Tips for the budding investor: Real Estate Investment Trusts (REITs) vs Residential Property Investment

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If you have been looking to start investing in property, you may have come across REITs – Real Estate Investment Trusts. For property investors in Singapore, REITs are a pretty popular choice, especially since the cost of investing in REITs has dropped in the aftermath of the CoVid-19 pandemic this year. But can the unique benefits of REITs really trump the benefits of traditional residential property investments? In the long run, which of these would work better for you? Here are 4 factors to consider before you decide.

REITs vs Residential Property Investment - How They Work

In Singapore, the way residential property investments work is pretty simple. When you purchase a residential property in Singapore as an investment, the return on investment (ROI) comes in two forms: the rental income, and the capital gain. By letting out your property to tenants, the rental income the property generates would come in a steady stream of small payments every month, or every few months. The capital gain is the profit that comes in when you decide to sell your property, that is, assuming you sell your property at a price that is higher than what you paid for it.

On the other hand, you can think of each REIT as a large fund that is specific to a particular market in Singapore. Unlike residential property, many people can invest in one REIT at once, and the finances invested will be managed by a professional expert in the market of that REIT. These funds generate income in a different way: through investments in other real estate assets, such as retail establishments. Because of this, the ROI for REIT shareholders comes in the form of a certain portion of this income every few months or so.

REITs vs Residential Property Investment - Pros and Cons

Now we arrive at the common question: which is better – REITs or residential property? Well, there are a few factors that can help us decide:

  1. Cost of Initial Investment
  2. Loan availability and leveraging
  3. Volatility Risk
  4. Effort and additional costs

Cost of Initial Investment - Winner: REITS

Right off the bat, REITs may seem much easier to invest in, simply because the investment sum needed is far lower than for residential properties! You see, in order to purchase a residential property in Singapore, you would need to produce a down payment on the property. This down payment can wind up being up to 25% of the property’s total price, assuming this is your first home. With the buyer stamp duty fees, this can come up to a sum of $275,000 for a $1 million property.  

In contrast, you would invest in REITs by buying a minimum of 100 shares per REIT. So, if we take the Keppel REIT as an example, which is priced at about $1.20 (rounding up) per share, buying a 100 shares would only cost you about $120. You will probably have to pay an additional fee to your broker for each transaction, but all in all, the minimum entry fees for REITs investment will very rarely top those for residential property investment.

Loan Availability and Leveraging - Winner: Residential Property

But the initial cost only captures part of the story. Yes, it’s true that the down payment for a residential property in Singapore will almost definitely be much higher than the cost of buying 100 shares of any REIT. However, some of this 25% can be covered by the funds in your Central Provident Fund (CPF) ordinary account. As for the outstanding balance on the property, most Singaporeans opt to take a housing loan from the bank. Housing loans in Singapore have notoriously low interest rates (about 2 percent), which, if you have the capital, can allow you to leverage better in the years to come. Check out this article for more on leveraging!

Unfortunately no bank will grant you a loan when it comes to investing in REITs though. Because of that, your investment stake for REITs is a bit more limited compared to investing in residential properties.

Volatility Risk - Winner: Residential Property

Of course, one more factor you should consider is that REITs generally have a much higher volatility risk than investing in residential property. This is mainly because in Singapore, we can enjoy fairly stable residential property prices because of the extensive cooling measures put in place by our government. So REITs become more volatile in comparison, especially since the value of each REIT is subject to fluctuations in its specific market.

Effort and Additional Costs - Winner: Depends

Is there any extra work  or cost involved in either type of investment? Yes, absolutely! Strictly speaking in terms of direct effort, residential properties demand more effort than REITs. But whether this is a good thing isn’t quite so straightforward.

In residential property investments, you’d need to actively interact and maintain your property for your tenants. This includes repairs, upgrades, and replacing old appliances to keep them up to date. Of course, these do reduce your ROI at a variable rate, which in part depends on how well your home is treated by your tenants.

In REITs, your ROI is reduced in a more fixed way – after all, the professionals managing your REIT need to get paid from somewhere. But in exchange, you need to put in little to no effort maintaining your investment from year to year. Whether or not this is a good thing actually depends on you. You see, it is not unheard of for REIT professionals to invest in a way that is not in the investors’ best interests. This definitely isn’t seen very often in Singapore if at all, but all the same, investing in REITs demands a certain level of trust from you. So if you’re feeling uneasy about investing in REITs, then you may find residential property investment a safer bet, since you’d have the freedom here to oversee your own investment.

Overall Return on Investment

So, which of these is more likely to generate a higher ROI for you? Given the better leverage, low volatility risk and added control over your additional expenses, property investment might have the edge over REITs. Furthermore, the ROI from residential property investments includes rental income in addition to the capital gains in your initial investment, while the ROI from REITs comes solely from income distributions.

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