Top REIT Investment Risks and How to Avoid Them
Singapore is one of the most expensive real estate markets in the world; hence, it can be difficult for young investors to invest in real estate. Here, REITs are the perfect alternative as they offer all the benefits of real estate investments at a fraction of the cost.
What are REITs?
Real Estate Investment Trust (REITs) are listed companies where you can invest your money. These companies pool the money from investors and use that money to buy, operate, and manage properties. In return, they provide great, stable dividends with yields of 5-8% a year. In a way, they make you a partial owner of various properties. This stability of returns and good profits has made REITs the ideal choice for new investors.
Most Common REIT Investment Risks
However, just like any other investment, REITs also have some risks attached to them. So if you are planning to invest in REITs, then you must consider these risks to avoid losses down the line. Here are some of the most common REIT investment risks.
Concentration risk refers to those REIT companies that only own a few properties from where most of their revenue is generated, with their Net Property Income tied exclusively to one or two key assets. This is one type of concentration. The second type of concentration is where the companies own and manage properties clustered in one location; this is called geographic concentration.
Such concentrations end up increasing the overall risk for you, as an investor, if the market faces a downturn or an event affects the properties, specifically the key asset. If the major assets or properties are damaged or affected by any events, be it political riots, natural disasters, or just an unfortunate market downturn, then they may end up causing a material negative impact on distribution per unit (DPU). This can, in turn, create a drop in the overall value of the unit as well as in yields.
The best way to avoid this risk entirely is by analyzing your prospective REIT’s portfolio thoroughly to see if they have any concentration with their assets. You should, instead, look for diversity in their property range, in terms of area, types of properties, and the number of them.
Just like the shares that you buy from SGX, even REIT units are subject to market conditions since they are also a type of publicly traded asset. Such conditions specifically include supply and demand of the units; so, there is always a risk that you might lose money in the long run if you invest in the wrong kind of REIT. Additionally, if the company reports operational losses due to any lack of demand, then there can be reductions in distribution money, which means low income for you.
Again, an excellent way to brace yourself against this type of risk is by working with a well established and reputable REIT. Some of them may not always give the most explosive returns, but with such stable companies, the risk is minimal as they know the market well and have safety measures in place in case things go wrong. To know for sure, you should analyze the portfolio of the REIT, and you must consider if the company has taken any risk mitigation measures in place.
Refinancing risk is another significant risk that you should look out for. This is usually related to the high levels of REIT gearings, and an average debt maturity that is short-weighted. That is, the short debt maturity makes the company likely to opt for refinancing within a short period. And since the Monetary Authority of Singapore (MAS) caps REIT gearing at 45%, the company has to work within the limit while refinancing its debt.
What this means for you is that if the REIT you choose goes into a new borrowing agreement to repay existing debt, or if it issues new bonds to balance out the mortgage, then the new refinancing terms may be less favorable and effective than the original terms. So, if the company is unable to pay the debt, it may have to sell some of its assets, and this can significantly affect the unit price and income distribution.
To avoid this risk, you must look for REITs whose gearing is self-capped lower than 35-37%, giving them enough buffer for leverage if the market faces a downturn. A REIT venturing too close to the MAS cap is a sign of potential trouble, and you should avoid them.
Lease Expiry Risk
One of the most overlooked risks when it comes to REIT investments is the lease expiry one. Sometimes, the REITs may hold lease properties, be it for a couple of decades or a century. Once their lease expires, they will have to return the property to the lessors. Here, if the REIT’s assets are nearing their lease expiration date, then it may affect the overall value of the REIT units for that company. This leads to a lack of supply, which turns away new investments, causing the company to incur some losses. This, in turn, can lead to a decline in the price of the units as well as dividend yields. To avoid this risk, the best option is to analyze the REIT thoroughly to see if any of their major assets are nearing the lease expiration date.
To conclude, investing in REITs in Singapore can be quite lucrative, but you must be aware of the risks that come with this type of investment. After long consideration, if the rewards outweigh the risks, then you should go ahead with your investment. You must only choose the best REITs in the market, and try to avoid as many risks as you can. Only by taking such steps can you enjoy the fruitful benefits of REIT investments like stable dividends and high yields.
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