5 Mistakes That First Time REITs Investors Make
Some investors are extremely excited to dive into a high-income investment when they hear about one, while some are more passive to invest in the various instruments. Before we get too excited about REITs, let’s look at some of the most common mistakes that first time REIT investors will make.
1) Going for high yield REITs.
Many of the amateur investors, including myself previously, will tend to get attracted by REITs with high dividend yields (distribution per unit, DPU). However, those REITs might not have the best returns overall. Let’s take a look at the formula:
Dividend Yield = Annual Dividends Per Share / Price Per Share
With 2 variables on the right side of the formula, it does not mean that high dividend yield provides you with a high amount of annual dividends. It could be due to the low price per share. Furthermore, some investors do look at increasing dividend yields and we should be very careful here as we need to look at the stock prices.
Some investors may choose to hold on to a high dividend yield REIT even though the stock price might be falling. One example will be the Soilbuild Biz REIT.
Stock Price Returns
Total returns taking account into the falling stock price and dividend yield, your returns will be:
Well, the high returns don’t seem that attractive after all. So before you click that buy button on the high yield REIT, look at what contributes to the high yield. Is it due to falling stock price? Or is it really due to the increasing dividend payout?
2) Purchasing only undervalued REITs.
Once again, you would have guessed this. Similar to the reason above, we often look at low price-to-book ratio for “undervalued” REITs. Let’s take a look at the formula:
Price-to-book ratio = Price of stock / Book value of stock
Hence, low PB ratio (<1), could be due to low price of the stock or high book value of the stock. We would certainly want to be looking for the latter. One point to note is to look at the range of PB ratio for the last 5 years of the REIT. There are certain REITs that are constantly overvalued, such as Parkway Life REIT. It does not mean that these REITs are bad, but rather, we should look at the PB ratio range to determine if it is undervalued or overvalued at that point of purchase. For example Parkway Life REIT PB ratio floats between 1.3 to 1.6 for the past 5 years, and it drops to 1.2 at the point of purchase due to rising book value, you could actually consider it as “undervalued”.
3) Ignoring gearing ratio completely.
One of the most important factor that is often being ignored will be the gearing ratio. Gearing ratio as mentioned in Get Rich With REITS article, is the amount of leverage for debt the company undertakes. By ignoring this, you might probably be exposing yourself to more risk than you would like to be exposed to. For companies with gearing ratio more than the 45% limit, they would be exposed to huge interest rate risks and your shares might be potentially diluted if they were to issue new shares to raise the capital for debts repayment.
4) Selecting the wrong REITs sector.
As sectors are cyclical in nature, selecting a wrong sector would hurt your investments. When the economy is good, people tend to indulge more and spend more on luxury goods like travelling and shopping. This gives an extra boost to the hospitality and retail REITs. To determine whether or not the economy is good, one quick and dirty way is to look at the Purchasing Manager Index (PMI). This measures the economic health of the manufacturing sector. If it is more than 50, it suggests that the economy is undergoing expansion. The current PMI index of Singapore is at 52.6 at this point of writing, and previous months PMI index has been steadily increasing, which suggests that the economic health is still in the “expansion” state.
5) Buying on downtrend and holding it for the yields.
I admit that I have made this fatal mistake of holding a REIT purely for its dividends before. By buying on downtrend was already a mistake so do cut your losses instead of holding your REIT and watch the price tumble. Do check for the trend before investing in your REIT and avoid at all costs, buying on a downtrend. Although the theory about “what goes down must come up” is probably true, being a retail investor, how much losses are you able to stomach before the price bounces up again? As a smart retail investor, you would know how to cut your losses and buy it on an uptrend, right?
In summary, these are some of the mistakes that most first-time REIT investor would have made and should be avoided. Being a retail investor, we cannot control the market and the best we could do is to follow where the funds flow to.