3 Pros And Cons Of Investing In REITs With Offshore Properties

Daniel Lee

3 days ago4 min read

REITs with overseas properties offer investors a way to diversify their portfolio beyond the local market, but they also come with unique advantages and challenges.

Like it or not, there has been an increasing trend for REITs in Singapore to expand their foothold abroad and acquire properties outside of Singapore.

As such, before diving into REITs with foreign assets, it's essential to weigh the pros and cons to understand how they may impact your portfolio.

In this article, I will present to you 3 pros and cons of investing in REITs with offshore properties so you can make an informed decision.

Advantages of Offshore Exposure

1: Freehold Property Status

Many overseas properties, especially in regions like Australia, Europe or the United States, come with freehold status. This provides a more permanent ownership structure, potentially making them more attractive for long-term investors seeking property with lasting value as they will not have to deal with the impacts of lease decay.

However, investors should take note that not all countries offer freehold status on their properties. Countries like China operate based on a leasehold structure that is similar, if not more stringent as compared to Singapore.

For context, the majority of the China properties in REITs such as Sasseur REIT and CapitaLand China Trust have an underlying land lease that expires around 2040s to 2050s while the China properties in Keppel DC REIT have an underlying land lease that expires around 2060s.

As a result, the impact of lease decay may still be present and you should always check the underlying land lease of the portfolio of the REIT instead of working with the assumption that all overseas property offers freehold status.

2: Higher Capitalization Rates

Properties in overseas markets often have higher capitalization (cap) rates compared to Singapore properties. The cap rate is calculated by dividing a property’s net operating income by the current market value.

This higher cap rate translates to greater returns for investors as overseas properties, particularly in markets like Australia and the U.S., tend to provide stronger rental yields.

As a rough gauge, the capitalization rates of Singapore vs. Overseas properties are as follows:

For those seeking higher income, these REITs can offer more attractive returns.

3: Access to More Opportunities

Investing in REITs abroad offers access to a wider variety of investment options that may be limited in Singapore. Specifically, in sectors such as industrial real estate, countries like China or Australia are likely to experience higher demand and better performances because of their focus on manufacturing and export-driven economies.

These regions offer industrial and logistical properties with higher growth potential than the more land-constrained Singapore which often focuses more on commercial properties such as shopping malls and office spaces.

Therefore, based on your investment strategy, it may be necessary for you to invest in REITs that own properties abroad in order to achieve the desired level of exposure.

Disadvantages of Offshore Exposure

1: Foreign Exchange Risk

One of the biggest risks with overseas REITs is foreign exchange (forex) risk. Since the property income is in foreign currency, any depreciation of the foreign currency against the Singapore dollar could significantly reduce returns.

Even if the properties perform well, forex fluctuations can erode the actual value of dividends for Singapore investors. Furthermore, given the historical strength of SGD, the odds are against investors who invest in overseas properties.

A classic example of this is CapitaLand India Trust, which has witnessed a consistent decline in its DPU despite performing spectacularly well in local currency terms. Since 2018, SGD has strengthened by almost 40% which has eroded any growth in the performance of the REIT.

While the impact of FX losses can be mitigated via hedging to a certain extent, the effectiveness of the hedging largely depends on the cost associated with it and the REIT manager’s ability to pull off a proper hedge.

2: Political and Economic Risk

Overseas REITs are also exposed to geopolitical and economic risks that are often less pronounced in Singapore. Changes in government policies, political instability, or economic downturns can negatively affect the property market in a foreign country. Investors in such REITs face greater uncertainty compared to the stability found in Singapore's resilient property market.

3: Different Market Dynamics

Foreign property markets operate under different demand and supply dynamics, which can impact property valuations and rental yields. For example, some overseas markets may face over-supply in certain sectors, leading to weaker rental demand.

Investors may also encounter challenges like cultural differences in tenant behaviour or weaker rental resiliency compared to the Singapore market. This variability can add uncertainty to the performance of overseas properties in a REIT's portfolio.

An example of this can be seen in the US office REITs (Keppel Oak, Manulife US, Prime REIT) which have seen massive drawdowns due to the major headwinds (due to WFH trends) in the US commercial space that resulted in low occupancy rates and devaluation of their properties.

Contrast that with the performance of Singapore office REITs (Keppel and Suntec REIT), it is evident that the difference in market dynamics can work both ways for investors.

Conclusion

Investing in REITs with overseas properties offers exciting opportunities but also comes with heightened risks.

While the prospect of freehold status, higher cap rates, and access to more opportunities in foreign markets is enticing, factors like forex risk, political uncertainty, and varying market dynamics should be carefully considered.

Investors looking to diversify their REIT portfolio should weigh these pros and cons to determine if overseas exposure aligns with their risk tolerance and investment goals.

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