If you are in your 20s or 30s now, you’ve probably gotten this investing advice from older adults: just save up for a property, lease it out and wait until it increases in value. Rinse, repeat, profit!
But buying a property can be intimidating for new investors with little cash. Luckily, in recent years, real estate investment trusts (REITs) have emerged as a popular way to invest in the real estate market without directly buying a property.
In the short term, the market outlook is certainly scary. Due to the coronavirus outbreak, REIT prices have fallen as much as 49% this year. But when it comes to property or REITs, you should be prepared to be in it for the long haul.
That’s why the best practice is to start early.
Why not use this period of uncertainty to get yourself prepared? Here’s what you need to know about REITs, and how they’re different from investing in physical properties.
What is a REIT?
A REIT is like a unit trust fund – it pools together many people’s money to hold a group of investments. But while unit trust funds (generally) invest in stocks and bonds, REITs invest in property. You can buy and sell REITs on the stock exchange, just like regular stocks.
With REITs, you can invest in real estate without having to directly buy a physical property.
REITs vs physical properties: how are they different?
Confused about how REITs are different from physical properties? Here are a few differences:
1. Capital needed
Buying a physical property requires a lot of capital. Typically, here’s what you’ll need to spend on:
- Upfront capital: The upfront costs of buying a property include a 10% down payment, stamp duty, loan agreement fees and legal fees. These costs could mean having to fork out around 15% of your property value upfront.
- 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 fees and taxes on rental income.
Investing in REITs requires a much smaller initial capital. Since REITs are traded on the stock market, you’ll only need to buy a minimum of 100 shares. But you’d probably want to invest more than the bare minimum, otherwise stock brokerage fees will take a big chunk out of your investment.
2. Leverage
With physical properties, you can get a very high proportion of financing at relatively low interest rates (around 4% to 5%). Depending on your eligibility, you could get a loan of up to 90% of your property value.
This means that 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: RM50,000 + RM450,000 home loan x 5% appreciation = RM25,000 | Investing in REITs: RM50,000 x 5% capital gain = RM2,500 |
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 use as much leverage when investing in REITs. Your bank may only offer margin financing between 1 and 2.5 times your collateral value, and interest rates can go up to 8%.
3. Diversification
Unless you’re 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 net worth could be tied up in a single property.
But investing in a single REIT could mean investing in a portfolio of real estate across different property classes. This reduces the risk of having to rely on a single property of income. You’ll also get to invest in sectors that could be difficult to access directly (like commercial, industrial or retail) or invest in overseas properties.
4. Liquidity
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. Selling it 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 quickly.
5. Taxes
When you lease out a physical property, your rental income may be subject to tax, while the dividends you receive from REITs are exempt from taxation.
When you sell your property, you’ll also be subject to Real Property Gains Tax (RPGT), while there are no taxes for capital gain (the profit made when the value of your stocks go up) with REITs.
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. On the other hand, this means that you’ll be giving up direct control over your investments for convenience.
REITs vs physical properties: investment returns
If you had invested in REITs over the past ten years, you probably would have made decent returns. If you had invested RM1,000 in Axis Real Estate Investment Trust (AXREIT) ten years ago, it would have grown to RM3,220 (including dividends) at the start of the year.
Malaysians REITs performance from January 1, 2010 to January 1, 2020
| Initial price | Dividends | Price | Capital gain | Total (capital return + dividends) |
||||
|---|---|---|---|---|---|---|---|---|
| Date | Price | Jan '20 | CAGR | |||||
| AHP | Jan '10 | 0.94 | 0.65 | 0.78 | -17% | 0.49 | 52% | 4% |
| ALAQAR | Jan '10 | 0.99 | 0.73 | 1.40 | 41% | 1.14 | 115% | 8% |
| ALSREIT | Oct '15 | 1.00 | 0.23 | 0.82 | -18% | 0.05 | 5% | 1% |
| AMFIRST | Jan '10 | 0.96 | 0.56 | 0.49 | -49% | 0.09 | 9% | 1% |
| ARREIT | Jan '10 | 0.88 | 0.66 | 0.73 | -17% | 0.51 | 59% | 5% |
| ATRIUM | Jan '10 | 0.90 | 0.80 | 1.04 | 16% | 0.94 | 104% | 7% |
| AXREIT | Jan '10 | 0.98 | 1.37 | 1.78 | 82% | 2.17 | 222% | 12% |
| CMMT | Aug '10 | 1.04 | 0.72 | 1.00 | -4% | 0.68 | 65% | 5% |
| HEKTAR | Jan '10 | 1.08 | 1.00 | 0.98 | -10% | 0.89 | 83% | 6% |
| IGBREIT | Oct '12 | 1.32 | 0.61 | 1.92 | 45% | 1.21 | 92% | 9% |
| KIPREIT | Mar '17 | 0.96 | 0.16 | 0.90 | -6% | 0.10 | 10% | 4% |
| KLCC | Jan '10 | 3.31 | 2.40 | 7.83 | 137% | 6.92 | 209% | 12% |
| MQREIT | Jan '10 | 1.05 | 0.82 | 0.93 | -11% | 0.70 | 66% | 5% |
| PAVREIT | Jan '12 | 1.09 | 0.65 | 1.71 | 57% | 1.27 | 116% | 10% |
| SUNREIT | Aug '10 | 0.92 | 0.77 | 1.82 | 98% | 1.67 | 182% | 11% |
| TWRREIT | Jan '10 | 1.17 | 0.78 | 0.80 | -32% | 0.41 | 35% | 3% |
| UOAREIT | Jan '10 | 1.26 | 1.00 | 1.25 | -1% | 0.99 | 79% | 6% |
| YTLREIT | Jan '10 | 0.88 | 0.76 | 1.33 | 52% | 1.22 | 139% | 9% |
Source: Investing.com, Yahoo Finance
However, thanks to the coronavirus outbreak, REIT prices have fallen as much 49% this year. This could be an opportunity for investors to pick REITs at relatively attractive prices, although you’ll have to consider how the coronavirus recession can affect a REIT’s earnings.
On the other hand, the housing market has been sluggish for the past few years, largely due to affordability issues and high levels of unsold units:
| Year | Median house price in Malaysia | Annual change |
|---|---|---|
| 2010 | RM158,000 | - |
| 2011 | RM165,000 | 4% |
| 2012 | RM170,000 | 3% |
| 2013 | RM250,000 | 51% |
| 2014 | RM270,000 | 13% |
| 2015 | RM295,402 | 16% |
| 2016 | RM298,000 | 2% |
| 2017 | RM303,000 | 3% |
| 2018 | RM296,944 | -4% |
| Q3 2019 | RM290,000 | -4% |
Source: National Property Information Centre
If you’re looking to rely on your investments for passive income, it’s also worth noting that rental yields for residential properties in Malaysia are around 4%, while REITs typically have a dividend yield of around 4% – 8%.
REITs vs physical properties: what are your financial circumstances?
Deciding between REITs or physical properties (or even both) depends on your financial goals and circumstances:
REITs
- You have limited capital.
- You don’t want the hassle of buying and managing a physical property.
- You prefer convenience when it comes to handling your investments.
- You want to hold a diverse portfolio of real estate.
Physical properties
- You can afford the upfront and ongoing costs of buying a property.
- You don’t mind managing (or paying someone to manage) your property.
- You prefer direct control over your investments.
- You want to take advantage of leverage.
REITs are a good way for beginner investors to dip into the real estate market, before buying a physical property later. But as always, remember to do your own research when looking out for quality REITs to invest in.
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