Sunday, October 28, 2018

A commentary on leveraging REITs with loans

I recently took a look at another blogger that utilized Maybank's 2.88 percent yield loan to leverage on REITs. The idea, in essence, was borrowing cash using the yield loan mentioned above to obtain dividend yields from REITs that will allow one to pay back this loan while accumulating the remainder as fine, hard cash. This blogger had loans in the hundreds of thousands (good lord) making use of this strategy.

Using Mapletree North Asia REIT as an example, one could get a dividend yield of 6.7%, pay off the 2.88%, and be left with a "free" 3.82% yield on your loan amount. That is in essence, making money work for you when you don't even have money.

In theory, that sounds like a fun and dandy idea, so I actually had a discussion with others about this.

Firstly, we have to find out the logic of why a bank like Maybank would be willing to loan out their money for you to leverage, instead of just buying these REITs themselves.

Most banks are regulated in ways such that they are unable to convert all the liquid cash they have into assets, due to certain financial regulations, that while differing in each countries, tend to set a certain percentage of debt to their equity in the form of a capital adequacy ratio. In essence, they are prevented from essentially throwing all their cash into REITs, so it would make sense for them to just loan it out to us poor souls, and just kill us with interest.

Benefit of leveraging in this context

Let's face it. That 3.82% yield is pretty good, considering that it is based off money that you don't own, and the leveraged amount could be 2 times larger than your initial capital ( had a call with maybank but honestly forgot what was the minimum margin ratio required).

If the REIT one purchases appreciates in capital gain, it can also be quickly sold off for extra cash on top of the "free "3.82%".

Now, what are the risks then?

Risk(s) of leveraging REITs

Firstly, 2.88% is pretty high. The potential upside may not necessarily be justified by the risk one takes when entering these positions.

Maybank, and other institutions that provide this service, retain the right to select what REITs they will allow you to purchase with the leveraged loan. This also means that at any time, if they find that the REIT no longer fulfills the criteria for their AAA rating ...
They will just remove it. What this means is that the financial institution now has the right to ask for their money back. In the event that you can't cough up the cash, it will either use the cash that you have to hold in the margin account (per the ratio) or if you are using other equities (other REITS as an example) to leverage off on, to pay for the outstanding balance. This will be on top of you holding a sub-AAA rating REIT, which would most likely be due to it suffering from some management issues.

Essentially, what this means is that one takes on the risks in two ways : the risk of the REIT's capital value dropping, and also being forced to sell/liquidate equities and cash to maintain the margin call.

Not a fun thing to happen.

Which brings us back to the other blogger. I noticed that he hasn't been posting for awhile now, and got curious about some of his/her holdings. Some of the REITs he has bought has depreciated nearly 50% or more in value. The margin calls triggered were probably not fun.

Conclusion
The main essence of this is that in investing, unless one goes for the Singapore savings bond, there is no risk-free option.  It is more about taking risk proportionate to one's expected returns.

If one wishes to utilize this, it would be prudent to look at the safest REITs, instead of just the ones that have the highest yield. Also, the amount leveraged should never be a large sum.



2 comments:

  1. Hello,

    Thank you for sharing. I agree with you that leveraging to invest in REITs is a bad idea. Besides the yield differential, there is also the risk of being forced to sell at a bad time.

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  2. Well, it is not exactly a bad idea as much as the interest one has to pay to get that returns. The whole idea does make sense to a certain degree; the one condition here that affects it is the interest rate one pays. 2.88% seems a tad high here. It is always about the risk - reward ratio.

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