With the extended low yield environment and the recent rally of the Singapore REITs, we are seeing some of the REITs are trading at their historically low yields. Traditionally, many investors will chase for high yields. Is high-yielding REITs always outperform the low-yielding REIT? In this post, we will discuss one of the critical consideration for REITs investors:
Low yield vs high yield, which is a better REITs investing strategy?
Is slow and steady-going to win the race?
When it comes to dividend investing, a higher yield stock is always preferred as compared to a lower yield stock. Many dividend investors will chase for high yields to boost their passive income in the short term. The same principle applies to REITs investing as well. While the high-yielding REITs might be an acceptable choice for some higher-risk investors, it isn't necessarily the right choice for conservative dividend investors who seek stable and predictable dividends. Also, a high-yielding REIT may not necessarily outperform a low-yielding REIT.
Let's start with a hypothetical example.
Investor A invests in a high-yielding REIT which pays a 10% dividend yield every year while investor B invests in a low yielding REIT which pays 4% yield. The low-yielding REIT offers a much lower return, but the REIT manager manages to grow its portfolio dividend payout by 8% every year.
High yielding REIT – 10% yield every year (10% Yield)
Low yielding REIT – 4% yield and 8% distribution per unit growth every year (Dividend Growth)
The share prices for both of the REITs remain unchanged for 25 years
All dividends are reinvested every year.
Below are their portfolio performance over the years.
Investor A, the high yield investor (Blue line int he graph), beats Investor B (Orange line in the graph) during the beginning years. But Investor B caught up in year 23. The total dividends received by Investor B are 50% higher than that of Investor A. Investor B received lower dividends initially but was rewarded with future growth.
The example above is a hypothetical scenario where a low-yielding REIT with dividend growth can outperform a high-yielding one in the long run. Of course, one can argue that it is tough for a REIT to maintain a distribution per unit (DPUs) growth of 8% for 25 years. But it is also not easy for a high yield REIT to pay 10% yield every year either.
The key point that we want to highlight here is that a stable and predictable DPUs is much more important than high dividend yield!
Most of the time, a REIT with high dividend yield has a higher leverage ratio and is highly sensitive to changes in rates. Also, high dividend yield may not be due to high DPUs; the drop in share price could be the reason as well.
For example, Sabana REIT (SGX: M1GU) has been maintaining its yield in the range of 8 to 10% from the year 2013 to 2018. However, when we take a closer look, the DPUs dropped from 9.38 cents in 2013 to 3.18 cents in 2018.
How did the REIT maintain a high yield while the DPUs are declining?
The 60% drop in price supported the high yield over the years!
If you would have attracted by Sabana's high yield and bought the REIT in 2013, your yield on cost in 2018 is less than 3%!
Source: Technical chart from investing.com
Without going into further details, the drop in DPUs and share price of Sabana REIT are a warning sign to suggest that there are fundamental issues on the REIT.
On the other hand, if we look at Mapletree Industrial Trust (SGX: ME8U), the REIT has been offering a dividend yield in the range of 6 to 7%. The yield has declined slightly over the years. However, the DPUs has been in the uptrend since 2013.
The annual dividend growth in the past five years was 5%!
The yield has been declining because the share price has been trending up for the past five years. This indicates that the REIT is doing well, and more investors are interested in holding the REIT which causes the demand to go up. Investors not just enjoy the higher dividend payout, but also benefiting from capital appreciation due to the increase in share price.
Source: Technical chart from investing.com
It should no surprise that chasing high yield is risky. As tempting as it may be, our REITs strategy is to always focus on dividend growth and quality portfolio instead of yield alone. Over the long run, the portfolio growth is driven by utilizing a time-tested strategy that includes fundamental analysis, qualitative evaluation and portfolio re-balancing approach.
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