In an investment world suffering from thirst because of zero interest rates, real estate is cool water.
As we’ve written recently, government bond yields in many markets are negative, or at historically low levels. This is due in part to quantitative easing efforts by central banks, and a “flight to safety” by investors eager for certainty – even if the “certainty” is that they’ll lose money in government bonds.
As a result, the yield on a ten-year U.S. Treasury bond is now at 1.48 percent. For Japan and Germany, 10-year bonds now have negative yields. And in Switzerland, all government bonds that mature within the next 30 years pay negative interest.
Singapore and Hong Kong bonds aren’t much better
Singapore’s government bonds are not in the negative yield club yet. But they are at historic lows. Right now on a 10-year government bond, Singaporeans will earn just 1.75 percent a year for the next ten years. Hong Kong’s bond yields are at historic lows, too. A ten-year sovereign bond is paying just 0.85 percent.
Extremely low bond yields are a problem for investors searching for income. They don’t want to earn (literally) less than nothing owning government bonds. Real estate is one answer.
Real estate vs. bond yields
In a recent study, commercial real estate giant Colliers International suggested that the Asia Pacific real estate market may benefit from Brexit. This is in part because Great Britain’s exit from the EU may result in more market uncertainty and a “flight to safety” by investors, and thus lower bond yields.
This may push some investors to look more closely at real estate as an investment option for yield. (Also, of course, lower interest rates make borrowing cheaper – which helps boost real estate returns.)
Lower government bond yields make the yield on rental properties that much more attractive by comparison. The table below shows the spread, or difference, between 10-year sovereign bond yields and the yield earned on real estate investment trusts, or REITs.
REIT and Bond Yield Spreads
A REIT is a publicly traded company that owns a collection of properties that produce rental income. Most of this rental income is then paid out to REIT shareholders in the form of a dividend. You can buy and sell REITs like a stock, paying just the brokerage transaction fees.
The income earned on a basket of investment properties – as reflected in the Hang Seng REIT Index – yields 4.9 percentage points more than a 10-year Hong Kong government bond. For Singapore, it’s a difference of 3.9 percentage points.
Lower for longer
Thanks to Brexit, interest rates will probably stay low for longer than many investors anticipated. The U.S. Federal Reserve, America’s central bank, will likely delay its next interest rate hike in part because of the economic uncertainty that came with the Brexit vote.
Because Hong Kong’s dollar is pegged to the U.S. dollar, Hong Kong’s interest rate policy follows what the U.S. does. That will keep lending rates down, real interest rates negative, and property prices high.
The Singapore dollar is not pegged to the U.S. dollar, and its central bank doesn’t adjust interest rates as part of its monetary policy. But, rates in Singapore generally mirror what’s happening in the U.S. So, as long as U.S. rates stay low, Singapore rates will stay low as well.
The REIT way to buy real estate
REITs are a low-priced and convenient way to buy real estate, and earn a far higher yield than government bonds, or many other yield-generating assets. But a REIT carries a lot more risk than owning a government bond. U.S. Treasuries, or government bonds, are viewed as “risk-free” – there’s virtually no chance of default.
REITs, though, trade like a stock and their prices fluctuate – and they could cut their dividends. And any increase in interest rates could hurt the dividend – and share price.
There are a number of REITs listed in Singapore and Hong Kong, but no good way to buy a basket of them. Besides the FTSE Straits Times REIT Index (noted in table above), the Singapore Stock Exchange (SGX) has a REIT index. It tracks 34 REITs that own everything from shopping malls to office buildings to residential properties. It has a yield of 5.8 percent, but is not available as an ETF. (The full list of the REITs that make up the index can be found on the SGX website.)
The Hong Kong Exchange has 11 listed REITs, 5 of which deal exclusively with mainland China property. The full list of Hong Kong-listed REITs can be found on the Hong Kong Exchange website.
If you would rather own a basket of REITs, instead of just picking one or two to invest in, you can try a U.S. REIT ETF. The yields on U.S. REITs are a little lower, but it will still give you some exposure to the real estate sector – and a higher yield than government bonds. One of the most popular is the iShares U.S. Real Estate ETF (New York Stock Exchange; ticker: IYR). It currently yields 3.6 percent and tracks a basket of U.S. REITs.