Common difficulties and how to avoid them
Real estate investment trusts (REITs) are a favourite asset class for income seeking investors looking for regular dividends. However, there are a number of difficulties regularly experienced by investors new to REITs, difficulties that are seldom addressed by trainers at public seminars. The following article details four of the main issues commonly faced by REIT investors.
Firstly, dealing with rights issues. REITs in Singapore have to distribute a minimum of 90% of net income to qualify for the relevant tax concessions. As such, it is very common for a REIT to raise funds by acquiring more properties or to refinance debt due to limited cash on hand. When REITs offer rights to existing unit holders, the rights will often be offered at a discount to the prevailing market price. The share price will most likely be adjusted downwards immediately after the announcement. There is also no way for retail investors to sell their current holdings immediately after the announcement is made. Subsequently, the investors are left with no choice but to either subscribe to the rights on offer, by injecting more cash, or are forced to sell the rights at an unfavourable price. If the investors do not have enough ready cash, or forget to subscribe to the rights, they will suffer a loss from their invested capital.
Secondly, REIT investors are unable to participate in private placement. A private placement is a capital raising event that involves the sale of securities to a relatively small, select number of investors. Usually there is a discounted price offered to private investors during the private placement exercise. With the injection of the additional shares into the stock market, there may be a dilution effect on the distribution yield. Retail investors may be worse off, as their current holdings are diluted without the chance to acquire their own additional shares at a discounted price. Similar to the rights issues, the share price will normally trade downwards after such announcement is made and, as a result, investors may suffer capital loss on paper.
Thirdly, receiving odd lots from a dividend reinvestment plan (DRP). Usually, REITs pay dividends in cash every quarter or semi-annually. As an alternative, some REITs introduced the DRP to investors as an option to reinvest the dividend at a discounted share price. This might look good at first glance, but most of the retail investors will end up with odd lots as their investment holdings are normally small. Odd lots are considered to be anything less than the standard 100 shares and are usually difficult to sell at a good price due to illiquidity and wide bid-ask spread. Trading commissions for odd lots are generally higher on a percentage basis than those for standard lots, since most brokerage firms have a fixed minimum commission level for undertaking such transactions.
Finally, the fourth difficulty facing REIT investors is that they are unable to arrange a regular saving plan (RSP) with only a small amount of capital. In the long term, a dollar cost averaging strategy is an excellent way to accumulate REITs without the need for timing the stock market. However, there are two major limitations for investors who would like to contribute a fixed amount of salary to build their REIT portfolio every month. For example, the investor who contributes US$1,000 per month is unlikely to be able to allocate into different REITs for diversification purposes and will probably end up with odd lots per REIT. In additional, the transaction cost per order is high, which will erode the return of the portfolio. These limitations make monthly RSP investing for REITs not a viable solution, either financially or operationally.
In order to overcome these four issues, a REIT investor can pool monies with other investors to complete bulk purchases. This can be achieved by leveraging the lower commission structure of a brokerage firm who are able to buy and sell in bulk.
