Investing in REITs

When we invest in REITs we are looking for an instrument that provides high, consistent and growing dividend income. The REITs that we invested in must be able to generate sustainable and growing rental incomes from their rental properties business. Without a good rental properties business, the REITs could not distribute sustainable dividends to its shareholders.

Other than dividends income, the fluctuation in REITs share prices enables us to make capital gain. A well-managed and growing rental properties business, for REIT, will inevitably lead to higher dividends payouts and therefore higher share prices. More on reasons to invest in REITs.

The key to invest in REITs successfully is to know the sustainability and potential of their rental income, the management integrity and their intention and competency to improve and grow their rental properties.

A good REIT has

• Sustainable and improving rental incomes
• Good management with integrity in managing the Reit
• Good management with intention and competency to improve and grow the properties in the Reit

For sustainable rental income:

• The properties in the Reits must be well-located, well-managed and well-maintained
• The Reits must have assurance of future income without relying on mere few big tenants
  

For growing rental income:

• Location, location and location of the properties in the Reit
• The management is actively seeking to increase properties held in the Reits
• The management is actively seeking to increase value of the properties in the Reits

Translate the criteria into checklist:

Questions to answer when invest in REITs:
1. Does the Reit have a broad base tenants in diversified industries?
2. Does the Reit have quality tenants with rental contracts more than one year? An average 2.5 to 3 years contract length is good.
3. How is the conditions and the locations of the properties in the REIT?
4. Does the original issuer still hold at least 70% of the REIT? This question is the main reason why management would do good to the REIT. The bigger their stakes in REIT the bigger the incentive for the management to manage the Reit well.

REITs we must avoid are those with properties that dumped by the issuer. The issuer would hold very little stake in the REIT after disposing their unwanted properties into REIT for a good profit and to earn management fees, trustee fees, etc. from the REIT.

To learn more about investing in REIT, check out this guide.

Part 1: Understanding REITs in Malaysia
Part 2: Understanding REITs in Malaysia (2)
Part 3: Investing in REITs

Starhill Reit's IPO Prospectus

Check out today's New Straits Times. It comes with the prospectus of Starhill Reit's IPO. The offer was reported in Yahoo news and Forbes. You may find the book building/ subscribing schedule in YTL's corporate web site. The opening and closing date for retail investors are 22 November 2005 and 29 November 2005 respectively.

Malaysia's YTL Corp. Bhd. (4677.KU) will raise around MYR523.4 million from Starhill Reit. There is an old write up on the Starhill Reit in NST's property times. Forbes's up-to-date write up on Starhill Reit is more comprehensive.

Axis REIT

There were numerous reports on Axis REIT, mostly favourable.

I am not comfortable with Axis REITs because I don’t understand property market well enough. The properties held by Axis REITs are mainly office buildings and warehouses (in Petaling Jaya and Shah Alam) which could be sensitive to market trend. Axis REIT’s rental incomes may fluctuate due to changes in the landscape of property market and the continuation of few existing major tenants, i.e. DHL, etc.

Should I want to invest in Axis REIT I will need to read and understand more about property market trends, I need to know their relationship with the major tenants, I will need to know if any of the major tenants is leaving Malaysia for good, etc. Such information is a bit difficult to get.

However, I can sleep well buying a REIT that holds mainly shopping malls. I don’t need to understand property market or know its trend. I just need to shop at the shopping malls to know whether the REIT is doing well and continuing to do so.

We will just need to be patient and wait for the IPO of SunCity, YTL, Landmark and IGP's REITs.

Understanding REITs in Malaysia (2)

Why did the Property Trusts under the old guidelines not do well?

There were not many incentives given and little gearing was allowed. Quality of the assets, low yields (returns from investment), falling dividend per share, passive management, etc. all contributed to the lackluster performance of property trusts before the new SC's guidelines.

Why do companies with such good rental properties want to put their rental properties into REITs?

Because they can unlock their rental properties value. This means they can sell, for example, 30% of the ownership of the property to the public, foregoing future rental income, in exchange for instant upfront cash pile and still be in control of the properties.

What is the criteria of a good REIT?

It must have good quality assets and good quality management. You must buy it at a good price and the management should grow the rental properties and increase the rental income for you.

Good quality assets means well-managed rental properties at good locations, broad base tenants (without the fear of losing one or two big tenants), and therefore the rental incomes will grow or at least be maintained.

Good management will drive growth through acquisitions or the building of more rental properties to increase rental incomes.

We like REIT with rental properties like shopping malls. Office rental incomes are generally a bit more volatile and hotel business may be cyclical. So we like only REITs in which their main rental properties are red-hot shopping malls like Mid Valley and Jaya Jusco (if their owners are willing to put them into REIT). If the shopping malls deteriorate you will know when you shop. For investors without a good understanding of property markets, REITs with assets like shopping malls are the safer investments.

What makes the prices of REITs stocks fluctuate?
Beside normal fluctuations due to simple demand and supply, when the market expects the rental to go soft prices of REITs' prices will fall. When the market expects rental to go up, REITs stock prices will go up. In a way, a good grasp of property market knowledge will be helpful in investing in REITs.

Part 1: Understanding REITs in Malaysia
Part 2: Understanding REITs in Malaysia (2)
Part 3: Investing in REITs

Understanding REITs in Malaysia

The term REIT stands for Real Estate Investment Trust. It is a trust fund that holds/ invests in RENTAL properties. Its major incomes is rental income and it is required to distribute most of its profit as dividend to its holders.

REIT can be one of the very exciting instrument for the purpose of cumulating income generating assets. We like REIT though with some very strict conditions.

Early this year, Securities Commission issued guidelines on REIT. These are improved guidelines for property trust funds. The market was and is still fairly excited about the changes. The first REIT, Axis-REIT, was listed on Bursa Malaysia (KLSE) in August 2005. We are expecting REITs from YTL Group, Sunway City and probably Landmark, IGB (for Mid Valley city) and KLCC, though these are in the pipelines. We are hoping Jaya Jusco will soon jump into the band wagon too.

What is REIT?

This is the exact words from investopedia's article, "What are REITs?":
"REIT has two unique features: its primary business is managing groups of income-producing properties and it must distribute most of its profits as dividends."

Unlike unit trust, which is sold through agents or banks, REIT is traded in stock exchanges. So it gives investors returns through capital appreciation from price changes and dividends (just like any listed company's stock).

Why do we like REITs? What are the benefits of REITs?

REIT holds rental properties. So its main incomes are rental incomes. Such rental properties can be office buildings, shopping malls, lands, etc. Usually, REIT will pay out at least 90% of its taxable profit as dividends. This is either required by regulations or due to tax incentives.

Rental is usually a fairly consistent source of income. So you see, with at least 90% payout, the income stream invested in REIT is fairly consistent for investor.

This makes REITs high-yield stocks and extremely attractive as income-generating assets or assets(i).

As investors, we just need to invest a small amount to own part of the shopping mall, offices, lands, etc. through REITs. We can sell it anytime and easily through stock markets. The transaction cost to buy and sell REITs is low compared to normal properties. We can own a diversified portfolio of properties. These are the benefits that the usual property investments cannot provide.

Yes, stock prices of REITs fluctuate. However, as long as the rental properties are well managed, the rental markets are stable and the rental incomes are consistent, you can get consistent dividend incomes. And if you bought the REIT at a good price, it gives you consistent good ROI, regardless of fluctuations of stock prices.

Do you still remember the objective of financial planning? For FPM that is to accumulate income generating assets.

More on the explanation of REIT from Investopedia.

However, M-REIT is a bit different from the usual REIT...

M-REIT refers to REIT in Malaysia that is regulated under the above mentioned SC's guidelines.

In a way, Malaysians are non-conformists. We always want to be a bit different from the rest of the world to show that "kita boleh". :-)

These are the salient features of M-REIT:

1. Investors' dividends will be taxed at investors' books.
2. Non-residents' dividends will be taxed at 28%. It is an upfront and final withholding tax.
3. There are NO explicit requirement of minimum payout ratio in the guidelines.

Item 1 makes M-REIT less attractive to local investors.
Item 2 makes it less attractive to non-resident investors.
The worst is item 3 - there is no explicit minimum dividend payout requirement. So as investors, we have to read the terms of the REITs carefully. We have to make sure the REIT that we invest in states that it will pay out 90% of its taxable profits even though it is true that the tax structure does encourage REIT to pay out dividends as high as possible.

Where to buy M-REIT?

You buy REITs through your stockbrokers/ remisiers. You can also book your trade through online stockbrokers. Check out the list of Malaysia online stockbrokers in our directory. REIT is listed at Bursa Malaysia or KLSE (old name). Or you can buy it through IPO. You may find the opening and closing dates to subscribe for IPO at the web site of Bursa Malaysia.

Unit trust agents or banks do not sell REIT, although REIT is trust fund. REIT's stock prices are determined by market supply and demand, just like company share prices. On contrary, unit trust prices are determined by NAV, net assets value, which is the value of its assets less liabilities (if any). It is calculated by unit trust companies daily.

Currently, there is one REIT, i.e. Axis-REIT, listed on Bursa Malaysia's TRUST section. The other three listed trusts are property trust, which is similar to REIT. Like REIT, property trust is subjected to the recent new guidelines from SC.

Part 1: Understanding REITs in Malaysia
Part 2: Understanding REITs in Malaysia (2)
Part 3: Investing in REITs