Are REITS overvalued? Should we still invest in them in 2018?
REITS have had their time in the sun in 2017. Mirroring the recovery and performance of STI index during the year, Singapore REITS (S-REITs) had outstanding capital gains on the back of solid and stable semi-annual and quarterly distributions.
As of 17 October 2017, based on data compiled by the Singapore Exchange (SGX), S-REITs delivered 21.2% total returns YTD, with 15.5% coming from price gains while the remaining 5.7% contributed by dividend distributions. Unitholders in S-REITS would have seen their portfolio swell for the year 2017.
Average yield for all REITS combined currently stands at 6.43%, which is still quite a significant margin over property rental yields, fixed deposit rates, and CPF interest rates. With Singapore posting record 5.2% GDP growth in Q3 2017, REITS would stand to benefit on potential higher rental reversions which may back its stable DPU.
The Big Question
The big question is whether REITS are overvalued and whether they would still be an attractive buy in 2018.
With interest rate hikes looming, investors are rightly concerned that borrowing costs and interest expenses for REITs’ financing arrangements would increase, hence lowering cash available for acquisitions and future growth. Cash flows available for distributions may also be impacted.
While most S-REITs have performed well in the year, the key lies in identifying the REITs that are still worthwhile investments at this time.
So how can investors tell which REITs buy? Take note of the following.
Look at the gearing ratio
In this case, it would be helpful to look at the gearing ratio for S-REITS as part of an investor’s overall analysis when making the call to purchase a REIT. REITS with a lower gearing ratio may be less impacted by the rising interest rate environment.
The median gearing ratio for S-REITS stands at 34%, with variations among the listed REITS. Examples REITS with lower than average gearing ratio would be SPH REIT at 25%, BHG Retail REIT at 27.5% and EC World REIT at 26.9%. With a strong economy, REIT management may be able to negotiate higher rental rates to offset the higher interest cost.
Look at price performance
Not all REITS experienced similar price gains for 2017, so investors could look at lagging REITS in terms of price performance such as OUE Commercial REIT and investigate the reasons for underperformance.
Investor could also turn to REITS with buildings located in other countries such as Europe, Australia and Japan. The economies of the respective countries may experience different growth rates and may outperform or underperform Singapore’s economy. Investors do not have to restrict their portfolio to REITS having a pure Singapore property profile. Among them includes IREIT Global, the newly listed Keppel-KBS US REIT and Cromwell European REIT. Investors may rotate their capital from outstanding REITS into lagging REITS.
Is it time to take profit on your REIT investment?
With such huge gains in 2017, investors may be looking to take profits in 2018.
REITS should be treated as an income yielding instrument where investors take a long term position, preferably more than 5 years. What’s more, Singapore REITS are some of the best managed REITs in the world, offering decent yields above 6%, trumping yield offered by private residential investments for retail investors.
A sound strategy would be practicing dollar cost averaging should prices fall. Investors wishing to be more defensive could also reinvest the distribution proceeds and refrain from topping up additional capital to purchase additional REIT units on the market.
Investors should have the mindset of holding REIT units for the long term, even as property prices and rental trend upwards, as a hedge against any serious financial turmoil.
Investing in a REIT has many similarities compared to direct real estate investment, but without much of the tenant management technicalities. In fact, REITS are still a growing sector in Singapore and would remain a vital asset class for income seeking investors for quite some time.
In this respect, REITs would continue to be a viable investable asset class in 2018. That said, investors should adopt a capital preservation strategy, while remaining cautious on leveraging share margin financing to boost short term returns on their REIT investments.
Want to learn more about Singapore REITs Investment?
Read also: How do interest rates affect REITs anyway?