Beware of Dividend Yield Trap in REIT!

Recently, a friend of mine highlighted the trap of investing into REIT with high dividend yield. He cited that investing into REIT should not be based on dividend yield of the REIT alone and investors should also take the following factors into consideration:

a)      Fundamentals of the properties

b)      Stability of income from the properties

c)      Occupancy rates and more.

For example, Tower REIT (TWREIT) owns 2 buildings, namely Menara HLA in Jalan Kia Peng and HP Tower in Bukit Damansara. TWREIT used to own Menara ING sited in Jalan Raja Chulan but it was sold some years ago.

Both Menara HLA and HP Tower are prime commercial office buildings in Klang Valley.  However, the performance of both buildings has not been encouraging due to decline in occupancy rates.

Menara HLA is 69% occupied as at end-2015 (2012: 99%) whereas HP Tower is 73% occupied as at end-2015 (2012:80%). Persistent decline in occupancy rates is not a good sign to REIT investors. 

Moreover, the outlook of office sector in Klang Valley has been challenging due to rising supply of offices, hence tenants will have better bargaining power and this will not bode well to TWREIT.

Average dividend yield of TWREIT stood at 7% in 2013, an investor who is attracted to the high yield and bought into TWREIT in 2013, is likely to have an under-performing investment by end-2015 due to the following:

a)  Decline in distribution per unit from 10.70 sen per unit in 2013 to 6.93 sen per unit in 2015 partly due to the loss of income from Menara ING following the disposal. Average yearly dividend yield was around 5.3% from 2013 to 2015. Although average yield was 7% in 2013, the yield declined subsequently due to lower distribution per unit.

b) Decline in TWREIT’s unit price from the average price of RM1.53 in 2013 to RM1.23 in 2015, translating into 19.6% unrealized capital loss assuming the purchase cost is RM1.53 per unit.

c) Although investor would have earned approximately 16% dividend return over 3 years, the 16% dividend return will be easily wiped off by 19.6% unrealized capital loss, leaving investor with negative 3.6% total return for 3-year investment period.

d) If an investor consistently makes negative return, it will be damaging to the wealth accumulation process.

If a REIT offers high dividend yield, always find out the reasons behind the high yield because the high yield could just reflect high investment risk in some instances!

To avoid being trapped, buy good REIT at an attractive price level. Good REIT does not mean the share price will not drop, sometimes it may drop due to market sentiment and so long it is not due to fundamental issue, I believe the REIT’s price will eventually recover or scale new high!