There are some days you wonder why a product so obvious no one has thought of to create.
It will be popular.
And it solves some of the problems we face now.
I am referring to a passive exchange traded fund (ETF) that tracks a local or regional real estate investment trust (REIT) index.
Currently at this moment, there is no such a product, but there is a REIT index. Its name is called SGX S-REIT 20 index.
And what we are hearing is some hearsay that an ETF like this might be approved.
Here is my case why a REIT ETF like this will be very beneficial to the Singaporean Wealth Builder, whether you are starting off with $1400/mth or have build up a lump sum of $500,000 in wealth, at a time when you are near to financial independence.
For reference, do review the SGX news on the latest performance of the REIT index here.
What is a REIT ETF?
REIT stands for real estate investment trust, which is a listed business trust that pools funds from you the investors and debts from banks and financial institutions to purchase a group of properties of a particular theme.
This theme could be industrial properties, retail properties like your shopping malls, commercial properties such as the office places you work in, healthcare properties, overseas warehouses, hotels.
For example, Capitaland Malls owned your favorite malls Junction 8, Tampines Mall, Bedok Mall, Mapletree Commercial owns Vivocity, Keppel REIT owns the MBFC that you work at, CDL Hospitality owns the hotels that tourist stayed at when they visit the region and Ascendas REIT owns the business parks that you may work in.
It gives you the investors an opportunity to purchase a portfolio of properties with a smaller lump sum amount, compared to a $700,000 to $1,000,000 condo for investment.
Like properties, they have capital appreciation (and negative capital appreciation) and a dividend yield from the rental that the tenants pay the manager of the business trust.
As a REIT investor you gain the dividend yield and capital appreciation over time.
For a list of popular REITs, their current Dividend Yield and Metrics, you can take a look at my Dividend Stock Tracker here.
An exchange traded fund or ETF, is a fund somewhat like a unit trust, but listed on the stock exchange. You can see the price movement change daily, as the value of the underlying assets change.
The ETF sought to mimic the value changes of a particular stock index, or asset index.
Each ETF is based on a particular theme, just like a unit trust.
In Singapore the most popular ETF is the STI ETF. The STI ETF follows the Straits Times Index, or the 20 largest blue chip companies in Singapore.
By purchasing such a STI ETF, you get to participate in the growth of 20 of the biggest companies in Singapore. You get to earn capital appreciation and a dividend yield.
Marrying the 2 together
A REIT ETF, will be a listed fund that mimics the value changes of a REIT index.
Last year SGX formed a REIT index called SGX S-REIT 20 Index.
By purchasing this ETF, it enables you to invest in a portfolio of REITs, participating in the general property growth in the country.
As an investor you will be able to earn capital growth + dividend yield.
The index components
The SGX S-REIT 20 Index is a free-float, market capitalization weighted index that measures the performance of the biggest REITs in the region (in this case Singapore based).
By Market Capitalization, we meant the biggest REITs.
Here are some of the more current REITs that make up the SGX S-REIT 20 Index:
When you invest in an ETF that tracks the SGX S-REIT 20 index, you can earned the cash flow from the rental distribution of the underlying properties paid to the individual REITs and then to the ETF.
The components do change.
If a REIT is doing badly and shrinks, and another REIT did well, the better performing REIT grow bigger and overtakes this poor REIT.
The index is thus the survival of the fittest.
Easy to Invest in Compared to Properties
Many in Singapore dream of owning properties in Singapore, but felt that it will take some time for them to build up a sizable amount for down payment.
If you own a HDB flat and would like to purchase a $1,000,000 investment condo, a 20% downpayment will be $200,000, a 40% downpayment (if you have an existing home loan running) will be $400,000.
An individual REIT already allows the investor who have $5000 to invest and participate in the capital growth and earning dividend cash flow. The buy commission is typically $29 or 0.18-0.25% of the transacted amount. This works out to be a 0.6% sales cost.
A SGX S-REIT 20 ETF, trades like an individual REIT, and with the same $5000, you can obtain a diversification into a wider property of REITs and their properties at one shot.
Since SGX have changed the trading lot size from 1 lot = 1000 shares to 1 lot = 100 shares, you can even get invested with $200 or $300.
The only drawback is the commission will eat into your return, unless the commission in Singapore comes down.
Relatively Passive Cash Flow Generating for the Financial Independence and Financial Security Seeker
If you seek to build wealth, it is because you have a purpose or goal why you want to build wealth.
One common goal is to be financially secure, and perhaps financially independent (read my formula on how much you need to be financially secure or independent).
So you build wealth machines, which is a fundamentally sound way of building sustainable wealth in a certain method with certain assets.
My idea is that many wealth machines, requires quite extensive time and effort on a recurring basis to ensure you build wealth in a sustainable manner.
A portfolio of stock and bond ETF is one method that is relatively passive compared to the rest.
However, as these top companies tend to pay out less dividends, they tend to have a larger growth component.
For someone that requires their wealth machine to distribute more cash flow, a wealth machine based largely on the SGX S-REIT 20 ETF might fit the bill.
Suppose that you have amassed $500,000 and believe that you require $2000/mth or $24,000/mth to be financially secure to do what you always love to do.
If the prevailing average dividend yield of the SGX S-REIT 20 ETF is 6%, by investing the $500,000 in the ETF, the ETF potentially could distribute $30,000/yr in cash flow.
You could conservatively spend $24,000/yr and reinvest the $6,000 back into the ETF or other investment assets. (Read the science to systematic spend down $500,000 in financial independence)
This wealth machine is much more passive than you actively manage a portfolio of individual REITs because you do not need to spend time evaluating if the manager of the individual REITs are doing the right things to help you maintain and grow your REIT.
As we have said previously, the index is more of a survival of the fittest.
As a caveat, it does not mean the 6.5% dividend yield is guaranteed. Just like if you own a rental property, if there are vacancies, your annual rental income for that year will drop, if the economy is not doing well, and occupancy rate goes down, your dividend will be affected.
Easy to Dollar Cost Average
If you are building up your wealth, and want to use something you can understand easier, doing it monthly, a REIT ETF such as this is also good.
Suppose you earned $3500/mth gross, and have a disposable income of $2,800/mth, you can save up $1,400/mth for 3 months, and take the total of $4,200 to invest in a SGX S-REIT 20 ETF, giving you exposure to a very very diversified portfolio of properties.
Alleviate a big problem of investing in individual REITs: Manager Risk
Readers who have read my materials would understand the way I look at REITs as an asset class. Properties to a large extend, can be very commodity like.
The one that adds the most value is the quality of the manager of the REIT.
A good manager:
- Seeks properties that are accretive to portfolio on a long term basis
- Gains access to good debt funding sources
- Gains access to larger pool of institutional investors for placements and preference shares issues
- Able to risk manage the average interest expense of the portfolio and the magnitude of expiry of debt in a single year or period
- Acquires and divest properties that are more well timed
- Better manage tenant renewal and marketing
- Carry out asset enhancement to optimize properties
It is a dream to find such a good manager, and while the REIT will tell you they work in a team, there will be periods where the quality of management becomes not good.
As an active investor, you have to consistently assess their performance to pay attention to such signs.
An SGX S-REIT 20 ETF will alleviate most of this concern because a single bad manager does not have a huge impact on your overall wealth. (However, if the whole industry of REIT managers takes a wrong direction, then your overall wealth will suffer. We will address this later)
You do not want to see the case of a single poor REIT manager, in a challenging industry impairing a large part of your capital.
Not having to access this risky aspect, for me, is one of the biggest upside.
Allows the Wealth Builder to participate in Economic Growth and Inflationary Periods
While many believe that interest rate is a big factor in REIT’s performance, I think it is very overstated.
What is seldom mentioned in the same breath is the effect of a healthy growing economy on properties.
While interest cost can go up in a rising interest environment, a rising interest environment won’t bring an economy down if the economy grows well. When an economy grows well, demand for industrial, commercial and retail property space follows as well.
If you believe that in the long run, we should have higher productivity and this economy we live in has a good future, this SGX S-REIT 20 ETF is a way to participate in it.
These periods tend to be inflationary, and as a wealth builder, you may be concerned if the investment preserves your purchasing power.
For Singapore market the history is rather short, but we can perhaps take some queue on aggregate data from a more mature REIT market such as the USA
In periods of inflation, the property values rises well, in periods of easing inflation, the REITs can take advantage of lower cost interest loans.
Here is another look at REIT performance in different inflation regimes.
The caveat here is that different geographies may not exhibit identical trajectories.
REIT industry have progressed
While the industry, compared to other countries is young, the industry have seen its fair share of problems.
The industry have seen a credit crunch in the Great Financial Crisis of 2008, where many REITs could not refinance their loans and have to seek more funds from the shareholders for non-accretive loans.
The industry have also went through much changes in governance, such as a shift in REIT management fees compensation from based on net property income and AUM, which tends to encourage mindless growing of a REIT’s asset under management.
More REITs decides to link performance to dividends per share growth.
Here is Ho Ching’s 2005 warning for REITs doing very drastic financial engineering.
The financial crisis have surfaced some unknown risks, that the REIT manager didn’t know could be so bad.
While the REIT market is rather young in Singapore, it tends to develop at a pace where more governance have reduces potential negative cultural issues that may plague the whole industry, which will negatively affect an entire portfolio of REIT based ETF.
Potentially reduces single Rights Issues dilemma
The second big problem for an active investor who purchases individual REIT is how they tackle the issue when the REIT attempts to raise a rights issue.
A rights issue is when the manager wants to raise additional money from you the investor, to purchase a new asset, or to shore up their balance sheet.
Many retail investors do not like REITs because they see the rights issues as “taking back your dividend”.
It depends on how you see this, because Bobby Jayaratham in his Investing in REITs book, frames it as the manager asking you whether you would like to be part of an attractive property investment. If you are interested, you have to cough out more money.
An SGX S-REIT 20 ETF mitigates this impact in a few ways:
- Since the index is cap weighted, it means the index is dominated by larger capitalization REITs. These REITs tend to be able to fund AEI, new property purchases with their slight increase in debt raising, or rental income not paid out. This reduces the propensity to call a rights issue. They may also be able to place out their shares to institutional investors better.
- As the ETF is diversified, it means that the amount of money an investor will need to cough out for rights issue is less per case study. This depends on how the ETF handles rights issues, whether they sell off the rights and not subscribe to it at a discount (in this case the investor like yourself loses value, not a good thing). Due to the diversification of the ETF, your losses on the selling of rights is dissipated.
However, if another great financial crisis comes along and many of the REITs called for rights issue to shore up their balance sheets to pay down debt, this may not work out well for the SGX S-REIT 20 ETF investor.
For investors not familiar with rights issues, take a look at some of these past case studies:
- IREIT’s Rights Issue and my Right’s Issue, Placement evaluation template
- Aims Amp Industrial REIT purchase of Optus
- OUE’s non-accretive rights issue
- Croesus Retail Trust’s Rights Issue
Passive Investment with Less Tax Issues for Singapore Investors
Singaporeans live in a tax haven compared to some other countries. There are no capital gains taxes on selling your stocks, and the dividends are a one tier tax at the company source. This means you do not pay another addition set of tax on your dividends. And there are no estate duty, or death taxes.
These are the privileges we enjoyed and it may not occur to you, until you take a look at overseas investors who have to actively plan to optimize the taxes they paid on investments.
If you are not knowledgeable, and did not put your REITs in your taxable account, you end up paying more taxes.
For Singapore investors who have to purchase ETF in London or USA because of the limitation of ETFs in Singapore, they have to contend with estate duty and dividend withholding taxes.
Using the SGX S-REIT 20 ETF to Construct a diversified ETF Portfolio
You always wanted to add a real estate tilt to your allocation.
Perhaps you favor a equity, bond and real estate allocation. I will be honest here I heard such an allocation from a known influencer but I couldn’t remember who.
All three asset classes on their own have a positive expected returns over the long run and the correlation might vary. This is what you want when you are constructing a portfolio.
In the USA you could purchase a property for US$100,000 and that could be 25% of your allocation. In our case each condo will cost you much more.
A viable alternative, the SGX S-REIT 20 etf allows you to form a 40%/30%/30% equity /bond/ real estate allocation.
Actively Manage REIT Quantitatively
Some investors have chosen to put much of their competency in this dividend yielding asset class.
Nothing wrong with that.
Perhaps they have build adequate competence to evaluate each individual REIT such that they have an active strategy for it.
One layer of evaluation that they might not want to risk manage is whether there are individual fundamental problems such as holding a portfolio that had a particular weak outlook versus the competition, or the manager have some debt refinance coming up at the wrong time.
They want to focus on the under value and over value of the asset class as a whole.
An ETF such as this abstracts away these problems so that you can focus on some of the industrial level problems and attractiveness.
In the above table, you may evaluate and make quantitative investment decisions based on valuation and aggregate risk profile, versus regional REIT index.
When you have an index, you can relate the aggregate REIT data, and make some quantitative valuation investment decisions based on whether the yield spread with the 10 year government bond yield is narrowing or widening, or whether the dividend yield is near to +1 SD of the average dividend yield.
Do be aware that while an index abstracts isolated REIT issues to be less of an impact, if the issue is industry wide, it will be something to be evaluated as well.
What is yet to be known: Expense Ratio of ETF and non-Synthetic nature of ETF
While there are many things going for the ETF, until the ETF is out, we won’t know about the yearly cost of managing the ETF, that is the expense ratio.
While a passive ETF like the SGX S-REIT 20 ETF is managed by algorithms and machines, unlike the traditional unit trust managed by a manager who needs to earn his keeps, we think such a passive ETF will have low expense ratio, but we could be wrong.
Why expense ratio is important is because, your returns over time is unknown, but what is guaranteed is the cost incurred.
Returns compound. That is what we know and are attracted to. Cost compounds as well. And Cost is guaranteed while returns are not.
The second unknown is whether the ETF constructed is using derivatives (synthetic) or the machine purchases an underlying basket of stocks (non-synthetic).
Non-synthetic is preferred.
I was honestly surprise that the traditional ETF houses like SPDR and Nikko didn’t explore this channel. There is one unit trust that does this in the market and that is the Phillip Singapore Real Estate Income Fund.
This fund tracks the FTSE Straits Times RE Investment Trusts Index and its results are rather good at beating the benchmark index. (See Factsheet here). The index return is rather lukewarm, which makes us wonder whether the active manager has the advantage here.
I think such a REIT ETF could be very useful to wealth builders who have very different wealth machines.
Are there any positives and negatives I missed out? Would you be interested in an ETF such as this?
If you are interested in investing, and managing your own portfolio of REITs, and would like to equipped yourself with the right competencies, do visit my REITs Training Center. It is FREE, and is an assortment of case studies and thoughts on the nuances of managing REITs to provide sustainable wealth. Enter the FREE Resource here >>