Sunday, September 25, 2005

"I need to buy a REIT!"

I had spent half an hour explaining the structure of a REIT and its source of income before learning that so-and-so did not actually have a securities custodian account. This meant that this particular individual could not apply for the latest REIT initial public offer. And I ran into another who said that he simply needed to go out there and buy a REIT because he was unsuccessful with the initial public offering. To me, if you hear about an investment (class) being talked about in lifts and covered till death in the local press, it means that we could well have a bubble waiting to be burst!

When REITs hit our shores about three years ago, not many gave them a second look. In fact, the first offer failed and the offeror had to go back to the drawing board. It restructured and came out offering a hefty 7 or 8% yield in a low interest rate environment. The capital gains of the early REITs which ensued was the result of yield compression as investors piled into them and grabbed them like hotcakes in recent years.

Today, the REITs trade at between yields of 4.2 - 5.3%. Investors are still enamored by them for they offer the prospect of relatively higher yields and a hope that they will repeat the stellar capital gains. I found it alarming that today's papers described such yields as attractive compared to fixed deposits rates offered by banks. Well, yes if you compare yields alone and forget about your capital. If one parks his hard earned dollars in a fixed deposit account, the returns may not be compelling but he enjoys the safety of capital return (assuming no default risk by bank). With REITs, I am not sure if capital return is assured in the current or projected environment. Interest rates clearly on the up-swing with the US Fed continuing to chalk up steady increases despite Hurricane Katrina's devastation. When interest rates inch up, yields of REITs are likely to need to increase. This would then translate to capital losses for the investor!

The foregoing is clearly my current humble view towards this asset class and you may differ. If you still need to invest in one, purchasing a REIT with a clear acquisition strategy helps. As the acquisitions tend to be yield accretive, it provides a defense for yield de-compression. However, bear in mind that the manager's task is made harder when the portfolio of properties increase.



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