WHAT'S the best way to invest in property? Should you buy a bigger home? Or maybe buy a flat to rent out?
Here's an idea that involves less work: Go for the latest, hottest and most popular real estate investment, a real estate investment trust, called Reit for short.
It works like this: A property company will take a few buildings it owns and puts them into a fund, similar to a unit trust. Unlike other funds, you buy and sell it like a stock, using a broker.
The first successful Singapore Reit - Capital Mall Trust - was launched in July 2002. Since then, seven Reits have listed here with property worth $11 billion.
Reits are popular because they pay out nearly all their profits in dividends. This determines the 'dividend yield', which is the annual dividend divided by the price.
If the Reit pays 6 cents per share and sells for $1, its dividend yield is 6 per cent.
Reits look safe since the revenues and profits come from long-term leases to tenants. Yields are a healthy 5 or 6 per cent and, so far, share prices have appreciated.
But there is a dark side. Two reasons why Reits are riskier than they look:
# Professors Merton Miller and Franco Modigliani won the 1990 Nobel Prize in economics partly because of their discovery that a stock's risks and returns are not affected by whether it pays high, low or no dividends.
Stocks confer ownership. And since you are the owner, a stock that pays a high dividend means the company is simply paying your own money back to you.
It is very much like moving money from your left pocket to your right pocket. It doesn't make you wealthier.
# Second, Reits are simply shares. Their prices fluctuate as much as other shares, like SingTel, Keppel Corp and OCBC.
Let's say you buy the Capital Mall Trust Reit at $2.30. Its dividend yield is around 5 per cent per year. That is good but it is only half the picture. The other half is the share price.
If the price drops to $2.20 over the next 12 months - which is quite possible - you will lose 5 per cent of your investment. It is called a 'loss of capital'.
It means your net return is the 5 per cent dividend minus the 5 per cent capital loss, which is zero per cent. Hey, you only broke even.
Contrary to popular wisdom, Reits fluctuate and are not safer than other shares. Nevertheless, demand and prices get a boost from the perception that Reits are super-safe. Should this change, Reit prices will drop.
One thing that could trigger a sell-off is rising interest rates. When fixed deposit rates were less than 1 per cent, a 5 per cent Reit yield looked pretty good.
Now, savings and fixed deposits are paying close to 3 per cent interest. Unlike Reits, bank deposits are risk-free.
Suddenly, a Reit's 5 per cent dividend yield no longer looks great.
This narrowing between bank deposit rates and Reit yields could spark a sell-off next year.
Approach Reits with care.
Be cautious: Possible conflict of interest exist
ONE subtle point quietly adds to a Reit's risk.
Let's say an imaginary company - Big Land - takes a few of its shopping malls and places them into Big Reit, in which it retains one-third ownership. It sells the other two-thirds to the public in an initial public offering (IPO).
The value of the property placed into Big Reit is determined by an 'independent appraiser', which appraises the property at $300 million.
Next, Big Land collects $200m in cash from the sale of the IPO to the public. It keeps $100m ownership in Big Reit.
On top of that, it receives added income by appointing itself as the property manager for Big Reit. Its annual management fee is set as a percentage of Big Reit's selling price.
Do you see any conflicts?
For one thing, Big Land is both the seller and the buyer of Big Reit.
But it is more seller than buyer. It is selling $200m while buying $100m of the new Reit. This gives it the incentive to price the IPO on the high side.
Furthermore, its management fee is boosted by a high selling price for Big Reit.
Of course, there are safeguards - like an independent appraiser which estimates the value of Big Reit.
But is it enough? Can good safeguards overcome bad incentives? It is an age-old question. No one knows for sure.
Buy Land. They ain't making any more of the stuff.
- Will Rogers, American humorist, 1879-1935