribution policy of a certain stock is determined by the company’s board of directors. The company is not necessary to distribute any of the earned money to shareholders. Even bank stocks that have a long history of dividend payout over many years are no exception. For example, HSBC‘s suspension of dividends last year is a good example.
- For Reit, most or even all of their net income after tax will be regularly distributed to investors in the form of dividends. According to the current regulations of the Securities & Futures Commission of Hong Kong, the dividend distribution ratio of Reits must be at least 90%. (Source: https://www.hkex.com.hk/Products/Securities/Real-Estate-Investment-Trusts?sc_lang=en)
- Investment restriction:
- One of the risks of investing in stocks is that along with the development of the company or any sudden changes in management, it may somehow lose its focus on their core business or the development, causing misuse or abuse of funds, and ultimately harming the interests of minority shareholders.
- For Reit, according to the regulations of the Securities & Futures Commission of Hong Kong, at least 75% of the total asset value of Reit must be invested in real estate projects that generate regular rental income at any time. (Source: https://www.sfc.hk/-/media/EN/assets/components/codes/files-current/web/codes/code-on-real-estate-investment-trusts/Code-on-Real-Estate-Investment-TrustsDec-2020-Eng.pdf)
- Loan restriction:
- Another major risk of investing in stocks is that companies sometimes over-leverage. Many companies continue to increase their loans significantly for mergers and acquisitions due to rapid expansion and aggressive development, which will eventually lead to large losses or even bankruptcy.
- For Reit, according to the regulations of the Securities & Futures Commission of Hong Kong, the total borrowings of Reit shall not exceed 50% of their total assets at any time (Source: https://www.sfc.hk/-/media/EN/assets/components/codes/files-current/web/codes/code-on-real-estate-investment-trusts/Code-on-Real-Estate-Investment-TrustsDec-2020-Eng.pdf).
From the above three points, we can see that Reit is more secured under the regulations. The risk of investing in Reits is thus greatly reduced in a certain extent when comparing to stock investment. Therefore, you may often hear that a certain listed company has bankrupted, but you rarely hear that a Reit is insolvent. Especially for retirees, their risk tolerance is limited, unlike young people who have time to earn it back even if they lose money. Overall, investing in Reit may help retirees or cashflow-needed investors effectively avoid interruptions of dividend receiving due to company management issues or government policies which can seriously undermine their cash flow planning and budgeting.
Reits vs bank stocks on dividend payout
The above graph compares the dividend per share of Link Reit (Hong Kong stock code: 823) and HSBC (Hong Kong stock code: 5) in the past 10 years. Last year, the British government prohibited banks from paying dividends due to the Covid-19. This is just one of the policy risks we mentioned before. Imagine in case a retiree needs dividends for living, this kind of policy risk really destroys his overall retirement plan. On the other hand, even ignoring the pandemic impact last year, let us look at the above graph for the years before 2019, we can also clearly see that HSBC’s dividend has stopped growing for many years while Link’s dividend has continued to rise. More importantly, government does not request Reits stop paying dividends because dividend payout is the cornerstone of the establishment of Reits. Other than that, Reit should always think about how to invest in projects that can generate dividends in accordance with the regulations in the use of funds. On the contrary, the development direction of companies such as HSBC will not focus specifically on increasing dividends, or in some cases not only do they change their long-term dividend payout policy, they may even harm the retirees’ investments by their management’s misjudgement on development strategies. For example, HSBC invested heavily in the United States in its early years, which caused huge losses during the 2008 financial crisis.
Reit vs bond
In terms of dividends, bonds are more stable and predictable than Reit, because when you buy a bond, its bond yield has been determined, and you will receive regular dividends until the maturity of the bond. Your annual returns will be fixed and unchanged during this period no matter how the market sentiment changes. For details, please refer to my previous article dedicated to bonds, “Main advantage of bond investing-stable cash flow“.
Why do we invest in Reit if bonds are so good? The answer is actually explained in the title of this article. Simply put, investing in Reit can achieve the purpose of resisting inflation. The reason is very simple. Buying Reit means that you buy a portion of a real estate, and the asset prices of these real estates normally rise along with inflation rate. For example, if you buy a shopping mall’s Reit, when the population grows or the average salary in this area increases, this usually stimulates consumption and increase of product prices. Then the sales of the shopping mall will increase as well. Hence, the shopping mall can increase the rent appropriately, that means the rise of the Reit’s rental income, so your distribution from this Reit will increase accordingly. On the other hand, the common valuation method of a Reit’s net asset value (NAV) is generally evaluated by the estimated total annual rental income of the property, and this NAV is usually used to estimate how much a Reit is worth. As an important reference, if the NAV of a certain Reit continues to rise year by year, its stock price will also rise in the long term.
Let us see an example. If you buy a bond which provides the yield-to-maturity of 6% per year, after a certain years, you will still receive the 6% annual return just as the first year, which will not increase over time as inflation. However, buying Reit is a different story. You have a chance that the dividend payout will increase with inflation year after year. For example, if you buy a Reit today which provides a 4.5% dividend yield. A few years later, the net asset value of the Reit you hold is very likely to rise along with inflation, even if you are still receiving 4.5% dividends by then, this is the 4.5% dividend yield after taking into account the inflation-adjusted Reit NAV. Of course, the amount should be higher than the original 4.5% yield in the first year. So you can see the strong advantage of Reit, no wonder why many people describe that Reit is somewhere between stocks and bonds, enabling you to earn both interests and price difference.
One more advantage of Reit over bond is that Reit has much better liquidity than bonds. You can buy and sell at any time, even if you rush to cash out from Reit you can easily and quickly do that. However, the liquidity of bonds is generally poorer, and the bid-ask spread is relatively larger. Generally speaking, bonds should be held until the maturity date for redemption. If you need to sell a bond before maturity, you probably have to suffer a small loss in order to successfully execute the sell order.
Rising inflationary pressures
In recent years, especially after the Covid-19 pandemic, governments are printing money unprecedentedly. In this background, asset prices will be pushed up. Therefore, many people choose to buy properties to hedge inflation. However, if you want to buy properties for the investment purpose, it is actually quite difficult to diversify the risks, because the price of a single property is already quite expensive, so it is difficult to buy more than one. Therefore, it is difficult to achieve the effect of diversification in terms of property types and locations. In this regard, investing in Reit can be an excellent solution of the aforementioned problems. Through Reits, investors can easily diversify their funds in different asset classes and countries or regions. In this way, investors can contain the risks by appropriate diversification and earn the long-term increase of asset prices with inflation.
My Reit portfolio
I am now managing the “Fixed income investment portfolio” for my retired family, in which I have allocated funds on Reits and bonds using the investment logics discussed in the article. If you are interested, you may have a look at it. The purpose of this portfolio is for gaining regular cash flow as well as resisting inflation for the capital.
Comments and sharing
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