SINGAPORE (Oct 8): The real estate investment trust sector in Singapore has been one of Singapore Exchange’s runaway success stories. The S-REIT sector is the sixth largest in terms of market cap globally and third largest in Asia, trailing behind Japan and Australia. Based on the latest available data, there are 11 S-REITs with all-overseas assets in their portfolios. They include Manulife US REIT and Keppel-KBS US REIT. Two more pure-play US REITs are likely to list in Singapore in the near future. Prime US REIT plans a listing before year-end, and an Ascendas-Singbridge-sponsored REIT with US assets could list early next year.
Yet, with perhaps the exception of Frasers Logistics & Industrial Trust, the yields of the foreign-asset REITs continue to trade at a discount to pure-play S-REITs with local assets. Pure-play Singapore-focused REITs are getting rarer, with only 10 left out of 40 listed S-REITs. Of these, two industrial REITs plan to merge, and of the remainder, just five or six are seen as attractive for institutional investors. Large-cap S-REITs with well-known sponsors and a modicum of foreign assets have also traded well. Market watchers attribute the outperformance of locally focused S-REITs to the investment mandates of institutional funds. The largest funds out of North America and Europe buy into S-REITs for their Asian assets.
Investors looking for exposure to the US REIT market are spoilt for choice. If they intend to hold a diversified portfolio of REITS, there are plenty of REITs around the world that deliver returns superior to those of S-REITs with foreign assets.
Global REIT ETFs offer diversified exposure
The investable REIT universe is immense, hence there is a challenge in building a foreign REIT portfolio. Which foreign REIT could outperform an index? REIT exchange-traded funds (ETFs) offer a solution to this conundrum. Unlike S-REITs, several global REITs are internally managed, saving on fees and viewed as more efficient.
Most REIT ETFs have common characteristics, such as diversified holdings with low fees and promised regular streams of income. For REIT ETFs, the geographical exposures and asset classes of the underlying REIT constituents may differ, as do fee structures or management expenses charged by the ETF providers. All in all, investors should articulate a clear investment objective in terms of country exposure, asset class and risk preference before they take a deep dive into finding the desired REIT ETFs.
The largest REIT ETFs by market cap are usually found in North America. The returns have been exemplary for the past decade for two main reasons: the revival of the US real estate market since the 2009 recession and a decade of quantitative easing with record-low interest rates.
Real estate fundamentals should continue to be underpinned by the US economic upswing, supported by tax cuts and rate hikes. However, the market performance of REITs may be affected by rising interest rates. REITs are priced based on the yield spread between risk-free rates and REIT yields. The 10-year US government bond yield has been trending up since mid-2016 (see chart). To compensate for rising rates and to maintain the yield spread, REIT prices may fall.
However, higher interest rates also imply improving economic conditions, which enable landlords to raise rents. Any pullback in REIT prices could offer attractive opportunities for investors to gain exposure to this asset class.
REIT ETFs outperform S-REITs with US assets
Manulife US REIT and Keppel-KBS US REIT have both declined by about 10% in year-to-date prices. On the other hand, the largest US REIT ETFs have outperformed the S-REITs.
For instance, Vanguard Real Estate ETF, which tracks the performance of the MSCI US Investable Market Real Estate 25/50 Transition Index, has consistently generated an annualised return of 8% for the past 10 years. Its dividend yield is 3.83%. This ETF holds 186 REITs in these sectors: specialised, retail, residential, office, healthcare, industrial and hospitality. More than 93% of the ETF’s assets are located in North America. Vanguard indicates that the highlight of this ETF is its low expense ratio of only 0.12% — 90% cheaper than the other funds with similar holdings.
Schwab US REIT ETF matches Vanguard Real Estate ETF in terms of shareholder return over a five-year period, at 8.45% per annum, but charges lower management expense (0.07%). It is also a pure North American REIT with a large portfolio of 100 holdings, providing significant diversification in US real estate classes. The dividend yield, at 3.98%, is lower than that of Vanguard Real Estate ETF.
Investors who look for pure US assets in small-cap REITs can consider Invesco KBW Premium Yield Equity REIT ETF. This fund invests at least 90% of its total assets in small- and mid-cap US REITs. The average weighted market cap of constituents is US$2 billion ($2.7 billion) — much smaller than the constituents in Vanguard Real Estate ETF (US$12 billion). The 10-year price return for this small- and mid-cap-focused REIT ETF is close to 7.9% a year after tax. Although it holds only 29 REITs, the management expense ratio of 0.35% is nearly three times higher than Vanguard Real Estate ETF’s while generating identical shareholder returns. Investors should be aware that small- to mid-cap REITs have higher price volatility. This is evident, based on Invesco KBW Premium Yield Equity REIT ETF’s beta of 1.45 compared with that of Vanguard Real Estate ETF (1.34). As the name suggests, Invesco KBW Premium Yield Equity REIT ETF has a high gross yield of 7.7%, based on the current price.
For global real estate exposure, iShares Global REIT ETF is a credible option. Its expense ratio of 0.14% is relatively low for a globally diversified REIT portfolio. The underlying index it tracks — FTSE EPRA Nareit Global Real Estate Index Series — is designed to represent general trends in eligible real estate equities worldwide. Though it still overweighs US real estate, which accounted for 65% of its total fund, the remainder 35% is well spread across developed markets such as Japan, Australia, the UK and France. With a large holding of 304 real estate companies around the world, this ETF generated a three-year annualised return of 5.75% and pays an average dividend of 4.36%. In terms of sector diversification, a quarter of this global fund is invested in retail REITs, followed by office and residential REITs at 14.5% and 13.2% respectively. Notably, it also has low market sensitivity to the Standard & Poor’s 500 with a beta of 0.33.
The two main attractions of REITS are their hard assets and regular dividend payout. Investors who want a regular income stream over a sustained period of time can look into Global X Super Dividend REIT ETF. This ETF’s approach is to select 30 of the highest-yielding REITs in the world; it has 43% of its fund focused on mortgage REITs. The indicative dividend yield is close to 8% and the ETF has already paid out a dividend yield equivalent to 5% up to September 2018. Based on its current price, its gross dividend yield was 8.4% in 2017. It also generated a three-year annualised return in net asset value (NAV) of 12.15%.
Mortgage REITs provide financing for properties by originating mortgages and mortgage-backed securities and earning income from the interest on these securities. Mortgage REITs are mandated to distribute at least 90% of their income to shareholders. Despite being riskier than conventional REITs in nature, mortgage REITs compensate by offering higher yields. Mortgage REITs are likely to be more sensitive to interest rate changes, and their NAVs are negatively correlated to interest rate trends.
The interest rate effect diminishes if investors hold mortgage REIT ETFs or a pool of mortgage REITs with substantial diversification. iShares Mortgage Real Estate ETF, the largest mortgage REIT ETF on offer with 36 mortgage REIT holdings, has a relatively low three-year standard deviation (risk) in price of 10.56%. Its gross dividend yield is around 10%.
Another mortgage REIT ETF offering is VanEck Vectors Mortgage REIT Income ETF, which has a smaller amount of assets under management (US$146 million). Its gross dividend yield is 8.2%. In its fund fact sheet, the manager points out that this mortgage REIT ETF carries “both significant risks and potential for significant returns”. The high sensitivity to interest rate changes is magnified by the leverage within the mortgage REITs. Because they comprise “bundles of individual mortgages”, mortgage REITs would naturally have a higher probability of defaults.
The five-year annualised return by NAV of iShares Mortgage Real Estate ETF and VanEck Vectors Mortgage REIT Income ETF are 8.61% and 10.17% respectively.
