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Is a Growth Strategy Feasible for REIT Investors?

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There are a number of regulatory impediments that prevent REITs from becoming growth instruments.

One such impediment is the rule that REITs would need to distribute 90% of rental income as dividends for investors to remain tax-advantaged instruments.

As REITs can only retain 10% of their rental collections, their primary instrument of growth will likely be via finding better properties to acquire and, each time they do so, they would need to raise money from shareholders or financial institutions through a private placement or rights issue.

Of late, we are seeing some REITs experience so much yield compression that they are starting to produce lower yields than banks.

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My dividends surpassed my living expenses when I was 32. I retired when I was 39 on an average of $9-$11,000 worth of dividends each month.

In fact, forward yields projected for DBS by Stocks Café is around 4.79% whereas Mapletree Commercial Trust has a projected yield of only 3.94%.

This begs the question of whether investors are coming alive to a new style of investing that focuses on growth rather than yields for REITs.

I just spent the morning testing different growth factors against a baseline portfolio of 40 REIT counters.

The REIT counter would have returned 8.58% over the past 5 years with a semi-variance of 6.98%. Over 10 years, it would have returned 14.95% with a semi-variance of 9.69%, which is not too bad for retail investors.

Here are some possible ways to play a growth strategy for REITs:

#1 – Targeting the largest REITs in SGX or invest based on index inclusion

If you choose a subset of 20 REITs with the largest market capitalisation, your ten-year returns would have been lower at 13.23% but you would have made a superior return of 10.36% over the past 5 years albeit at a higher risk.

A subset of this strategy would be to fish for REITs to be included into major indices, counters like Mapletree Commercial Trust had a huge boost in prices when it was brought into the STI components recently.

REITs also receive a big boost when they join the FTSE EPRA NAREIT Global Real Estate Index although size is only one criterion to gain entry. Equally important are factors like liquidity and free float.

  • Targeting the REITs with the largest earnings per share growth

Testing the local markets with growth investing factors, only EPS growth over 1 year showed some promise returning 14.6% over 10 years and a superior 9.87% over the past 5 years at a higher downside risk.

  • Targeting REITs with data centre assets

The final possible strategy would be to target REITs with data centre assets as it is believed that tenants do not look forward to moving data centres after servers are racked and software installed, so they are almost captive tenants.

If you invest this way, the only candidates suitable for investing are Keppel DC REIT (4.68% current yield) and Mapletree Industrial Trust (5.98% current yield).

In my humble opinion, the single issue animating the investment thesis for these REITs is whether are there assets for the REITs to acquire over the next few years.

The yields have been compressed to such an extent that it’s difficult to imagine any other positive catalyst for such investments.

For now, I am not done in my search for credible growth factors for REITs. I have started taking small nibbles at data centre REITs largely using my dividends from my other REITs holdings.

Investors attempting a growth strategy may want to focus less on quantitative factors but to read more analyst reports and look at qualitative factors such as available candidates in the acquisition pipeline and likelihood of index inclusion.

In any case, do not expect any attractive dividend yields over the short term. For the Early Retirement Masterclass, we will continue to try and find inefficiencies in the market that allows us to capture dividend strategies at lowered risk and valuations. If you are interested to find out how, you can register for a seat here, or directly book a ticket here.

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