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- Singapore Budget FY2015 extended income tax and GST concessions for REITs
- Why owning REITs has its advantages over owning physical properties
- Wide variety of REITs in Singapore to choose from to suit your needs. Over 34 REITs with a total market capitalization of $66.7 billion. Retail REITs’ yields are expected to have strongest growth this year
- Selection criteria for REITs with 5%-7% yield, debt exposure among others
- Five years of tax concession and why REITs, such as CMT, offers a stable income stream for investors
Singapore Budget FY2015 Tax Break
The Singapore Budget for Financial Year (FY) 2015 has been announced and while there are a lot of goodies inside for Singaporeans, I am going to focus on Real Estate Investment Trusts (REITs) in this article. The good news for REIT investors is that the government has extended income tax and Goods and Service Tax (GST) concessions for REITs for another five years even if they are collecting stamp duties from 31 March 2015 onwards. This would be good news for investors who seek to enhance their income stream from dividends paid by REITs and this article aims to provide insight for investors about it.
The Singapore REIT (S-REIT) market was set up in early 2000 with indefinite foreign income tax exemption for an indefinite period of time. However by late 2000, the government inserted a sunset clause with an expiry date of 31 March 2015. The appeal of S-REITs has been built on the premise of being tax-efficient, reliable, and a regular return on investment. S-REITs are obliged to return 90% of their income to investors regularly to enjoy the tax breaks provided by the government. The continuation of the tax breaks for investors will enhance the attractiveness of REITs as an investment vehicle.
This means that investors do not have to give up 10% of their dividends to the tax authorities if the income tax breaks expire. In addition, REITs do not have to pay GST or income tax from their foreign holdings and this will enhance their profitability for the next five years. However as the stamp duty exemption goes, they will have to pay more for their property acquisition and we can expect slightly lower distributions this year.
Benefits of S-REITs over Property
Buying a REIT is getting ownership of a property without the hassle of owning a physical property. In order to extract rental income from a physical property, property owners have an exhaustive list of tasks to do. They have to find trusted property agents to find tenants and property for them and be familiar with the paperwork and regulations even if the agent will be doing some of it for them. They will have deal with tenants who may be troublesome.
Even if they are lucky enough to find pleasant tenants, they will have to arrange for maintenance work to keep the property in order and run risk of foreclosure if they can’t keep up with their mortgage payments for a variety of reasons. As REITs are more liquid than property, one can sell it quickly and get the funds within four working days without excessive transaction fees associated with a typical property purchase.
They will need to have a margin of safety after calculating their net rental income as their costs may be higher than expected. This can happen when tenants leave before they can find new tenants to replace their lost rental income or when maintenance costs becomes more expensive. Being an S-REIT owner is the equivalent of being the boss and having someone else do all this work for you. All you have to do is to collect the dividends every quarter after you choose which REIT to buy.
The drawback is that you can’t do whatever you like to the REIT property which is possible when you own a physical property. For example, you can’t chase away a tenant that you dislike at Suntec City or redecorate it if you dislike the design even if you own the Suntec REIT. However you can do so if you own a row of shop-houses or an actual mall for instance.
Singaporean investors are spoilt for choice when it comes to S-REITs. The S-REIT market today is the second largest in Asia after Japan with $66.7 billion in market capitalization and twice the size of Hong Kong which comes in third. We have 34 REITs to choose from in different categories. They are broadly categorized into industrial (e.g. warehouse, factories), healthcare (e.g. hospitals, nursing homes), hospitality (e.g. hotels), office/commercial (e.g. office towers like MBFC), residential (e.g. serviced apartments), and retail (e.g. shopping malls).
The chart above shows that if you want the highest dividend (also known as distributions) growth, you might want to choose Retail REITs where they are expected to grow by 10%. There are REITs with a combination of different categories of properties in their portfolio and we have to keep in mind that the total return is a combination of distributions and capital gains.
As Singapore is a small island, many REITs venture out of our 718 km square of land mainly to other Asian countries. However a majority of S-REIT exposure remain heavily in Singapore as seen in the pie chart below from DBS.
S-REITs have reduced their exposure to China and Australia to focus on Singapore and Japan. So you can find a variety of REITs that suits your needs from the different category and country diversification.
S-REIT Performance 2014 Table
We can take a look at all the S-REITs listed on the Singapore Exchange (SGX) below provided ranked by their total return in 2014.
This chart shows us that high distribution yield is not the only consideration when we are selecting REITs. For example, LIPPO Malls Indonesia has the highest dividend yield of 8.0% but it is still ranked last because its share price has fallen way too much to cover its yield. Investors who bought it from January 2014 and sold it in December 2014 would have lost 11.1% even after counting the dividends which they receive.
The list above shows us that it would be more prudent to target a dividend yield with a filter of 5-7% and choose a reputable REIT. If you are a buy-and-hold investor, you might not be too concerned over performance of the REIT price. In that case, you can have a higher dividend yield target but it would be prudent to choose a well-established REIT.
REIT Selection Guidelines
- In the selection of REITs, in addition to its distribution yield, we have to look into its Net Property Income (NPI) as well. NPI is the income net of all relevant expenses which can be distributed to unitholders of the REIT. This will ensure that a REIT will maintain its distribution level in the years to come.
- The other factor to consider when choosing your REIT is to look into their debt level. REITs cannot have debt higher than 35% of their property value due to regulations. So investors would have greater assurance if they choose a REIT with lower debt and also one with higher level of their interest rates fixed as possible. REITs with a better debt profile would be better able to hold its price level and hence provide better total return. Ideally one should not overpay for the REIT and should buy it at a slight discount to its Net Asset Valuation.
- One last factor to keep into consideration is the rising interest rate environment. The US is expected to rise rates in mid-2015 and interest rates are expected to rise globally when this happens. This would mean that REITs with more of their debt unsecured would face a bigger challenge. This would also encourage an outflow of funds from Singapore into other destinations.
It is not possible to get a REIT that will have all these qualities so a balance has to be struck to find the optimal REIT for your portfolio. Besides all these hard numbers, there are also some other industry specific factors that will affect the REITs performance. If for example, we have greater tourist arrivals in Singapore this year then hospitality REITs will do well.
In conclusion, we have five years before the tax breaks end and this is a good time to get exposure to REITs if you are into income investing. Let’s take a look at what five years of investing in REITs can do for you.
Suppose you bought 1,000 units of CapitaMall Trust (CMT) at $1.46 per unit on 12 January 2009. CMT has properties in the retail sector and it owns iconic retail properties such as Junction 8, Plaza Singapura, Funan, Clarke Quay and Bugis Junction among others prime retail space in Singapore. It is the first and largest retail REIT with a reliable distribution history and a high occupancy rate of over 99% for 2014. If you are not looking for high capital gains, CMT would provide a steady income stream for you every 3 months.
CMT would have been worth $1.86 per unit at the end of 2013. During those five years, you would also have received dividends every three months for a total of $471.90 at the end of 2013. If you don’t believe it, you can refer to CMT’s dividend history and add it up yourself. So in other words, in five years, an investor of CMT would have earned back 32% from dividends alone and another 27% in capital gains.
This is an example of a slow and steady way to earn income and make capital gains using REITs. There are other REITs that can earn you 38% in a year as seen in the 2014 rankings table above but that is something that can only be seen after the fact as it is heavily tilted towards capital gains. However we invest in REITs mainly for its consistent income generating characteristics. If you are looking for capital gains, that will be something for another article.
I hope that this article helps you to understand S-REITs better in helping you secure your financial independence by building up a stable income stream. Five years can go past very quickly and you could aim to gain exposure to REITs to take maximum advantage of the limited window for the tax concessions.