Churchouse Letter
October 2013          by Peter Churchouse

REITs Revisited

Just over 2 years ago we made the case for Asian REITs.

The REITs we selected on average have return over 50% since then.

In this edition of the AHA Report, we revisit this theme. We update our selections, and we add a broad country hard asset sector to our list.

Enjoy the issue,

Peter


Revisiting Our Asian REIT Investments

A few years ago, I encouraged a widowed relative, well into her eighties, to invest a little of her savings into three real estate investment trusts. Like me, she had come from a generation who knew how to save, knew the value of money, but had not been taught how to invest. This involved a little arm-twisting on my part as she was reluctant to let that money out of the bank account where she could see it, and where she knew it would be safe. She finally relented and invested in the REITs I suggested. A few months later I got an excited email from her (yes, she was very email literate) glowing about a dividend cheque from one of the REITs, along with notification of a cheque on the way from another. Those dividend cheques made a noticeable difference to her day to day budget, allowing her the freedom to indulge in a few luxuries that she would not previously have been able to afford. And the value of the units has also steadily risen, something that certainly would not have happened with the money tucked away in the bank.

A central focus of our work in the Asia Hard Assets Report and Digest is to help our readers find great investment ideas that will last the test of time and underpin their long-term financial security. The fundamental truth is that a great many people's pension provisions will not prove adequate. Public sector pension systems are generally underfunded, and will be highly unlikely to provide sufficient income to sustain even a modest lifestyle in retirement. Many private pension schemes are also underfunded. People are living longer, and dependency ratios are rising in many parts of the world, so public and private pension systems will need to pay out more money, over longer periods of time. They will be stretched, and many will not be able to deliver the levels of income promised.

My conclusion for some time now has been that we all need to take the initiative in making our own provision for long-term financial security, regardless of what private or public pension systems we participate in. We covered this in more detail in our July 2012 report titled “Long Term, Your Government Will Leave You In The Lurch,” and I will continue to pound the table on this one. Countless younger people I know who are earning good money, and have the ability to save in a meaningful way, don’t do so. In fact, they often park their hard-earned money into personal-finance products that are often insurance-based. They are being bled blind through endless fees and charges. I know. I made the same mistakes early on. Personally, although I have for many years saved and invested for long-term income and capital gains, I have made mistakes along the way. I know I could have done things better. That experience, I hope, will be able to guide readers to a more secure financial future. It is abundantly clear that your government is highly unlikely to do so.

REITs on Our Radar Screen for Some Time Now

We have long held that investment in real estate investment trusts (REITs) should be a central part of an investment portfolio targeted at generating long-term asset growth and a solid income stream. We first wrote about this back in August of 2011 (“Risk off the Table – A Window for Asian REITs”) and recommended a basket of Asian REITs. Figure 1 shows the subsequent total returns of that basket in local currency and U.S. dollar terms. The total return of our basket, including dividends, is over 50% in local currency terms and nearly 40% in USD (this is double the 20 percent return of both the S&P 500 and MSCI World over the same period).

REITs typically own real-estate assets for rental income.

They are generally limited in the amount of property development that they can take on. This reduces risk associated with property development.

REITs can be a good hedge against inflation. Real estate prices and rents typically outstrip inflation by several percentage points each year over the long term. Inflation relentlessly eats away at the value of your savings. Owning investments with a good chance of mitigating this risk makes sense. Investments in real-estate assets have a very good probability of protecting your income and assets against inflation.

Many of us invest directly in real estate, usually residential, but it is difficult for us all to buy an office building or a shopping centre. Investment in REITs gives you exposure to real estate that you would otherwise not be able to access on your own. The majority of REITs invest in commercial property rather than residential property, and most tend to focus on one property sector , whether it’s office, retail, industrial or hotels.

REITs typically provide higher dividends than most normal shares. They are generally required by law to pay out at least 90 percent of their net income to shareholders in the form of dividends. Most listed companies pay a much smaller percentage of their profits as dividends to shareholders. We love this income.

REITs are tax-efficient. Holders of REITs also typically enjoy tax benefits that shares in other companies do not. For most normal shares, companies pay tax on their profits, and shareholders pay income tax on any dividends that they receive. For REITs, income is taxed only once, not twice. (Note we are not tax specialists).

REITs can have reduced financial risk. In some jurisdictions, REITs are limited in the amount of debt that they can take on, thus reducing financial risk.

All of this means that REITs typically provide steady, reliable, reasonably predictable dividend income to shareholders. They are not growth stocks in the same way as property developers and other "hard-asset" companies. But as property prices and rentals increase, the value of the shares in REITs should typically rise.

I have often likened REITs to a halfway house along the investment spectrum between stocks and bonds. Typically they are less risky than stocks but more speculative than high-grade government or corporate bonds.

For the past couple of years, we have argued the case for holding REITs even more strongly than normal. With interest rates at record lows, REITs provide an income stream that cash does not. Dividend yields for REITs in a great many jurisdictions have been way higher than interest on deposits and on most high-grade sovereign and commercial bonds. In Asia, it has been possible to build a portfolio of high-quality REITs that would have delivered a gross dividend yield of between 6 and 7 percent. Not bad when interest on time deposits has been virtually zero and government bond yields somewhere in the 2 to 3 percent range, if you’re lucky...



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