Dangers of investing in REITs for passive retirement income in a volatile market

REITs, Dividend income, Investment, Investment Strategy, Investment mistakes2022-09-22

If you are investing for dividend income, chances are, you might have heard or dabbled in Real Estate Investment Trusts (REITs), such as Singapore Real Estate Investment Trusts (S-REITs) which generally have a good reputation among investors.

It offers an opportunity to tap into the nation’s robust real estate market without having to buy multiple properties. Plus generally, you don’t need to pay income taxes from the dividend income earned from REITs (which you need to do so on the rental income you earn if you own physical properties).

On top of that, S-REITs offer a wide diversity of exposures across multiple segments such as office, hospitality, data centres and many more.

But benefiting from hassle-free investment exposure to real estate comes with a fair price.

Can you really depend on REITs for your retirement income?

Below are the dangers you need to watch out for in REIT investments. You would need to manage them well if you are serious about getting stable income from REITs.

At The Money Folks, we help our clients invest and build multiple income streams that potentially enable them to retire with more than $1 million. Reach out to us for a financial assessment call (by application approval only).

Disclaimer: This post represents our personal views and opinions and is neither associated with any organisation nor reflect the position of any organisation. This content is also only for informative purposes and should not be construed as financial advice. Past performance does not necessarily equate to future performance. Please seek advice from a Financial Adviser Representative before making any investment decisions.

Can REITs still provide good dividend income in a high-interest rate environment?

It is common practice for REITs to finance their properties through bank loans and other sources of funding. The interest paid for any form of financing will be considered as part of the REIT’s cost of debt.

Like our mortgage loans, the rise in interest rates will consequently increase REITs’ costs of debt.

For illustration purposes only.

How will the rise in the cost of debt affect investors?

With the higher cost of debt, REITs’ (and subsequently, investors’) profit margins will be lower.

To remain attractive to investors, REITs need to earn more to offer higher dividend yields and provide the desired distributable income.

Does your selected REIT have the potential of earning more in this economy?

As an investor, it is important to monitor the REITs’ cost of debt as a risk indicator in a high-interest rate environment. Where possible, opt for REITs that take on loans with fixed interest rates instead of floating interest rates.

You will need to also understand their gearing ratio – which shows how dependent the REIT is on its leverage. The higher the ratio, the higher its dependency on loans.

In Singapore, the MAS regulation calls for REITs’ total debts to be limited to up to 50% of their total assets.

For illustration purposes only.

If you are keen to build passive income that is resilient during economic changes, feel free to reach out to us. We use a recession-resilient investment framework to help our clients invest and build multiple income streams.

Simply fill up this simple financial assessment so we can provide you with our insights and potentially help you reach your financial goals.

Dilution of shares might lead to a price drop

Like all other businesses, REITs need to raise funds.

There might be a problem if an S-REIT wants to raise more capital but already reached its gearing limit.

They might resort to raising equities. Since REITs are entitled to carry out active fundraising exercises, two consequences might arise:

  • You might be given the option to buy more shares (thus fork out more money) of the REIT to retain your desired percentage of shares. This is called a Rights Issue where existing shareholders are given the right to subscribe to issued shares in proportion to their current holdings.
  • Next, would be a private placement exercise. This is a method where issued shares are offered to accredited investors, institutional investors or mutual funds. Retail investors would not participate in such an exercise.
  • This is quite a common practice amongst REITs. For example, Ascott Residence Trust carried out a private placement in August 2022 to raise $150 million offered to eligible investors.

These are possible scenarios, such as, if you don’t take up your rights, that would dilute your percentage of shares in any REITs.

Below is an illustration of the dilution of shares.

For illustration purposes only.

And dilution of shares could potentially impact your returns, as with a lower percentage of shares owned, the lower your expected payouts will be.

For example, if the total payout of the REIT is equivalent to $100,000, and you own 3% of the shares, you would potentially receive $3,000. However, if subsequently there is a Rights Issue but you choose not to take up your rights to retain your desired percentage of shares, this means the percentage of shares you own will be less than before. Hence, you would likely receive lower payouts.

And if this happens, frustrated investors might start selling off their shares.

This could eventually result cause the REIT’s share price to drop.

But if you are still getting consistent dividend income from your REITs investment, will the drop in share price affect you?

Well, there may come a time when you might need to liquidate your investment.

If your stock prices dip, you might potentially experience losses.

That is why it is important for you to understand the type of REITs you are investing in and whether they have a strong potential for capital growth in the long run.

You might choose the wrong REIT!

There are a lot of factors involved when investing in REITs.

And any factor (or a combination of a few) could be the wildcard in making a REIT a sustainably profitable one.

Do the properties under the REIT have a good strategic location?

What sector are they in?

These are some of the various types of REITs:

For illustration purposes only.

What economical risks are these sectors exposed to?

For example, during the pandemic, hospitality and retail REITs were very badly hit due to limitations of social interactions.

Even the healthcare segment can be affected as well. Especially for healthcare businesses that have a significant source of income from foreign patients.

Besides that, REITs can also be influenced by a change of lifestyle. As the pandemic influenced the adoption of hybrid arrangements for businesses, staff were not always required to be in the office which led to some businesses scaling down on office space.

This would potentially affect the commercial segment of REITs too.

It just goes to show that there are many influences on properties that contribute to their success or failure.

It is not easy to truly understand the properties or holdings of any particular REIT as there are so many factors involved. Hence, how easy would it be for you to truly assess and understand the risks involved in investing in a particular REIT?

This is why even for relatively stable assets like REITs, it is important to not put all your eggs in one basket. Diversification is key in minimising your risks.

If you are unsure how to do so, do reach out to us and we are more than happy to share our professional advice.

REITs are only a slice of the dividend income pie

There are many other income-generating assets like bonds, dividend stocks, annuities and many more.

What’s most important is a strategy to invest in and optimise these various assets in your portfolio so you can potentially reach your desired financial goal.

This is the framework our team uses to generate multiple streams of passive income for our clients:

In this perspective, alongside other assets, REITs can be a good complement to your portfolio.

If you want to have a personalised income-generating portfolio, we specialise in managing and growing your wealth for you.

Many in our team are recognised as the top 5% of financial advisor representatives worldwide, and our clients are on track to potentially achieve their retirement goals 10-15 years earlier than planned.

Preserve wealth in volatile market fr. $20/day

At The Money Folks, we help our clients invest and build multiple income streams - potentially enabling them to achieve early financial independence. This is done using our recession-resilient investment framework.

The information in this article is meant for general information purposes only and does not constitute financial advice. Please consult your Financial Adviser Representative before making any investment decisions. Investments have risks. Past performance is not necessarily indicative of the future or likely performance of an investment.

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