Lately, I received a series of questions relating to asset allocation between REITs and physical properties via email from Ms. C. So after I had read her email, I would first offer a scenario that is relatable to these questions.
So, let’s begin:
Here, I’ll limit my discussion to Malaysians who are below 35 this year and have RM 100,000 in investable capital, to begin with. Therefore, in this situation, they could choose between Option A and Option B.
The Scenario
Option A:
Invest in a REIT Portfolio that is worth RM 100,000.
Option B:
Invest in a residential property worth RM 400,000 in the Klang Valley. With this, the RM 100,000 in capital shall be deployed as follows:
a. 10% Down Payment = RM 40,000.
b. Estimated Transaction Costs = RM 10,000.
c. Estimated Renovation & Furnishing Costs = RM 25,000.
d. Buffet of 12-Month Property Expenses (include mortgage) = RM 25,000.
Question: Let’s assume that this mortgage rate is 3.7% a year and its tenure is for 35 years presently, the mortgage installment works out to be around RM 1,600 a month. The stock price of REITs may decline over time if their fundamentals are poor. In the case of physical property, its investment performance may be mediocre, if its rents and price appreciation are weak. Hence, would it be fair to say that the investment risk of REITs and physical property is ‘kind of the same?
answer:
Nope, I don’t think so.
This is because REITs own multiple properties that generate rent from multiple commercial tenants in multiple locations, either in a country or globally. Thus, if you invest in a REIT, you’ll enjoy a greater level of diversification in respect of its tenants, properties, and locations. Whereas for a residential property, its source of income is limited in terms of the number of tenants and geographical location. In this respect, I would say REITs have an advantage in terms of diversification and thus, may carry lesser risk (if the risk is measured based on income diversity).
Income Diversity = REITs > A Residential Property
Question2: In a bear market, the price of REITs may fall and this would cause their investors to incur capital losses. Meanwhile, as for residential properties, owners may not be aware of the current valuation of their properties as they do not hire valuers to estimate the valuation of their properties on a yearly basis. So, in this case, is it fair to say that residential properties could also fall in price in a bear market? If so, does it mean that the investment risks between the two are ‘the same?
Answer:
Let’s start with the first question.
Yes, I agree in principle. Property prices may fall in a bear market. Obviously like most property owners, we don’t engage valuers on a yearly basis. But, we could have a rough estimate of the current valuation of our properties with Brickz.my, a portal that compiles actual transacted property prices in Malaysia. As such, I’ll say that it is best to check out Brickz.my to substantiate this theory of ours. This would prevent us from making conclusions out of assumptions.
Next, to our second question, I would disagree.
The financial impact of a 10% decline in REITs is hugely different from a 10% fall in the price of a physical property. For instance, if you choose Option A and had invested RM 100,000 in a particular REIT, your capital loss is RM 10,000 if this REIT fell by 10% in stock price. But, if you had chosen Option B and put RM 40,000 in the down payment for your RM 400,000 property, the amount of capital losses that you would incur is RM 40,000 if the price of your property fell by 10%.
This difference in impact is caused by the use of leverage.
So once again, I would say that their investment risks are different.
by Ian Tai Financial Content Machine. Dividend Investor. Produced 500+ Financial Articles featured in KCLau.com in Malaysia and the Fifth Person, Value Invest Asia, and Small Cap Asia in Singapore
