Real Estate Investment Trust vs Physical Properties, Which Suits You?
Thinking about investing in real estate? Buying physical properties isn’t the only way to go about it these days. In recent years, real estate investment trusts (REITs) have emerged as a popular way to dip into the real estate market without directly buying a property.
If you’ve been considering investing in REITs, here’s what you need to know about them, and how they’re different from investing in physical properties.
What is a REIT?
A REIT is like a unit trust fund, in that it pools many people’s money to hold a group of investments. However, instead of investing in stocks and bonds like unit trust funds do, REITs invest in property. You can buy and sell REITs on the Singapore Exchange (SGX), just like stocks.
REITs are therefore a way to invest in real estate without having to directly buy a physical property.
REITs vs physical properties: what do you have to consider?
Here are a few factors you need to consider when deciding to invest in REITs or physical properties:
1. Capital needed
Buying a physical property requires a lot of capital. Typically, here’s what you’ll need to spend on:
- Upfront capital: If you’re buying your first property, the upfront costs of buying a private property will include a 25% down payment, stamp duty, Additional Buyer’s Stamp Duty, legal fees (S$2,500 – S$3,000) and valuation fees (S$200 – S$1,500).
- Ongoing capital: You’ll need a stable source of income to continue servicing your home loan. You’ll also need to pay maintenance fees, property tax bills and taxes on rental income.
Buying additional physical properties will require much more capital, especially with the enforcement of property cooling measures last year. Taking out a second bank loan to buy another residential property, for example, will require you to fork out 12% in Additional Buyer’s Stamp Duty and a 55% down payment.
Investing in REITs requires a much smaller initial capital. Since REITs are traded on the SGX like stocks, you’ll only need to buy a minimum of 100 shares. However, you’d probably want to invest more than the bare minimum; otherwise, stock brokerage fees can take a huge chunk out of your investment.
With physical properties, you can get a very high proportion of financing at relatively low (around 2%) interest rates. With your first private property, you could get up to a 75% loan. This means, for example, it’s possible to purchase a S$1,000,000 property with a S$250,000 down payment.
If property prices go up, your return on investment would be much higher than if you hadn’t taken advantage of leverage. Here’s an illustration of how this works:
|With leverage||Without leverage|
|Investing in physical property:|
S$250,000 + S$750,000 home loan x 5% appreciation
|Investing in REITs:
S$250,000 x 5% capital gain
However, this works both ways: if property prices go down, you’d lose much more equity than if you hadn’t used leverage.
On the other hand, you can’t employ as much leverage when investing in REITs. Your bank may only offer margin financing up to 3.5 times your collateral value, and interest rates can go up to 6%.
Unless you’re absolutely swimming in cash, you’re probably not going to buy properties in bulk. When you purchase a property, a huge portion – if not most – of your assets will be tied in a single property.
However, investing in a single REIT means investing in a portfolio of real estate across different property classes. Such diversification reduces the risk of having to rely on a single property of income. It also provides the common investor with the opportunity to invest in sectors that would otherwise be difficult to access, such as commercial or retail properties.
Buying real estate involves finding a property, negotiating prices, obtaining a home loan and waiting for lots of necessary paperwork to be cleared – it’s a process that could take months. Similarly, selling real estate involves listing your property on the market, finding a buyer, negotiating prices and – no prizes for guessing – more paperwork.
The time it takes for the property transaction process to take place can be a drawback if you need to sell your holdings to obtain cash.
When you lease out a physical property, your rental income is subject to income tax, while the dividends you receive from REITs are exempt from taxation.
6. Property management
Unless you engage the services of a property agent, buying a physical property means having to go through the hassle of maintaining the property and dealing with tenants.
With REITs, however, these aspects of property ownership are handled by a professional management team.
Keep in mind though, when you leave the management of your assets to experts, you’ll be giving up direct control over your investments for convenience.
REITs vs physical properties: investment returns
In recent years, REITs have performed better than physical residential properties. Here’s how residential properties fared over the past few years:
|Singapore residential price index|
|Private residential properties||-4.0%||-3.7%||-3.1%||1.1%||7.9%|
Residential property prices have been rather flat for the period between 2013 and 2017, with private properties only picking up in the first half of 2018.
By contrast, the SGX S-REIT 20 Index (an index that measures the performance of the largest REITs on the SGX) reported an annualised total return (i.e. including dividends) of 6.2% over 5 years in 2018. If you had continually reinvested all your dividends from 2012 to 2017, your compounded annual return would have been around 10%.
If you’re looking to rely on your investments for passive income, it’s also worth pointing out that gross rental yields for private residential properties in Singapore are around 2.5% (as of 2016), while REITs typically have a dividend yield of around 4% – 8%.
REITs vs physical properties: what are your financial goals?
Ultimately, deciding between REITs or physical properties (or even both) depends on your financial goals and circumstances. Here are a few things you should consider:
|Involves ongoing costs||No||Yes (mortgage, taxes, maintenance fees)|
|Yield||4 – 8% (dividends)||Around 2.5% (rental)|
As with investing in traditional real estate, REIT investors should not expect big capital gains overnight, and should take a long-term view of their investment.