Investing in REITs

Although REITs in Malta are not very popular with the local investors, they have been around from the 1960s. A real estate investment trust (“REIT”) is a company that owns, operates or finances income-producing real estate. They are essentially funds investing in income producing property. A REIT gives the opportunity to investors to invest indirectly in the property market by buying REIT shares which are listed on the Stock Exchange.

Recently, the Malta Stock Exchange has issued a Market Consultation Document in order to allow relevant market operators and stakeholders to provide feedback to the REITs bye-laws being proposed. In Malta, the appetite from institutional investors to buy and hold commercial property in their portfolio is relatively low, due to the lack of liquidity and high maintenance costs associated with holding physical properties. Such investors have also limited investment allocation because of the current regulation which makes it increasingly difficult for regulated institutional investors, such as investment funds and insurance companies, to increase their investment allocation into physical property.

Currently, if someone wants to invest in REITs one may only buy foreign investments. REITs values are largely influenced by the amount of income collected from property rents. Generally, as real estate property value increases, rent also increases, which leads to higher dividend payments. In turn, higher dividends attract a greater number of investors and the value of the REIT increases. The fact that traditional stock and REIT prices are driven by exogenous variables, diminishes the correlation between the two groups. The correlation of REITs to the stock market can go either way. REITs were once considered highly uncorrelated to stocks. However, in 2008, once the economy entered in a recession, the correlation gap narrowed.

Looking on how REITS have performed when compared to stocks, the MSCI U.S. REIT index increased by 28 percent while the MSCI Investable Market Index gained 22 percent, during the period January to October 2019. REITs have established a track record of reliable and growing dividends, combined with long-term capital appreciation through stock price increase. They have provided investors with attractive total return performance for most periods over the past 45 years, compared to the broader stock market, bonds and other asset classes.

Listed REITs are professionally managed, publicly traded companies that manage their businesses with the goal of maximizing shareholders’ value. That means positioning their properties to attract tenants and earn rental income and managing their property portfolios by buying and selling of assets to build value throughout long-term real estate cycles.

REITs offer a number of benefits to both retail and institutional investors who want access to the property market. It also acquires diversification benefits in a portfolio of investments which can be easily traded on the stock exchange. The investment vehicle distributes a high stable income since they have an obligation to distribute most of its rental income as dividends. This has driven total return performance for the REIT investors, who benefits from a reliable annual dividend payout and for a long-term capital appreciation. REITs’ total return performance over the past 20 years have outperformed the S&P 500 and other major indices. Listed REITs operate under the same rules as other public companies for regulatory and financial reporting purposes, hence they have to publish their yearly financial statements. REITs invest in income paying real estate thus eliminating the risk of incurred costs whilst the property is still being developed. This allows the REITs to start taking immediate returns once the property is generating income from its tenants. REITs enable landlords of commercial properties to release ownership of such properties and provide them with an alternative source of funding. Illiquidity in this sector is a significant issue, however, with the introduction of REITs this problem can be resolved.

REITs are adversely affected by weakness in real estate prices. Although REITs’ long-term returns are impressive, there have been periods in which they have underperformed significantly. In 2007, for example, the iShares Dow Jones US Real Estate ETF dropped by 20.35% and by another 40.03% (on a total return basis, which includes dividend income) the following year, during the bursting of the real estate bubble.

REITs also have the potential to produce negative total returns during times when interest rates are relatively high. In such instances, REITs experience volatile periods. When rates are low, investors typically move away from safe haven assets to seek income from other areas in the market. Conversely, when rates are high or in periods of uncertainty, investors often gravitate back to fixed-income investments. While sometimes miscategorised as “bond substitutes”, REITs are not bonds; they are equities. Like all equities, they carry a measure of risk significantly greater than government and corporate bonds. When volatility occurs in the stock market and displays unexpected and sometimes unwarranted price movements, REITs becomes very volatile due to their close correlation to the stock market. REITs are considered as equity investments and therefore are not immune from the downside risk of prices.

From an investor perspective, keeping in mind that an investment portfolio is generally held for the long-term, REITs can be a possible alternative to generate periodic income. Their comparatively low correlation with other assets, such as bonds, provides additional diversification that can help to reduce overall portfolio risk and increase returns.

Adrian Mifsud, CeFA, is an Investment Advisor at Jesmond Mizzi Financial Advisors Limited. This article does not intend to give investment advice and the contents therein should not be construed as such. The Company is licensed to conduct investment services by the MFSA and is a Member of the Malta Stock Exchange and a member of the Atlas Group. The directors or related parties, including the company, and their clients are likely to have an interest in securities mentioned in this article. Investors should remember that past performance is no guide to future performance and that the value of investments may go down as well as up. For further information contact Jesmond Mizzi Financial Advisors Limited of 67, Level 3, South Street, Valletta, on Tel: 2122 4410, or email [email protected]