One of the major lessons in 2019 is that the appetite of REIT investors is insatiable. REITs have increased in prices so much that folks are understandably getting worried that a bubble might be forming in the markets.
One qualitative reasoning is that older investors, whose appetite for passive is so great in the face of an extended period of low yields, have rushed into this asset class. As it takes time to collect dividends, it is much harder to convince a REIT investor to sell some of his holding that generate passive income for him.
In the Early Retirement Masterclass, we employ an empirical approach of quantitative back-testing to support or debunk common REIT strategies in the investment world.
In this article, I will review three common retail investor strategies that are benchmarked against the baseline strategy of buying and holding a basket of all REITs counters.
These three strategies are as follows:
- Holding a basket of half the S-REITs universe with higher dividend yields.
- Holding a basket of half the S-REITs universe with lower gearing or the debt-equity ratio.
- Holding a basket of half the S-REITs universe with lower-Price to Book Value.
The results are interesting if you review the back-testing numbers across time.
Here are some possible conclusions from the results:
- Overall performance of REITs is slowly reverting to normal market returns but it is still doing well relative to the rest of the market.
Very predictably, the 10-year back-tests stretches back to 2009 which was at the tail end of the Great Recession so REIT investors have done very well. As the back-tests stretch from December 2018, we notice that the 10-year performance of REITs is trending downwards. This is fine because REITs are simply reverting to market returns after more than a decade of outperformance.
- Buying REITs with a low price to book value may not be a good idea.
The idea of buying $1.00 of real estate with $0.99 is compelling but retail investors are already overplaying this strategy such that it has been failing for a while. Perhaps some portfolios of properties are cheap for a valid reason.
- It is no longer good enough to focus solely on high dividend-yielding REITs.
The most interesting change is that focusing on the universe of REITs that pay higher dividends will result in underperformance compared to buying the whole REITs universe. This is what happens when many investors plough into REITs counters in search for higher yields. This is the first sign that cash flow from real estate is getting more expensive as we speak.
- Gearing remains a useful way to select REITs that outperform
While high dividends are starting to fail, REITs with a lower gearing seem to consistently generate extra gains with the exception of one blip in April. Selecting REITs with a low gearing also has the added benefit from having a lower chance of getting a rights issue.
Naturally, having just five data points is not enough to conclude with strong confidence that these strategies are actually failing.
Instead, the numbers should be used to lend some credibility to the idea that REITs have enjoyed such a good 2019, that new investors will not experience as great a time as investors in the past.
For the Early Retirement Masterclass, we mix and match a combination of factors to find superior risk-return REIT portfolios that cannot be merely explained by back-testing results alone.
Our philosophy is that the rationale for screen selection must always be firmly grounded in business ideas. Beyond the quantitative approach, students are made to add a qualitative layer of reasoning to refine the stock screens further before the portfolio is ready for launch.
If you’re interested in finding out more, you can register for a seat here.
If not, I hope this article has at least warned you away from casually selecting REITs. It would be akin to selecting a lifeboat at random while the titanic was sinking without really inspecting it for holes.
- Juris Doctor(Cum Laude)
- Bachelor in Engineering from NUS (1st Class Honours)
- Masters in Applied Finance also from NUS.
- CAIA, FRM qualifications and passed all three CFA examinations.
I have recently completed my Juris Doctor and have been called to the Singapore Bar. For the past 15 years I was an IT manager and I have worked in multinationals, financial exchanges, trade unions and even a government agency. I started my career as an AS/400 administrator and moved on to manage IT projects and operations.