Singapore REIT Bonds: An Alternative to Property?

Last week, the URA released figures suggesting that private residential prices fell -0.5% quarter-on-quarter in 4Q 15, bringing the 2015 full year decline in prices to -3.7%. This comes after private residential prices fell -4% for the whole of 2014, while the vacancy rate also headed higher to 8.1%. In an environment where capital gains from property investments are becoming harder to achieve, should investors be looking at bonds issued by Singapore Real Estate Investment Trusts (REITs) as a viable alternative? Let's take a closer look at what the S$6.875 billion SGD-denominated Singapore REIT bond market can offer to investors.

• Fixed coupons
• Capital preservation
• Absence of taxation
• Tenors are shorter and certain

Fixed coupons

Unlike bond coupons which are fixed, rental rates of Singapore properties have the flexibility to move based on supply and demand. Thanks to rising vacancy rates and a huge looming supply (55,638 private residential units in the pipeline, as of end-Dec 15), rental rates have been on a downtrend in recent years, with URA rental indices declining between -5.4% and -9.3% from their previous highs (as of end-Dec 15). In contrast to rent, bond coupons are fixed at the point of issuance even as bond prices fluctuate – an investor can thus lock in a fixed yield (based on prevailing market prices) in a REIT bond. At the time of writing, even as investors are looking at yields in the low 1% range for short maturity debt of some of the larger REITs, you can still lock in yields approaching 5% for bonds issued by REITs with smaller asset bases.

Capital preservation

While property has traditionally been viewed as the investment vehicle of choice to grow one's wealth, falling property prices won't do much for your capital preservation needs in the interim. Bond investments preserve capital in the sense that bond principal has to be repaid upon maturity. Consequently, while you won't profit from REIT bonds if property values spike, you also won't be penalised if property prices slump, since the principal amount is fixed.

Absence of taxation

Even if the 3-3.5% average market rental yield (as cited by SRX in May 15) sounds fairly reasonable, cash buyers should take a closer look at the various taxes incurred in owning and renting out a property. Under IRAS taxation rules, rental income on property is subject to income tax, while you'll also pay higher property tax on your residential property if you rent it out, as opposed to enjoying a concessionary "owner-occupiers tax rate". Add to that the costs incurred for maintenance and conservancy fees, and your rental yield drops considerably. And if you're looking to sell your property early, you may even be subject to Additional Buyer's Stamp Duty! On the other hand, both capital gains and coupon payments from bonds are not subject to Singapore taxation, unless you're solely in the business of trading bonds.

Tenors are shorter and certain

While property generally does not have a "maturity" date (looking at the Freehold or 99-year status provides some guidance), bond tenors are generally much shorter and provide much more certainty. At this juncture, you're looking at the option to buy REIT bonds maturing in 1 to 8 years; you'll get your principal back upon maturity while your stream of cash flows are fixed (and legally binding) and will be paid in a timely fashion. In contrast, tenants may terminate rental contracts prematurely or renegotiate for lower rents, leaving you with uncertainty in cash-flows from your rental property.

Why not REITs?

Astute readers will point out that we've compared REIT bonds to a typical physical property investment, but not talked about their merits in comparison with actual REIT investments. As we've discussed previously in Understanding Real Estate Investment Trusts (REITs), REITs share similar characteristics with physical property – a REIT's Net Asset Value is dependent on the market value of underlying real estate, while distributions are also a function of the rental values achieved on the REIT's property assets. REITs may also not provide the required capital preservation qualities you desire - the Phillip Spore Real Estate Income Cl A SGD has posted as a -10.4% total decline (as of 27 Jan 16) since we highlighted our caution on valuations in the sector back in April 2013 (see Singapore REITs: Time For Some Caution?).  

If you're a property investors looking for an alternative asset class which can combine the benefits of capital preservation and a stable stream of income, why not consider an investment in a Singapore REIT bond today? Read Singapore REIT Bonds: Two Higher-Yielding Investment Strategies to find out more!