Fortunes have been made from property. Fortunes have also been lost on property. Have you ever wondered why?
How is it possible that bricks and mortar or a parcel of land can have such
a profound effect on wealth?
The simple answer is that land is a finite resource. In theory, property
prices should rise over time, as rising economic activity and population
growth drives demand for the available space.
Property prices tend to rise over time. That is primarily why many people
are attracted to it as an investment.
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MOTLEY FOOL STOCK ADVISOR GOLD MAY 2017
In-built growth mechanism
Identify REITs that can consistently
deliver
Build your portfolio
Aim to include some REITs for
balance
Income for life Spend or reinvest
your quarterly REIT distributions
EFFORTLESS GROWTH
Invest well and watch your REITs grow
1DO-IT-YOURSELF
Learn how to select the most reliable REITs
2LOW MAINTENANCE
No need to constantly buy and sell your REITs
3
How To Turn Your REIT Dreams Into Hard Cash
Written by David Kuo
One way bet Property can have terrible periods, as
well as stretches of quite spectacular
ones. It cannot - as much as we would
l i k e - e s c a p e t h e e c o n o m i c
fundamentals of supply and demand.
When demand for property exceeds
supply, prices could rise. But when the
opposite happens, prices could just as
easily fall.
Consequently, the cyclical nature of
property can both create and destroy
wealth. But that’s not the entire story. No
it’s not….
“…the cyclical nature
of property can both create and destroy
wealth.”
Property can also be a very expensive
asset to buy. Don’t we know it?
That invariably means that a visit to a
friendly bank manager is somehow
involved along the way.
That can add extra layers of risk to
property ownership. These could
include the outlook for interest rates,
the prevailing state of the economy,
geopolitical considerations, changes to
demographics and the availability of
credit. They all have a lot to answer for.
So who, in their right mind, would ever
want to get involved in the property
market, if it can be so inherently risky?
Many do, is the simple answer.
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MOTLEY FOOL STOCK ADVISOR GOLD MAY 2017
H e r e , t h e r e a nd everywhere Take a look at the number of property
developers, landlords, house builders
and construction companies that
populate not only the Singapore stock
market but many overseas markets too.
Our Singapore market for instance,
especially our mid-caps, would look and
feel quite different, if not for the many
Real Estate Investment Trusts or S-REITs
that lend their weight to the index.
REITs, which vary considerably in size,
can be interesting investments. Some
people might even try to tell us that
they are so unique that they should be
treated as a separate asset class.
But let’s put that bit of misinformation to
rest straight away. They are not.
There are only four asset classes. In other words, there are only four types of investments we can hold that will provide us with income. For that reason, gold is not an asset class, despite what some might say.
Soft and hard commodities, which
include iron ore, palm oil, cotton and
belly pork, are also not asset classes.
Hedge funds are not a separate asset
class either, though some might try to
convince us that somehow they are.
Same goes for private equity funds.
They, too, are not a separate asset class.
There are only four types of investments that generate income:
1. Cash 2. Bonds 3. Property 4. Shares
Classy assets Cash, bonds, property and shares are
the only four asset classes. To qualify
they must generate income.
Cash pays interest; bonds deliver
coupons; shares distribute dividends,
while properties yield rent.
REITs invest in income-generating
properties. They might invest in
shopping malls, commercial buildings,
accommodation and industrial parks,
which are rented out. Some even invest
in telecommunication towers.
These assets generate income which
can reward investors with distributions.
These payouts are a share of the
income that REITs derive from their
property. Distributions are, to all intents
and purposes, dividends, which mean
that REITs are, essentially, income-
generating shares.
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MOTLEY FOOL STOCK ADVISOR GOLD MAY 2017
Confusion reigns The potential for confusion lies in the
rules that govern the way that REITs
operate.
Unlike shares, REITs do not have
discretion, when it comes to paying
dividends. They are required to pay out
at least 90% of their profits as dividends
to investors, whether they like to or not.
There are no ifs. There are no buts.
By paying out almost all of their profits
to shareholders, REITs are, in turn,
afforded a favourable tax status. They
are virtually exempt from paying any
corporation tax.
That was one of the main reasons why
they came into existence, in the first
place.
“REITs are required to pay out at least 90% of their profits as dividends to investors, whether they like to or not.”
A potted history REITs were first introduced in the US
around 50 years ago to encourage
investors to pool their money in the
property market. The idea caught on in
other countries later on.
Thing is, developing property on a
massive scale can be costly… very
costly. But if property investors were
taxed once at the corporate level and
again at the personal level, who would
want to do it?
The answer is not that many. But a
favourable tax treatment might.
So REITs, with their favourable tax status,
provided developers with the capital
they need to build more. Meanwhile,
towns and cities benefitted from much-
need construction.
A REIT would only receive preferential
tax treatment, if it paid out nearly all its
income as distributions to investors.
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MOTLEY FOOL STOCK ADVISOR GOLD MAY 2017
So, the attraction of REITs lies in their
ability to generate long-term rental
income for shareholders, who are also
known as unit holders.
Investors buy REITs for both the
r e c u r r i n g i n c o m e a n d p r i c e
appreciation, should the properties
held by REITs rise in value over time.
Show me the cash The income-producing characteristics
of REITs can create some curious but
interesting results.
Since payouts might be thought of as
being somewhat predictable, REITs are
often seen as proxies for bonds. They,
like bonds, could be capable of
delivering dependable income for
investors, over the long term.
But just as bond prices might move in
the opposite direction to interest-rate
movements, the prices of REITs have a
tendency to do the same.
When interest rates rise, investors would
probably want to pay less for each unit
of a REIT to generate a comparable
return from, say, a risk-free investment,
such as a government bond.
Similarly, when interest rates fall,
investors might be prepared to stump
up more to capture every dollar of a
REIT’s distribution.
There is another reason why REIT prices
might move in the opposite direction to
interest rates movements.
“Investors buy REITs
for the recurring
income and price
appreciation.”
That is because REITs tend to borrow
money to buy property. So, higher
interest rates could, say, result in heftier
interest payments, which, in turn, could
sap distributions available to investors.
The prospect of lower distributions in
the face of rising interest rates could,
therefore, depress the share price of
REITs.
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MOTLEY FOOL STOCK ADVISOR GOLD MAY 2017
Here’s the rub Rising interest rates - rather than hurting
REITs – could even benefit them.
Interest rates generally rise because the
rate of inflation could be on the
increase. In order for central banks to
keep a lid on inflation, they need to
ensure that their interest rates are
sufficient to bear down on rising
consumer prices.
But in an inflationary environment, REITs
could justifiably charge higher rents,
which could result in more rental
income and, in turn, higher distributions
to shareholders.
Put another way, a REIT’s performance is
in f luenced by preva i l ing credi t
conditions and the economy. We should
try to keep that in mind when we are
thinking about investing in REITs.
In theory, if either the economy is doing
well or credit is readily available, then
REITs should be capable of doing well
too. That should ensure regular
distributions to investors.
As income from REITs is often the
primary objective for many investors, it
is perhaps understandable why they
might pay so much attention to their
yields. That is just one way to assess a
REIT. But it is not a reliable way of
looking at REITs.
Nevertheless, it can be a good starting
point.
The pecking order Current ly the average y ie ld on
Singapore REITs is around 7%. That is
almost twice the yield for the Singapore
market.
In every instance, the yield on S-REITs is
higher than the market average. That
could imply that almost every one could
be a good prospect.
But it is important to dig a little deeper,
to avoid jumping to the wrong
conclusions, or worse still, jumping into
the wrong investment.
The average yield on
S-REITs is 7%.
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MOTLEY FOOL STOCK ADVISOR GOLD MAY 2017
It is important to consider that a high
yield might not automatically equate to
a good investment.
The yield is made up of two separate
components – the dividend, which is the
numerator, and the share price, which is
the denominator. A high yield could,
therefore, be the result of a dividend
that is too optimistic or a share price
that is too pessimistic.
We need to figure out why….
Cash is King Distributions by a REIT have to be paid
from income. So it is crucial that
a n y t h i n g t h a t i s p a i d o u t t o
shareholders is adequately covered by
profits.
The higher the coverage, the better and
safer it could be. It means that the REIT
does not have to work too hard to meet
its obligations.
Dividend coverage varies amongst the
30 S-REITs. The median coverage is
around 1.05. In other words, for every
dollar paid out as dividends, there is
$1.05 of profit behind them. But there
are differences between the best and
the worst.
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MOTLEY FOOL STOCK ADVISOR GOLD MAY 2017
The dividend coverage is noticeably
lower than for shares, in general.
Typically, dividend coverage of around
two times profit for most shares is
desirable. It allows the company to
retain some of the profits to grow the
business.
But REITs are different.
They are required to pay out most of
their income as dividends to qualify for
the favourable tax treatment. Them’s the
rules. So that’s why the dividend
coverage is lower.
However, profits are not a reliable way
to look at REITs. No they are not. There
are much better ways to gauge the
health of REITs and their payouts.
But first, a look at one of the major
expenses for REITs – interest payments.
Interesting times REITs typically borrow heavily to fund
their purchases. So, it is important to
ensure that not only are dividends
adequately covered but that interest
payments can be easily met too.
In the case of S-REITs, on average the
profits are more than three times higher
than interest payments. The median
interest cover of 3.8 times suggests that
S-REITs are in reasonably good health.
In fact Singapore REITs could probably
afford to borrow more. Some can. But
some are unable to do so.
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MOTLEY FOOL STOCK ADVISOR GOLD MAY 2017
Changing gears The reason why some can’t is not too
hard to understand. There are stringent
regulations in Singapore that restrict
how much REITs are allowed to borrow.
The ceiling for the amount of debt
taken on by REITs has been capped by
the Monetary Authority of Singapore at
45% of Total Assets. In other words, the
gearing must be below 45%.
Currently, the median gearing is a
modest 34%, which might suggest that,
on average, S-REITs could have room to
borrow more, if they wanted to.
However, averages can be deceptive.
Some REITs have borrowed less than
30% of their Total Assets. But some are
already closing in on the limit of the
debt ceiling.
So what’s better – to have too much
debt or not enough borrowings?
Is lesser better? There are a couple of implications to
the assumption of debt. And it may not
always be the case that a lower level of
borrowings is necessarily better.
Debt, i f used judiciously, could
significantly improve shareholder
returns because the business is using
other people's money.
But too much debt could also be
detrimental. Oh yes it can.
It can restrict the amount of money that
a company could borrow at a later date
to pay for new acquisitions. When that
happens, the REIT might pass around
the begging bowl for more cash.
Debts also need to be either repaid or
refinanced when the loans mature.
There are no guarantees that either of
those two things could happen, when
the lender comes a knocking. Again, the
indebted REIT might have to tap
shareholders for cash.
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MOTLEY FOOL STOCK ADVISOR GOLD MAY 2017
Leverage Ratio The Leverage Ratio could provide some
help in determining a REIT’s exposure
to debt. It measures the total amount of
liabilities compared to total assets.
The average Leverage Ratio for the
Singapore market is around 1.7. It’s
similar for REITs. Their median Leverage
Ratio is around 1.6.
A high Leverage Ratio can improve the
Return on Equity. It can have a powerful
multiplier effect on the profits that a
REIT generates for shareholders. So it
can be tempting to lean towards REITs
that have substantial leverage.
But it’s not easy to tell when a REIT has
borrowed too much. It can creep up on
you just like when we have been
overeating, and one day we can no
longer fit into our clothes.
Fix it Another useful measure is to compare a
REIT’s long-term borrowings to its short-
term debts.
When interest rates are falling, REITs
that predominantly use short-term loans
can benefit. It means that they could
refinance loans at more favourable rates
when the debts mature.
But if interest rates should rise quickly,
they could be disproportionately hurt.
On the other hand, REITs that have
taken on longer-term loans could be
insulated from interest-rate rises, until
they need to refinance at a later date.
Less than 2% of S-REIT debts are short-
term loans. This might suggest that on
average Singapore REITs could be
adequately shielded from short-term
interest rate hikes.
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MOTLEY FOOL STOCK ADVISOR GOLD MAY 2017
By the book We should never lose sight that REITs
are property assets. So it is important to
think of them as such. We should weigh
up carefully how much we are paying
for every dollar of Net Asset.
In the same way that you would
probably balk at overpaying for a house
or a condo, the same goes for buying a
REIT. They are, after all, just a collection
of income-generating bricks and
mortar.
One way to assess REITs is to look at
their book values. Since the properties
held by REITs are appraised regularly,
the book value should provide a
reasonable gauge.
Currently, Singapore REITs are, on
average, trading at a small discount to
their book values, though some are
trading at quite a hefty premium.
There could be valid reasons why the
market might be pessimistic. An
economic slowdown could make some
properties less valuable.
“One way to assess
REITs is to look at
their book values.”
Remember the market is always looking
forward to what it thinks might happen.
There might also be perfectly good
reasons why the market could be
prepared to pay a premium for some
REITs. Prize assets in prime locations are
highly valued. They might also rise in
value, faster than other properties.
The best time to buy a REIT is when the
market is under-appreciating the value
of its assets. In other words, the best
opportunities could be when a REIT is
either not trading at a massive premium
or at a discount to its Net Asset Value.
That could happen for all sorts of
reasons. Irrational market behaviour is
not uncommon.
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MOTLEY FOOL STOCK ADVISOR GOLD MAY 2017
Show me the money Another way to view REITs could be to
consider how much we are paying for
every dollar of cash that they generate.
Cash is not the same as profits.
So, a better way to value REITs might be
to look at their Funds from Operation
(FFO), rather than profits. In some
countries, FFOs are reported as a
matter of course in a REIT’s accounts.
But not in Singapore, yet.
That said, it is not too difficult to work
out the numbers for ourselves.
Currently, the median Price-to-FFO for
S-REITs is a not-too-demanding 14. It
means that investors are paying around
$14 for every dollar of cash generated.
Cash is probably more useful than
profits, which tend to be complicated
by accounting rules that require REITs to
d e p re c i a t e a n d a m o r t i s e t h e i r
properties. REITs also have to account
for non-recurring items such as the
disposal or purchase of properties.
Property values tend to rise over time
rather than depreciate. But general
accounting rules require properties to
be depreciated over their lifetime. The
upshot is that the reported profit
number could underestimate the cash
generated by the asset.
Additionally, REITs tend to hang on to
their properties for ages. In fact, we
should be a little concerned if a REIT
buys and sells buildings too frequently.
So the purchase or sale of a building is
not something that they do regularly.
But by general accounting rules, the
gains or losses from the disposal of
buildings have to be accounted for in
the profit figure. That’s the way the
cookie crumbles.
Consider how much you are paying for every dollar of cash
that the REIT
generates.
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MOTLEY FOOL STOCK ADVISOR GOLD MAY 2017
Capitalisation rate A common problem with comparing
different REITs is that it can be a bit like
comparing almonds with pistachios.
That’s just nuts.
Is it really possible to compare, say, a
REIT with prime properties in the
Central Business District with another
REIT that owns a portfolio of suburban
malls? Which is better?
It’s not easy. But capitalisation is a way
of solving the problem. It looks at the
rate of return that a property owner
expects to achieve from its assets. It is a
measure of the annual income that a
REIT generates from its properties.
At present, the median capitalisation
rate for S-REITs is around a 6%. It means
that they are able to generate roughly
$6 from every $100 of property assets.
It implies that S-REITs are relatively low
risk because they are generating steady
income from reasonably valued assets.
But hang on. Isn’t a higher capitalisation
rate better? Wouldn’t it be great to
squeeze tenants until the pips squeak?
That might seem like a good idea. But it
could also mean that the REIT could be
charging too much rent, which, in turn,
could mean that the high income might
be unsustainable over the long haul.
It could also mean that the landlord
might have targetted riskier tenants.
Alternatively, it might mean that the
tenants are on short-term leases.
Unfortunately, there is no right or wrong
capitalisation rate. But perhaps those
clustered around the market median
could be seen as being more stable for
the long-term investor.
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MOTLEY FOOL STOCK ADVISOR GOLD MAY 2017
Putting it altogether We have looked at different ways of
valuing REITs. But what - if any - is the
best method to look at these income-
generating assets?
Should it be the distribution yield or
price-to-book, both of which are
popular amongst investors? The answer
is that everything should play a part
when evaluating REITs. There are no
short cuts.
If we put ourselves into the shoes of a
property manager, it is probably the
cap i ta l i sat ion rate that w i l l be
paramount. So, perhaps we should be
paying more attention to that.
The capitalisation rate could play a role
in the types of properties that a REIT
might want to buy. It could determine
when a REIT might decide to sell an
asset. And it could even establish the
maximum interest rate that a REIT can
afford to borrow money at.
S o f r o m a n i n c o m e i n v e s t o r ’s
perspective, we should perhaps start by
looking at REITs whose capitalisation
rates are bunched around the median,
with, say, a minimum rate of 5% and a
maximum of no more than 9%.
That should prov ide us w i th a
considerably smaller crop of REITs to
investigate further.
What to look for: * Yields between 5 - 9% * Profits twice that of interest payments
* Distribution growth of more than 4%
* Price to book around the market average
Filter tips From the smaller batch of REITs, we
could start eliminating those with
distribution yields below 5% and those
with yields above 9%.
Wash, rinse and repeat for REITs with
interest cover of more than two, and
those with price-to-book values that are
clustered either side of the median.
By eliminating the outliers we can start
to identify the best performing REITs.
Currently, the list includes CapitaLand
Commercial Trust, Starhill Global,
Frasers Commercial Trust, Suntec REIT,
Frasers Centrepoint Trust, Ascott REIT,
CapitaLand Retail China, CapitaLand
Mall Trust, Mapletree Commercial Trust
and Keppel REIT.
That’s still a big bucket of REITs.
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MOTLEY FOOL STOCK ADVISOR GOLD MAY 2017
But we are not quite done yet. We
should be looking for REITs that have
demonstrated a good track record of
growing their payouts too.
That cou ld be a s ign o f good
management. So, as a final test we
could set a criterion of, say, four
consecutive years of rising dividends. In
fact, we can be as ruthless as we like.
We could set a minimum compound
growth rate of 4%. That’s enough to
keep up with inflation. With that, we are
left with Suntec REIT, Starhill Global,
CapitaLand Retail China, CapitaLand
Mall Trust, Frasers Centrepoint Trust,
Ascott REIT and Keppel REIT.
But we are still not quite done, yet.
The fun begins The next stage is the really fun part of
researching REITs. This is where - with a
much smaller crop of REITs – our job of
finding the right investments should
now be considerably easier.
“My stock picking method, which involves elements of art and science plus legwork, hasn’t changed in 20 years.”
Peter Lynch
The same goes for investing in REITs.
So it’s time to slip on our walking shoes
and visit the properties. That means
taking a look at the buildings. If they are
commercial offices, then ask yourself if
they are the kind of places that you
would like to work in. Do they have
adequate amenities, good facilities and
convenient transportation close by?
If it is a shopping mall, then turn up at
different times of the day to check
shopper traffic and footfalls. Are
shoppers laden with carrier bags or are
they just walking around empty
handed? Pop into the shops to see just
how busy they are. Check out the
restaurants? What is the mix of eating
outlets to retail stores in the mall?
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MOTLEY FOOL STOCK ADVISOR GOLD MAY 2017
The final chapter When we invest, we should set out to buy
wonderful companies at fair prices.
Evaluating companies through a bottom-up
approach might seem old fashioned. But it
forces us to look at business fundamentals
before we start looking at prices.
Fundamentals can tell us whether they are
wonderful businesses. The latter will tell us
if it is possible to buy those wonderful
businesses at a fair price.
All too often investors focus on the price
b e f o re t h e f u n d a m e n t a l s . Th at i s
tantamount to putting on our shoes before
we have put on our socks. We would never
dream of doing that.
Yet many investors will look at yields and
price-to-book before they have even
looked at the company’s balance sheet.
It is little wonder that they panic at the first
sign of market turmoil.
“We don’t get paid for activity, just for being right.”
Warren Buffett
If we analyse a company properly, and buy
with a decent margin of safety, we have a
greater chance of being right.
David Kuo owns shares in Mapletree Commercial Trust, Parkway Life REIT, Keppel REIT, Starhill Global, CapitaLand Retail China and CapitaLand Mall Trust.
All information is provided exclusively by The Motley Fool Singapore Pte Ltd, a licensed investment advisory research provider (MAS Licence No. FA100056-1). Any information, commentary, recommendations or statements of opinion provided here are for general information purposes only. It is not intended to be personalised investment advice or a solicitation for the purchase or sale of securities. Before purchasing any discussed securities, please be sure actions are in line with your investment objectives, financial situation and particular needs. International investors may be subject to additional risks arising from currency fluctuations and/ or local taxes or restrictions. The information contained in this publication are obtained from, or based upon publicly available sources that we believe to be reliable, but we make no warranty as to their accuracy or usefulness of the information provided, and accept no liability for losses incurred by readers using our research. Recommendations and opinions are subject to change without notice. Please remember that investments can go up and down, including the possibility a stock could lose all of its value. Past performance is not indicative of future results.
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Contact Member Support at: [email protected]
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MOTLEY FOOL STOCK ADVISOR GOLD MAY 2017
APPENDIX List of Singapore REITS (as of April 2017)
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MOTLEY FOOL STOCK ADVISOR GOLD MAY 2017
Company Name Ticker Market Cap (S$m)
AIMS AMP Capital Industrial REIT SGX:O5RU 846
Ascendas Hospitality Trust SGX:Q1P 843
Ascendas Real Estate Investment Trust SGX:A17U 7278
Ascott Residence Trust SGX:A68U 1802
BHG Retail REIT SGX:BMGU 338
Cache Logistics Trust SGX:K2LU 729
Cambridge Industrial Trust SGX:J91U 730
CapitaLand Commercial Trust SGX:C61U 4555
CapitaLand Mall Trust SGX:C38U 6842
CapitaLand Retail China Trust SGX:AU8U 1237
CDL Hospitality Trusts SGX:J85 1385
EC World REIT SGX:BWCU 576
Far East Hospitality Trust SGX: Q5T 1065
First Real Estate Investment Trust SGX:AW9U 996
Fortune Real Estate Investment Trust SGX:F25U 2943
Frasers Centrepoint Trust SGX:J69U 1828
Frasers Commercial Trust SGX:ND8U 1007
Frasers Hospitality Trust SGX: ACV 1249
Frasers Logistics and Industrial Trust SGX:BUOU 1365
IREIT Global SGX: UD1U 445
Keppel DC REIT SGX: AJBU 1319
Keppel REIT SGX:K71U 3402
Lippo Malls Indonesia Retail Trust SGX:D5IU 1094
APPENDIX List of Singapore REITS (continued)
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MOTLEY FOOL STOCK ADVISOR GOLD MAY 2017
Company Name Ticker Market Cap (S$m)
Manulife US REIT SGX:BTOU 743
Mapletree Commercial Trust SGX:N2IU 4292
Mapletree Greater China Commercial Trust SGX: RW0U 2725
Mapletree Industrial Trust SGX:ME8U 3028
Mapletree Logistics Trust SGX:M44U 2675
OUE Commercial Real Estate Investment Trust SGX: TS0U 892
OUE Hospitality Trust SGX: SK7 1224
Parkway Life Real Estate Investment Trust SGX:C2PU 1470
Sabana Shari'ah Compliant Industrial REIT SGX:M1GU 480
Saizen Real Estate Investment Trust SGX:T8JU 8
Soilbuild Business Space REIT SGX: SV3U 664
SPH REIT SGX:SK6U 2464
Starhill Global Real Estate Investment Trust SGX:P40U 1603
Suntec Real Estate Investment Trust SGX:T82U 4471
Viva Industrial Trust SGX: T8B 724
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