The Margin REIT Strategy - A Strategy In Writing (Please Complete Reading The Article!)
To me, I always feel human emotions are unable to control the use of margin. Leverage is such a powerful seductive tool that I do not believe any person can escape from it once he/she touches it. Similarly, to believing justice will prevail, I believe in not giving margin a second look.
Nevertheless, I met J recently and he showed me how he used margin to invest and achieved 10% gain p.a. since 2016. To be honest, 10% is not huge. But a consistent 10% is a relatively good return. He basically compares “margin investing” to buying a property. I specifically think it should be compared to buying a 2nd property. This is because his method requires us to consider rental income. I believe we seldom will rent out the 1st property out. The 2nd property will probably be the one to be rented out.
2nd Property Purchase Scenario
You decided on a $1 million property. Since it is the 2nd property, you decided to borrow the maximum 45% Loan to Value (LTV) - which is $450k. Let’s assume you passed the total debt servicing ratio (TDSR) and credit checks. This meant that you will be making monthly installment payment to the bank to pay down your loan. In addition, you have also made plans to make capital repayment, which in turn may reduce your tenure. In a very lucky scenario, you may also already found a tenant for the property and the rent is able to more than cover your monthly installment.
Possible Margin Investing Scenario
Let’s say you had already saved up enough emergency funds and you are left with $1 million disposable cash. You decided to place the sum of money into a margin account which will allow you to leverage to 3.5 times at around 3.28% interest per annum. In order to ensure you will make a return, you decided to only purchase REITs counters. In this way, you are sort of ensure a return of 5% to 8% per annum and is able to have a positive spread which will add on to your return. To my understanding, most of REITs counter are Grade A and allows up to LTV of 70%. Finally, you knew you have a full time job and will receive monthly salary. Thus, you decided to make fixed capital payment to the margin account. Thus, eventually when you fully pay off the loan, you will transfer the shares to your CDP account.
But one will argue that margin investing has a factor that is called “Margin-Call” which property loan do not have!
Are you sure? Do you know that property loan also has a factor deem as “on-margin call”?
The following extracts are from a MoneySmart article:
“Say you have a property worth $1 million. You take out a home loan to buy it, and after a few years servicing the loan, you still owe $700,000.
Suddenly, the property market crashes, and the value of your house plummets. The bank conducts a valuation, and it determines that your house is now worth only $600,000. This is less than your outstanding home loan of $700,000!
The bank can then choose to issue an on-margin call*, and you would need to top up the difference of $100,000. You can do this using either cash, or your CPF.”
*Please read the MoneySmart article for a full understanding of this on-margin call for property loan.
But others may also argue we should never compare properties with REITs. I am not comparing "apple to apple"!
I do agree that I am not comparing "apple to apple". But I do find a lot of similarities with the 2 products - especially in its demand.
I will not discuss on property, for many of you will understand the reasons behind its demand and how government requires cooling measures to curb the continuous price increase.
However, for REITs, my opinion is that demand is still significant in Singapore due to the following:
- There are numerous Gurus have achieved financial independence via REITs, and there are many others who are intending to follow them into achieving Financial Independence.
- Even after numerous rights issues and bad management decision, you continue to see some of these REITs continue to be listed in SGX. Then again, there could be many reasons to its continued listing such as management has change for the better, etc. But it continues to be there. Google Sabana REIT or Keppel REIT.
- In Singapore, in my opinion, if a company continues to give dividends, there is a chance your company’s share price will recover. This is further supported by Lion Philips REIT ETF and NikkoAM-StraitsTrading Asia ex Japan REIT ETF share price graph. As per the graph below, these ETF has not been performing well over 2018, but recovered strongly in 2019.
|REIT ETF Share Price Graph Since Listing (Via Yahoo Finance)
Based on the comparison, I believe both scenarios have their positive factors. Nevertheless, since I am reviewing the Margin REIT Strategy, I will try to amend the strategy to suit more like 2nd property purchase without losing its positive points.
These are the following rules I came up with to reduce risk and frequency of margin call:
Rule 1: The basis of this theory is because you want to eventually own the REIT. This strategy will not work for trading or short term strategy.
Rule 2: You must have a fixed income job, with emergency cash (at least 6 months of salary) being placed aside.
Rule 3: To reduce volatility, only pledge cash at the start of the margin account. NO SHARES as COLLATERAL.
Rule 4: Leverage of 3 times of the cash pledged at the start should only be amounting to a maximum of 3 months of your salary.
Rule 5: For each REIT, only loan up to a maximum LTV of 50%.
Rule 6: Ensure that you make fixed monthly repayment to the margin account.
Rule 7: Total Loan should not be higher than 12 months of fixed monthly repayment.
Rule 8: For each REIT you choose, dividend yield must be at least 6% (To be explained below).
Rule 9: Learn to choose a good REIT. I prefer a REIT at Low Price to NAV as per Kenny's website.
Rule 10: Concentrate to get maximum return. Since the total loan amount is not significant, the highest number of REIT should be set to a maximum of 3 REITs.
Rule 11: If the share price of a REIT falls, without ignoring the above rules and ensuring the fundamental does not change, you MAY choose to invest in more of the same 3 REITs. But once you reinvest into the REITs, your 12 months tenure should restart. This is similar to repricing or refinancing a property loan. Thus, there is a need to recalculate.
Rule 12: If a REIT dividend distribution reduces to below 6% or if share price drops more than 30%, DO CONSIDER PAYING OFF THE WHOLE LOAN AND TRANSFER THE REIT TO YOUR CDP ACCOUNT.
The above rules created a situation where it reduces the amount you can loan, but it also reduces the probability of a margin call and helps with getting better returns.
Nevertheless, the rich can always ignore some of the above rules, and follows their own views. After all, if you are very rich, you will not have any issue passing TDSR and buying a 2nd property too. In addition, if you are very experience and confident enough, you can also proceed to ignore some of the rules above. This is, after-all, still a strategy in writing.
Now, it will be good for us to understand how much return can we earn from this strategy:
|Actual Yield Calculation a using Margin with Monthly Repayment
From the picture above, you will realised that a REIT with 8% dividend yield will only return 6.36% dividend yield due to the interest payment.
For a REIT with 4.5% dividend yield, you will end up getting only 2.86%.
On the other hand, for a REIT with 6% dividend yield, you will get a slightly better 4.36%.
However, if you make monthly payment installment to make sure you pay off the loan for the next 12 months, your actual yield will improved as per the table below:
|Actual Yield Calculation using a Margin with Monthly Installment Payment
8% dividend yield minus interest payment – End up 7.11%
4.5% dividend yield minus interest payment – Still a bad 3.61%
6% dividend yield minus interest payment – A slightly better 5.11%
In my opinion, if we took on such a risk, I want to expect at least a 5% dividend yield. Thus, as per my rules above, I believe that we should be repaying monthly and only choose a REIT with at least a 6% dividend yield.
On the other hand, some people may ask – What happens if there is a margin call? What is the probability of a margin call?
There are many friends informing me that margin call is the worse kind of call you can get in the morning and advised me against doing it (Do note at this point, this is still a strategy in writing). Many have tried it and done it.(Please read the comments in this InvestingNote Post).
So What happens if there is a margin call? - Easy. Just pay up. In fact, pay off the whole loan will be the best. Do note that based on Rule 2 and Rule 4, you should still have some emergency cash that is sufficient to pay off your loan amount.
But What is the probability of a margin call? Thus, I have decided to use First REIT share price as an indicator. Google First REIT on the recent share price drop and scandals it was involved.
|First REIT share price (via Yahoo Finance)
|First REIT share price (via Yahoo Finance)
|Margin Strategy with Share Price Change and Repayment
As per above table and Rule 5, with repayment and LTV of 50%, Margin Call will have a very low probability of happening.
|Margin Strategy with Share Price Change and Without Repayment
Even with repayment, at LTV of 50%, the probability of Margin Call is still low.
However, do note that the First REIT share price is taken on a end-month basis. Margin Call will happen on daily basis and not a monthly basis. During the latest scandal, I remember I saw First REIT fall from $1.200 to a intra-day low of $0.820. This is a fall of more than 30% in share price.
When I do my calculation on Margin Ratio, a fall in share price of 30% will result in Margin Ratio dropping from 200% to 140%. Anything below 140% will probably result in a Margin Call. Therefore, as per Rule 12, do consider paying off the whole loan and restarting the whole process again. If you are preparing to only top up and average down, please note that you will need to follow Rule 11 and recalculate the whole process.
The most important issue in Margin Investing is the Human Emotions. One may not be able to handle the "greed" that follows if one made significant gains, or the rash decision when a margin calls happens.
Furthermore, this is a WARNING - if you DO NOT UNDERSTAND WHAT I AM WRITING, please DO NOT PROCEED.
This is also a rich man's strategy. For many who tried this strategy, it seems that they understand the pros and cons of using margin and has a certain level of networth - thus, able to top up the margin call whenever it happens.
Nevertheless, this is still a strategy in writing. This is because I still have enough cash and I operate similarly to a fund manager. This Margin REIT strategy is still more suitable for individuals.
If I have enough cash, I do not believe there is a need use margin to purchase REITs at the moment, since the use of margin will reduce my yield. In addition, there is too much to consider in using a margin strategy. It could be too troublesome.
Therefore, if I start using my margin strategy, it should be when there is a mini crisis on the market or on a single stock. I intend to use this facility as a market timing tool.
Please do your own due diligence before you engage in the Margin REIT Strategy.
I will also be making a Margin REIT Strategy Tool (still in works) from my excel table above. If you are interested in the tool, please follow the actions below:
- Like TUBInvesting Facebook Page
- Like Fundamental Scorecard Facebook Page
- Join Fundamental Scorecard Telegram Group
- Then PM me on Telegram for the Margin REIT Strategy Excel Spreadsheet (Requires another 2 days, still in works!)