Firstly, before I share my views, let me briefly explain what a REIT is. It is simply an acronym for Real Estate Investment Trust. REITs are established to invest and hold onto commercial real estate for the purposes of deriving rental income for the long-term. They are listed securities that are traded on stock exchanges like Bursa Malaysia and the SGX.
Investors may invest into units of their preferred REITs. In return, they would be receiving a regular payout known as income distribution, which is generated by netting off property-related expenses from the REIT’s rental income. Often, it is regarded as a better alternative to buying physical properties for it is a lot more convenient and liquid to have exposures into real estate.
The question is:
‘Are REITs better investments than physical properties?’
Personally, I invested into both REITs and physical properties and like them both for their own unique attributes. Here, I’ll list down 8 differences between them so that you can decide for yourself which of the two is more suitable for you for the time being.
REITs require fewer capital, hence, are a lot more affordable than investing into physical properties. For instance, most REITs listed on Bursa Malaysia are priced at around RM 1+. Given that the minimum units per transaction is 100 units, as such, the minimum capital needed to invest in REITs could be as low as RM 100. However, for a lower-priced property, let’s say a medium-cost apartment priced at RM 150,000, the amount of capital required to buy the apartment would be around RM 22,500, thus, is less affordable than REITs.
Usually, there is little form of borrowings used by investors in buying REITs. The exception is for investors who choose to use share margin financing to invest in them. But, with that being said, investors who had invested into REITs would be leveraging on the REITs’ financial strength, where they would expand their own portfolio by acquiring brand new commercial properties in the future. Whereas for property investors, the use of borrowings would be more evident as they, in most cases, will fund their purchases via mortgages.
In most cases, units of REITs are acquired, owned, and disposed off individually. They are not co-owned by a group of investors unless they are bought under or via a corporation which is less encouraging because of higher withholding tax in Malaysia for corporate investors. Meanwhile, investors can be ‘creative’ when it comes to physical properties, where they can be invested individually or jointly or corporately under a corporate entity like Sdn Bhd. This is because properties can be co-owned with your spouse, family members, relatives, friends and also your business or investment partners.
If you are a Malaysian, residing and earning income in Malaysia, you would find it easier to start investing into properties in Malaysia, especially the ones which are located within 10-20 km away from your current residence or your premise of work. But, REITs are different. They allow investors to buy properties located in different parts of the country conveniently with a single button. If the REIT is listed on the SGX, it is even better for investors as SGX-listed REITs are gateways to buy properties worldwide such as Asia-Pacific, North America, and Europe.
Imagine having brands like Starbucks, Uniqlo, BWM, Nestle, … etc as tenants of properties in your REIT portfolio. Essentially, you are earning passive income on a regular basis from rents and leases paid by these high-quality tenants to REITs and the best part is – You are free from managing both the properties and their tenants. Investing into REITs for passive income is as simple as you buying these units, keep them, and just let the cash flow into your bank account.
But, that is not the case for physical properties. It is dependent on how you opt to generate income from them. This would include long-term rental, short-term accommodation, room rental or AirBnB. The shorter the stay, the more work to put into managing your property investment. For instance, you may potentially earn more income from AirBnB. But, the question is: ‘Do you have the time and energy required to run your unit successfully?’ Or, would it be better for you to spend your time on activities which are more productive? If you opine that it is too tedious to actively manage your own property, you may opt either to invest in REITs and rent your physical property out to a long term tenant.
6. Income Tax
Income distribution from Malaysian REITs are paid out to investors after netting off 10% withholding tax, if you are an individual investor. You don’t need to file in or declare your income distributed from Malaysian REITs. Thus, the benefit is that, if you are already in a high income tax bracket, let’s say 20+%, the income you receive would be free from income tax.
But, the same cannot be applied to the rental income from physical properties. If you made profits from renting out your properties, you are obliged to declare them in your income tax filing and your tax payable is calculated based on your income tax bracket. With that being said, there are a number of tax benefits for real estate investors to capitalise on so that you can reduce your total payment of income tax to the government, depending on the ownership structure of the property, be it individual, joint-ownership, or under a corporation.
7. Disposal Gains
If you buy a REIT for RM 1.00 in January this year and choose to sell it off at RM 1.20, the capital gain of RM 0.20 received is tax-free. However, it is not the case for physical real estate as capital gains from the disposal of properties would be subjected to RPGT, which is the acronym for Real Property Gain Tax. The rate of RPGT is subjected to the actual property holding period before its disposal. The shorter (1-3 years) your holding period, the higher (30%) the RPGT that you will incur for your profits from selling off your property.
8. Debt Service Ratio (DSR)
Let me first explain the concept of DSR.
For instance, you earn RM 10,000 in monthly income and are making a monthly debt repayment (installment) of RM 3,000, which includes home mortgage, car loan, credit card debt, and PTPTN loan. Therefore, your DSR is 30% as your total monthly debt repayment is 30% of your monthly income.
DSR calculation is important to tell whether or not you are still eligible to apply for a loan from the bank in the near future. Typically, a bank may disburse loans to an individual up to 60% of his monthly income, capping his DSR at 60%. So, it is to ensure that the borrower has the means to repay or service his debt.
From the bankers’ point of view, they recognise rental income from renting out physical properties as a valid source of income. For instance, in addition to your RM 10,000 in monthly income, you collect RM 1,000 in rental income. From the bankers’ perspective, the amount of loan you can obtain for is calculated based on RM 11,000 in monthly income instead of RM 10,000, hence, enabling you to obtain a much higher loan in the future.
However, income distributions from REITs are less emphasized by local bankers. If you have invested RM 100,000 into a portfolio of REITs and are earning some 6% in distribution yield per annum (RM 6,000), you may submit this documents (statement of investment account and dividend vouchers) to your bankers, they would more likely to use them as evidence to your sources of funds, which may be helpful in your future loan application.
But, income distributed from REITs will not change your DSR figures, at least, in your banker’s viewpoint. If you earn RM 1,000 in income distributions a month, on average, the amount of loan you are eligible to apply for in the future would still be based on RM 10,000 in monthly income, not RM 11,000.
Conclusion: Which of the Two Should I Invest Into?
I can’t say for all.
But, let me share I did in the past so that you can use it as a reference. For me, I started off with REITs as I could not afford to buy myself a physical property. So, REITs, to me, is an alternative to a property. Instead of parking all of my savings into fixed deposit, I opted instead to accumulate REITs as a means to save up to buy myself a physical property in the future.
The REITs chosen are mostly the type that pay incremental dividend income for they are also more likely to appreciate in unit prices. My selection of REITs have been made by assessing its fundamental qualities (financial reports) and as well as understanding its growth prospects.
As I was accumulating REITs on a progressive basis, concurrently, I built my cash reserves and credit profile. I read books on real estate investing, signed up for a good property workshop, and shop around for physical properties. This process of studying, saving, investing, … etc took me a couple of years until finally, I was able to afford an investment into a physical property.
Today, I won’t say one is better than the other. Rather, I find physical properties to be profited handsomely from buying at a huge discount today and long-term capital appreciation in the future. But, they may be negative cash flow. Hence, I have REITs as a means to earn regular income distributions to partially offset its negative cash outflow to boost my holding power onto my physical property.
So, in short, I find both REITs and physical properties are complementary to one another when it comes to wealth building.
Happy Investing 2020!