Slow progress is better than no progress. That certainly holds true for REITs in the Philippines. With just two listed REITs at the time of writing, we’re way behind our Southeast Asian counterparts. And we’re especially behind developed economies like the United States as they’ve had REITs since the 1960s, with the modern REITs around the 90s.
But now that they’re here, we all can remain optimistic about the opportunity that it affords us, investors. Are REITs in the Philippines a good investment? I’m certainly glad to include them in my portfolio.
REITs are a fantastic way of gaining exposure to the real estate industry and enjoy rent-like dividends without the hassles of buying and managing properties.
But like every investment, REITs have their downsides. How do you choose which REITs to buy, or how do you even tell if you’re getting a good deal on the stock? Are they perfect replacements for rental properties? If you’re a real estate investor, should you even bother having REITs?
Let’s take a look.
Page Contents
What is a REIT?
REITs, or Real Estate Investment Trusts, are listed companies primarily invested in properties that generate rental income. They’re traded like any other stock in the stock market, and that means fluctuations in pricing and high liquidity — you won’t have to worry about your money getting stuck in a property.
How do you say “REITs”? Pundits pronounce it “reets.”
Two types of REITs
There are two types of REITs: Equity REITs and Mortgage REITs. Equity REITs are what I previously defined. On the other hand, mortgage REITs are REITs that hold mortgages and other bond-like obligations secured by real estate collateral.
Because the listed REITs in the Philippines are equity REITs — and, frankly, I don’t see mortgage REITs listing in the Philippines anytime soon — we’ll keep our attention on equity REITs.
More on our Country’s listed REITs in a bit.
Property sectors of REITs
Now that we know REITs invest in real estate properties, it’s helpful to know that REITs typically operate in a particular real estate niche. (Related: Why You Need to Find Your Real Estate Niche for Massive Growth)
As investors, it is important we know where our REITs’ exposures are (i.e., which specific industries) for proper asset allocation. For example, if you’re heavily invested in malls through your businesses or other stock holdings, and if your goal is diversification, then it’s probably best to stay away from REITs that principally control retail/mall properties.
Here’s a non-exhaustive list of property sectors for REITs but bear in mind that a lot of these don’t apply to the current state of REITs in the Philippines. I’m including them here anyway for future reference (or if you’d like to invest in international REITs).
- Apartments
- Retail
- Office
- Industrial
- Health care
- Self-storage
- Hotel
The state of REITs in the Philippines
The first REIT in the Philippines was Ayala-backed AREIT. With delays in their scheduled IPO due to the Country’s lockdowns, it ultimately pushed through in August 2020. This was followed by the DoubleDragon Meridian Park Properties REIT (DDMP REIT) in March 2021.
But what’s interesting is the governing law for REITs is the REIT Act of 2009, or RA 9856. So why then the decade-long delay? Without going into the details, the conditions of the act were too restrictive and economically unfavorable for the companies. There were simply no takers.
This was fixed by the amendments through the Implementing Rules and Regulations (IRR). If you’re interested in knowing the exact changes, here’s a comparative matrix of the amendments to the REIT IRR prepared by the SEC.
With the amendments and lockdowns, we truly really are in the infancy stage of REITs in the country. And that presents a few opportunities.
Why invest in REITs?
Whether or not it’s smart to invest in any asset is usually a question of fit. That is, does it fit your overall portfolio. Is it the superior choice against other assets and how does it behave relative to your other assets.
We’ll talk about its performance against competing assets first, and then discuss its possible role in your portfolio.
REITs vs. stocks
Technically speaking, REITs are stocks. But relative to most common stocks, REITs are much more consistent with their dividends. In fact, REITs are required by law to give out 90% of their distributable income as dividends. See section 4 of the implementing rules and regulations (this link takes you to the LAWPHiL Project’s copy of the IRR).
So what does this mean to you? Is it inherently better to hold dividend stocks?
The answer isn’t as clear-cut. There is a tradeoff between growth and dividends. In theory, a company that doesn’t give out dividends is a high-growth company — they reinvest everything back to the company for its growth.
On the other side of the spectrum are stable and mature dividend-paying stocks such as utilities and REITs.
REITs are for investors looking to add stocks on the dividend-paying side of the spectrum.
REITs vs. bonds
Now, if you are looking for dividend-paying stocks, bonds are the close alternative. Bond interest payments are like the dividends of REITs. Both give out periodic payments to the investor.
So how are bonds and REITs different?
For one, bonds include a guaranteed face value. They include a promise to pay back the principal at maturity. There is no such guarantee for REITs (although large REITs are somewhat stable in today’s age).
Conversely, REITs have the potential for capital appreciation. Because REITs are invested in real estate properties, and because the values of real estate properties potentially appreciate, REITs can grow over time. (See the discussion below, under Choosing the best REITs, on reasons for internal and external growth by REITs.)
But as listed companies with fluctuating values, your investment isn’t guaranteed.
This then comes does to a question of preference. Do you favor growth potential over guaranteed principal?
(Related: The Risk and Return Trade-off Applied in Real life (Uncommon Examples))
REITs vs. rental properties
As I’ve already said, REITs are a fantastic way of gaining real estate exposure. People then naturally want to know which one’s the better alternative. (We’re specifically talking about rental properties in the world of real estate.)
Are REITs better than rental properties?
REITs offer better diversification, more liquidity, they allow real estate exposure with little money, and you do away with property management duties such as repairs, rent collection, or tenant screening.
In contrast, buying physical real estate and rental properties is a harder but possibly more lucrative route. You have full control of your property in terms of upgrades or rental rates; tax deductions are greater; potential for greater returns from leverage; and the greater barriers to entry also mean more upside potential.
In other words, REITs are the easier and more convenient option. Physical rental properties are the harder but potentially more lucrative option.
For most investors, REITs should do fine. But if you’re a real estate investor, know that you’re losing out on potential gains from forced appreciation, home-run deals on small properties, etc.
(See REITs vs. Rental Properties: Which is Better for a more detailed discussion on the differences between the two.)
REITs in a portfolio
Since REITs primarily earn through rental income, and rental rates typically rise with inflation, REITs are consequently a good inflation hedge to add to a portfolio. (But probably not as effective as physical real estate.)
REITs have also been found to have a low correlation with other common stocks. This means the prices of REITs remain relatively stable regardless of what happens to other stocks. It is a risk-mitigating measure — all things the same, adding low correlation assets to a portfolio reduces the portfolio’s risk. See this discussed at Reduce Risk in the Stock Market: Diversification Primer.
All this is saying that REITs lower the overall risk of your portfolio.
How to invest in REITs in the Philippines?
Buying REITs is basically buying stocks in the stock market. If you have an existing account with a stockbroker then you’re set.
For first-time investors of the stock market, open a brokerage account first by selecting from this list of online brokers in the Philippines: https://www.pse.com.ph/directory/#tp1
Once you’ve funded your account, all that’s left to do is search for the REIT of your choice.
List of REITs in the Philippines as of June 2021
- AREIT, Inc. (Ticker: AREIT)
- DDMP REIT, Inc. (Ticker: DDMPR)
Megaworld’s listing is coming soon. Other upcoming REITs in the Philippines include Robinsons Land and Filinvest Group.
(I’ll try to keep this list updated. Please feel free to comment if the information here is dated.)
Choosing the best REITs in the Philippines
Now, this part might be overkill with just a couple of REITs to choose from. But I’m of the mindset that funds are limited and every single investment should make economic sense to you and your portfolio.
Besides, these apply to REITs in general. Understanding the concepts will especially be helpful if you decide to invest in REITs outside of the Philippines.
These factors are what you, the REIT investor, should consider before diving in.
Factor 1: Sector
REITs typically specialize in a particular sector. For example, there are REITs that primarily buy apartments, retails, industrial, etc. You must understand what sectors your REIT is investing in.
How significant of a factor is this?
Consider how, over the last couple of years, you would have had markedly different results from a hotel REIT vs. a data-center REIT.
Factor 2: Location
This might be less of an issue with REITs in our country since they’ll probably diversify their holdings across the Philippines. For example, AREIT has holdings in Makati and Cebu.
For the global investor though, this is a significant factor to consider.
Factor 3: FFO and AFFO
The best measure of performance for REITs is actually NOT net income. Depreciation is a significant item in a REIT’s balance sheet, and using net income presents a distorted picture.
Instead, the Funds from Operations (FFO) or the Adjusted Funds from Operations (AFFO) are used for analysis.
Although you shouldn’t ignore net income, AFFO is the most accurate means for determining a REIT’s free cash flow. Have a look at the formula for AFFO:
AFFO = FFO minus the following
- Recurring capital expenditures
- Amortization of tenant improvements
- Amortization of leasing commissions
- Adjustments in rent
And the formula for FFO:
FFO = Net Income minus Capital Gains from Real Estate Sales plus Real Estate Depreciation If the AFFO is available in the REIT’s disclosures, then use that. But to be honest, if it isn’t readily available, I just use the FFO.
Growth in FFO
The capital appreciation from your REIT is heavily tied to its FFO.
According to the income approach of valuation, an asset’s value is the present value of its future cash flows. Free cash flow is the preferred proxy for future cash flows. What this means is we should be concerned with the growth of our REIT’s FFO.
FFO growth can be explained in two categories: Internal Growth and External Growth
Internal Growth in FFO
Internal growth in FFO can be explained by rental increases, rent bumps, tenant upgrades, savings in expenses, etc.
External Growth in FFO
External growth in FFO is explained by acquisitions, expansions, and other non-rental revenues.
Before investing in a REIT, examine its FFO/AFFO and see if growth is sustainable or not.
Factor 4: WALE
WALE, or the weighted average lease expiry, tells us how long (measured in years) the existing contracts are expected to last and provide a stable income. A higher WALE means greater stability.
For instance, the WALE for AREIT in May 2020 (last year) was 5.8 years. This means you can expect to maintain the level of dividends (probably) over that period.
The vacancy rate is one of the major risks of rental properties and WALE allows us a peek at the level of vacancy we can expect in the future.
Factor 5: Yield
Unsurprisingly, a REIT’s yield is an important factor to consider. We’ve already talked about the alternatives to REITs such as bonds and preferred stocks. If these provide better risk-adjusted returns, then there’s less reason to go for REITs.
Also, by targeting a specific yield, some investors find it sensible to exit when the increase in price results in achieving their targeted yield.
For example, if an investor’s reason for going into REITs is to yield a total of 10% over the next few years, then it makes sense to sell the REIT when the price increases by 10% and realize the profit now.
Conclusion: Should you invest in REITs?
I’d say invest in REITs if you want or need the real estate exposure, particularly in rental income, but prefer the liquidity, ease, affordability, and diversification benefits of REITs. They lower portfolio risk and are a decent inflation hedge.
For real estate investors, it might also make sense to invest in REITs, but to a lesser degree. To me, the greatest benefit for real estate investors is the diversification it affords your portfolio. It’s not a replacement for buying real estate, but it wasn’t intended to be.
