On my way home after Chap Gor Mei dinner (home cooked food by my mom and sis is the best!), I made a detour and visited Borders as a friend told me they are having a 20% storewide discount. The first book I picked up was a book by Robert Kiyosaki, titled "Conspiracy of the Rich". The title was intriguing and captured my attention.
As I flipped through the book, I was actually thinking of buying it until I reached a section which made me put it back on the shelf.
Robert says that most people are lacking in financial education or do not have the right financial education. Having the right financial education gives people an unfair advantage. That, I agree.
Robert went on to say that there are many ways to build passive income, which is true. He went on to say that running businesses (and by that he meant big businesses with hundreds of employees) to generate passive income requires the greatest financial intelligence. This is followed by investments in real estate but as most people do not have a high level of financial intelligence, they opt to invest in real estate mutual funds known as REITs. This is followed by paper investments such as stocks, mutual funds and the likes as paper investments require the least amount of financial intelligence.
Now, I will not discuss his choice of words (stylistics) here although that particular section was somewhat disturbing as I sensed snobbery in the writing. Maybe, I am too sensitive. So, I shall just discuss his contention that since most people do not have a high level of financial intelligence, they opt to invest in real estate mutual funds known as REITs instead of actual real estate.
Personally, I think investing in real estate is a good way to build our wealth if we know how to. I have been very open about it in my blog and I have shared my experience. Definitely, collecting rent is another way to build passive income. However, I also enjoy investing in REITs. Not all REITs, mind you, but REITs which meet certain criteria: low gearing, high yields and trading at an attractive discount to NAV.
Now, let's go through these three criteria one by one:
LOW GEARING
When we invest in a piece of real estate, we put down 20% of our own money and borrow the rest. The idea is to make sure that we borrow at a low rate of interest and let the rental income cover the monthly repayment of the loan and still have money leftover. We are talking about a gearing level of 0.8x here in such a case.
REITs would probably have borrowings but for listed REITs and in the current environment, it is hard to find a REIT with a gearing level higher than 0.4x (well, CIT is an exception).
Robert talks about good debts and bad debts. This is something many of us are familiar with but most would agree that less debt is rarely a bad thing. Many, in fact, work towards reducing debt in their lives.
HIGH YIELDS
If we decide to buy a condominium, for example, what kind of yield could we expect? Let's say it is a $1m studio apartment somewhere near town, the yield is probably something close to 3.5% per annum. Not fantastic and even in a low interest rate environment, the returns would not be attractive.
Now, if we look at some of the REITs available in the stock market here in Singapore, there are some REITs with yields of 10% or so. Attractive? You bet.
DISCOUNT TO NAV
When we buy a piece of real estate, we are usually buying it at valuation or above valuation (just look at the COVs being asked for HDB flats!) and during bad times, we might just get a bargain at below valuation.
With REITs, we have an opportunity to own real estate at a discount to their NAVs in most cases. We do have a few REITs which are trading at or above their NAVs (and I don't invest in those). I like to ask my friends, if a nice condominium in a good location is valued at $2.9m and is now being sold to you for $1.6m, would you buy it? The answer is always a unanimous "YES!". It's a no brainer.
Perhaps, the book is meant for an American audience but I do not know how Robert arrived at the conclusion that people with lower financial intelligence invest in REITs instead of actual real estate. For me, it's just a simple case of value for money. I invest in the REITs that I do today simply because they provide extraordinary value for money.