Benefits
Portfolio diversification
REITs typically own multi-property portfolios with diversified tenant pools, which reduce the risks of reliance on a single property and tenant in the case of directly owning a real estate asset.
Income distribution
REITs normally have regular cash flows since in most cases, most of the revenues are derived from rental payments under contractually-binding lease agreements with specific periods.
Participation in the property market
Most REITs are structured around large properties. With REITs, you can own stakes in such properties.
Professional management
REITs allow investors the opportunity to buy into properties managed by professional property management companies.
Risks
Market risk
REITs are traded on the stock exchange and the prices are subject to demand and supply conditions, just like other stocks.
Investors could receive less than the original investment amount when they sell their units in a REIT. The prices generally reflect investors’ confidence in the economy, the property market and its returns, the REIT management, interest rates, and many other factors.
Like other stocks, investors must be able to tolerate such price movements.
Income risk
Dividends may not be paid if a REIT reports an operating loss. This may occur if tenant occupancy levels fall drastically or if tenancy agreements are renewed at much lower rental rates than the previous agreement or the occupancy rate could fall.
You should consider whether the REIT has taken any measures such as procuring payment upfront or contractual lock-ins of rental rates and other clauses in tenancy agreements.
Further, if the underlying properties are financed by debt, refinancing risks may arise from increasing interest rates which may potentially reduce distributions to unit holders.
Concentration risk
If a substantial portion of the value of a REIT’s assets is derived from one or a few properties, you may be exposed to a greater risk of loss if something untoward should happen to one of these properties. Similarly, if a REIT depends on only a few tenants for its lease income, you are exposed to a greater risk of these tenants not being able to fulfil their lease obligations.
Liquidity risk
Although investors are able to exit their investments easily by selling it on the exchange, the real estate fund itself may be relatively less liquid compared to funds investing in financial securities such as stocks and bonds. This is because it is difficult to quickly find buyers and sellers for property, especially if the value of the property is high. As a result, it may be difficult for REITs to vary their investment portfolio or sell its assets on short notice should there be adverse economic conditions.
Leverage risk
When a REIT uses debt to finance the acquisition of underlying properties, there is leverage risk. As is the case with other listed companies, in the event of an insolvency of the REIT, the assets of the REIT will be used to pay off creditors first. Any remaining value will then be distributed to unit holders.
Refinancing risk
As REITs distribute a large amount of their income to unit holders, they may not have the ability to build up cash reserves to repay loans as they fall due. Thus they will typically seek financing by entering into new borrowing agreements, or other capitalisation measures such as rights or bond issues. One potential risk is higher refinancing cost when loans are due for renewal. Another risk is that a REIT which is unable to secure refinancing may be required to sell off some properties if they are mortgaged under the loan. These risks could affect the unit price and income distribution of a REIT.
Selected information was taken from www.sgx.com and www.moneysense.gov.sg.
