Investing in Real Properties vs. REITs Amidst Country Garden’s Restructuring and China’s Property Sector Concerns

Introduction

The real estate investment landscape has always been a dynamic and complex realm, with various factors shaping investment decisions. Amidst the traditional debate between real properties and Real Estate Investment Trusts (REITs), recent events have brought a new layer of complexity. In this comprehensive guide, we will explore the pros and cons of both investment avenues, delve into the captivating world of REIT dividends, and address the heightened concerns surrounding China’s property sector, epitomized by Country Garden’s restructuring. The real estate investment landscape is at a crossroads, with investors grappling between the allure of real properties and Real Estate Investment Trusts (REITs). While examining the merits of these options, recent events within China’s property sector have introduced a global dimension to this decision. In this comprehensive guide, we will explore the pros and cons of both investment avenues, delve into the intriguing world of REIT dividends, and analyze how China’s property sector concerns could influence the broader world economy.

Part 1

Investing in physical real properties involves purchasing tangible assets with the potential for rental income and capital appreciation. Here are the key advantages and disadvantages of this approach:

Advantages of Real Properties:

1. Tangible Asset: Physical properties provide a direct sense of ownership and control. You can influence property management, improvements, and customization.
2. Rental Income: Rental properties can yield a consistent income stream through tenant payments, offering a reliable source of cash flow.
3. Potential for Appreciation: Real estate has historically exhibited the potential for long-term appreciation, allowing investors to benefit from capital gains upon property sale.

Disadvantages of Real Properties:

1. Capital Intensive: Investing in real properties requires substantial upfront investment, including down payments, maintenance, and potential renovation costs.
2. Active Management: Property management demands time and effort. Landlords must handle tenant relations, maintenance, and other responsibilities.
3. Illiquidity: Real properties are relatively illiquid, meaning it might take time to sell a property and access funds compared to other investment options.

Leveraging Costs for Real Properties:

1. Mortgage Interest: Leveraging involves borrowing funds to invest in properties. The cost of leveraging includes mortgage interest payments, which can significantly impact cash flow and overall returns. Current private home loan rates in Singapore fluctuate in the range of 4.19% to 3.20% (Lowest Fixed) as at publication.
2. Down Payment: While leveraging allows you to invest with a smaller initial capital, the down payment required for the property purchase is an essential upfront cost. If you are using a private bank loan in Singapore, you will need to make a downpayment of 25% of the purchase price or valuation, whichever is higher. A minimum of 5% of this downpayment MUST be in cash, while the remaining 20% can be paid using your CPF OA or cash.
3. Risk and Reward: Leverage amplifies both gains and losses. While it can enhance returns during periods of appreciation, it also exposes investors to higher risks during market downturns.

Tax Considerations for Rental Income in Singapore:

1. Rental Income Tax: Rental income earned from Singapore properties is considered taxable. Tax rates are progressive, varying based on the amount of rental income earned.
2. Expenses Deduction: Property-related expenses, such as property tax, maintenance costs, and mortgage interest, can be deducted from the rental income to reduce the taxable amount.
3. Owner-Occupied Property: If you live in the property and rent out a portion, you may be eligible for certain tax exemptions or reliefs.

Capital Appreciation: Not a Guaranteed Outcome for Real Properties:

1. Market Volatility: Real estate markets can experience fluctuations due to economic conditions, demand, and other factors, affecting property values and potential appreciation.
2. Local Factors: Factors such as location, infrastructure development, and neighborhood changes influence a property’s appreciation potential.
3. Active Management: Successful capital appreciation often requires ongoing investment in property improvements and maintenance, which might impact overall returns.

I am grateful to Josh Tan from The Astute Parent for providing insights in his video below. Also drawing from my own experiences, I’ve come to realize that opting for central locations (e.g. CBD area) might not always guarantee substantial capital appreciation. This is particularly relevant because many investors prioritize rental income for the long term. While the paper valuation might appear elevated, it doesn’t necessarily translate to the actual sale value, especially if transaction volumes are inadequate to substantiate it. Therefore, for first-time buyers, I personally advise against becoming overly enthused by the location or potential rental income and rushing into a situation that may lead to financial losses.

As the residential property market’s price growth is projected to moderate due to a weaker economic outlook, potential first-time buyers in Singapore might consider exploring alternative options such as Commercial and Industrial properties. In 2023, there is an anticipation of continued, albeit slower, growth in prime office rents. The current softer market conditions could offer an advantageous period for occupants to recalibrate their office needs. Those looking to downsize while upgrading to higher-quality offices might find this an opportune moment. With a substantial influx of high-tech spaces expected in the market this year, occupiers have a chance to reevaluate their space requirements and secure quality, centrally-located industrial properties. Although prime logistics supply is expected to remain constrained in 2023, logistics occupiers requiring significant space should plan their expansion strategically, considering build-to-suit solutions or advance planning for growth. Retail rents across various submarkets are predicted to increase further in 2023, with Orchard Road potentially benefiting from increased tourist arrivals. As crowds return to office areas, this will drive leasing demand in CBD retail spaces. Simultaneously, the suburban market is expected to sustain rental growth due to robust demand.

For those considering investments in the U.S. real estate market, the earnings scorecard: 2023 Guidance below offers valuable insights. In the last month, nearly 200 U.S. REITs have released their second quarter earnings, providing crucial data about the commercial and residential real estate sectors. Notably, the quarter witnessed robust growth in residential rents, particularly in the single-family segment where supply constraints are prominent. This contributed to impressive reports from residential REITs. Retail REITs, often overlooked, have experienced a resurgence over the past 18-24 months due to a notable increase in store openings compared to closures. This trend has led to record-high occupancy rates and substantial double-digit rent growth. Additionally, office REITs have shown remarkable stock performance this earnings season, with results turning out to be better than anticipated. There are also indications of an increasing momentum in the “return to the office” movement.

Part 2

REITs (Real Estate Investment Trusts) pool funds from investors to invest in diverse real estate assets. Here, we focus on the dividends aspect of REITs:

Advantages of REITs:

1. Diversification: REITs offer a diversified real estate portfolio, enabling investment in various property types and locations without requiring substantial capital.
2. Passive Income: Legal requirements mandate REITs to distribute a significant portion of their income as dividends, making them appealing to investors seeking passive income.
3. Liquidity: REITs are traded on stock exchanges, providing higher liquidity than physical properties. Shares can be bought or sold relatively easily.
4. Dividend Yield: REIT dividends often provide competitive yields, potentially delivering a steady income stream that outpaces traditional investment options.

Leveraging Costs for REIT Investments:

1. Fund Borrowing: Some investors may choose to borrow funds to invest in REITs. The interest paid on the borrowed funds becomes a leveraging cost. Otherwise, there is typically no leverage cost for investors who use cash, CPF OA, etc.
2. Indirect Leverage: REITs themselves may use leverage to acquire properties, impacting their financial structure and potentially influencing dividend distributions.
3. Risk Management: Leveraging in REITs is managed by professional fund managers. This can provide a level of risk mitigation compared to direct property ownership.

Tax Considerations for REIT Dividends in Singapore:

1. Dividend Withholding Tax: REIT dividends are subject to withholding tax in Singapore, which is typically deducted by the REIT before distributing dividends to investors.
2. Tax Exemption for Local Investors: Singapore tax residents may benefit from tax exemptions or reduced withholding tax rates on REIT dividends under certain conditions.
3. Foreign Investor Taxation: Non-resident investors may be subject to higher withholding tax rates on REIT dividends, depending on tax treaties between Singapore and their home countries.

US REITs saw an upswing in July, attributed to major indices wrapping up the first half of the year on a robust note and analysts adopting an optimistic outlook for the sector. Wall Street’s principal benchmarks concluded the initial half of the year with a positive trajectory. Noteworthy is the historic achievement of technology shares in terms of market capitalization, alongside a moderation in inflation indicators. The Nasdaq secured its most impressive first-half performance since 1983. Analysts are notably increasing their upgrades of REITs, surpassing their previous activity a few months prior. This change is attributed to improved earnings and performance, along with the growing possibility of the current interest rate hike environment coming to an end. While US REITs have experienced a decline in the past weeks, this presents investors with a compelling opportunity to acquire numerous high-quality REITs.

Part 3

Recall China Evergrande, the colossal player in Chinese real estate whose overwhelming debt triggered a global market upheaval in 2021? Its downfall marked the commencement of a predicament for China’s housing sector, causing a sharp decline in apartment sales and leaving both major and minor developers in a financial quandary.

Presently, financial turmoil at Country Garden, another significant player in real estate, is evoking new anxieties. These issues also serve as an alarming indicator of China’s economic state.

Country Garden’s ongoing restructuring serves as a reflection of more extensive apprehensions concerning China’s property sector. Although this circumstance might not directly influence the decision between real properties and REITs, it emphasizes the necessity for meticulous evaluation of market dynamics, timing, and associated risks:

1. Market Volatility: Recent events highlight the volatility and uncertainties within the real estate market, emphasizing the importance of diversification and long-term strategies.
2. Macro Trends: China’s property sector challenges underscore the significance of understanding global economic and political factors when making investment decisions.

Conclusion

Investors face an intricate decision between real properties and REITs, with the recent events in China’s property sector adding a layer of complexity. By assessing the advantages and disadvantages of each avenue, understanding the potential of REIT dividends, and considering broader market trends, you can make informed decisions aligned with your financial goals and risk tolerance.

While the concerns surrounding Country Garden’s restructuring and China’s property sector are noteworthy, they should be evaluated alongside other factors influencing your investment choices. This is the pivotal point that has led me to make a deliberate shift in my investment strategy, prompting me to put a temporary pause on my plan to purchase rental properties. Rather than taking the traditional route of direct property ownership, I have decided to redirect my focus and allocate my resources towards investing in Real Estate Investment Trusts (REITs).

The multifaceted considerations explored in this blog have illuminated the potential benefits and drawbacks of both investment avenues. While real properties offer the allure of tangible assets and the prospect of direct management, the challenges of active involvement, substantial upfront costs, and the uncertainty of capital appreciation have given me pause for thought. Conversely, REITs present an alluring alternative, with their promise of diversification, potential for steady dividend income, and crucially, ease of liquidity. The current market dynamics, including positive analyst sentiments, shifting interest rate environments, and trends in specific property sectors, have further fueled my interest in exploring the realm of REITs.

This strategic shift in focus does not denote a permanent departure from the notion of owning rental properties. Instead, it reflects a prudent adjustment based on the current market landscape, my risk appetite, and my long-term financial goals. By opting for REITs at this juncture, I intend to leverage the advantages of professional management, liquidity, and a diversified portfolio, without immediately shouldering the responsibilities and costs associated with property ownership.

In conclusion, while I have temporarily paused my pursuit of buying rental properties, it’s crucial to recognize that investment strategies remain dynamic and adaptable. They evolve in response to shifting circumstances, market trends, and personal objectives. This decision, rooted in a comprehensive understanding of the pros and cons of real properties versus REITs, is aligned with my intention to make informed choices that optimize the potential for financial growth while managing risks effectively. As the investment landscape continues to evolve, I remain open to reevaluating my strategy and adapting it accordingly, always seeking the most prudent path towards achieving my long-term financial aspirations while benefiting from the inherent ease of liquidity that REITs offer.

Other readings:

• DBS downgrades Prime US REIT on high gearing, refinancing risks, falling occupancy (theedgesingapore.com)
• DBS lowers ARA US Hospitality Trust’s TP to 45 US cents on slower-than-expected travel recovery (theedgesingapore.com)
• Sasseur REIT reports 1HFY2023 DPU of 3.322 cents, 2.6% lower y-o-y, due to lower renminbi and higher finance costs (theedgesingapore.com)
• CapitaLand Investment reports lower 1HFY2023 earnings with reduced portfolio gains (theedgesingapore.com)
• Frasers Property sees macroeconomic challenges hitting Thai residential sales | The Straits Times
• Property resale market stabilising, may have peaked: PropertyGuru report – CNA (channelnewsasia.com)
• Country Garden credit distress likely to spill over to China markets – Moody’s (msn.com)