Why I avoid REITs
How time decay turns your property income into disappearing capital
Dear Investor.
Zee here. Numerous students and peers have asked me about REITs (Real Estate Investment Trusts), unfortunately I do not invest in them.
Many investors treat REITs like a must-have: steady income, property exposure, and the comfort of familiar assets. But beneath the surface, the risks are often misunderstood or downplayed. Over the years, I’ve learned that not all “stable” yields are created equal, and some come with trade-offs that quietly eat into long-term returns.
In this newsletter, I want to walk you through the key reasons I personally steer clear of REITs, and why the income they promise often isn’t worth the hidden costs.
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What’s the “Melting Ice Cube” Problem?
When you invest in a Real Estate Investment Trust (REIT), you’re essentially buying a share of a property portfolio. But here’s something many new investors miss: not all properties are created equal, especially when it comes to leasehold properties.
Think of a leasehold property like an ice cube melting in your drink. Each year that passes, the property loses value simply because it has less time remaining on its lease. Eventually, when the lease expires, the land reverts to the government or original landowner, and you’re left with nothing.
Now to help visualize this better, the Bala’s Curve provides a simple yet insightful way to visualize the lifespan of a leasehold asset. In practical use, the curve helps people estimate how much a property is worth relative to a freehold unit with similar characteristics. Bala’s Curve is a framework commonly used in Singapore to understand how the value of a leasehold property declines over time.
This reflects a simple idea: a property with many years left on its lease still offers long-term utility and potential rental value, while one with only a few decades left becomes significantly less attractive to buyers, banks, and even government schemes.
Today, Bala’s Curve or the accompanying table is still referenced by valuers, government agencies, and developers as a rule of thumb for comparing leasehold properties to their freehold equivalents.
How Leasehold Works Around the World
Leasehold systems vary significantly across different markets:
Common Leasehold Markets
Singapore: Typically 99-year leases, with land reverting to the state
Hong Kong: Similar system with 50-75 year leases
United Kingdom: Long leaseholds (99-999 years) but with ground rent obligations
Australia: Some states have leasehold crown land
China: All land is state-owned; residential leases typically 70 years
United Arab Emirates: Varies by emirate, often 99 years for foreign investors
Freehold Markets
United States: Predominantly freehold ownership
Canada: Mostly freehold with some exceptions
Most of Europe: Generally freehold systems
Why this matters: If you’re investing in Asian REITs or property funds, you’re much more likely to encounter leasehold issues than if you’re investing in North American REITs.
The Math Behind the Melting Ice Cube
Here’s what happens over time:
Year 1: Your building has 99 years left on its lease
Year 20: Your building has 79 years left
Year 50: Your building has 49 years left
Year 80: Your building has only 19 years left
As the remaining lease shortens, the property becomes worth less, regardless of location or market conditions. It’s simple math, but it’s often buried in the fine print.
The Hidden Trap for Global REIT Investors
The Yield Illusion
Many REITs in leasehold markets advertise attractive yields like 6% or 8%. Sounds great compared to government bonds or dividend stocks, right? But here’s the catch:
Not all of that distribution is profit. Some of it might actually be your own capital being returned to you, disguised as income.
Here’s a realistic example:
REIT advertises: 7% distribution yield
Property values decline due to lease decay: 2% per year
Your actual total return: Only 5%
Compare this to a freehold REIT paying 5% where property values remain stable or appreciate—you might actually be better off with the lower yield.
Why This Happens
When you receive your quarterly or semi-annual distributions from a REIT, it feels like passive income. But if the underlying properties are losing value due to shrinking leases, you’re essentially receiving back your own investment capital.
It’s like withdrawing money from your savings account and calling it “interest earned.”
The Manager’s Dilemma: A Universal Challenge
REIT managers worldwide face similar pressures, though regulations differ:
Keep paying high distributions (makes investors happy short-term, but the asset base deteriorates)
Retain cash to buy new properties (protects long-term value, but reduces your quarterly payouts)
Different jurisdictions handle this differently:
Singapore/Hong Kong: Strict distribution requirements (90%+ of taxable income)
US REITs: Must distribute 90% of taxable income
European REITs: Varies by country (60-90% typically)
This regulatory pressure forces most REITs to distribute cash even when they need it to refresh aging leasehold properties.
The Real Costs You Don’t See
Acquisition and Management Fees
When a REIT buys new properties to replace aging ones:
Acquisition fees (typically 1-2% of purchase price)
Ongoing management fees (usually 0.3-0.5% of assets annually)
Performance fees in some structures
These fees are deducted from your returns, but they’re rarely highlighted in marketing materials.
Dilution Through Capital Raises
When a REIT needs money to buy properties, they typically:
Issue new shares/units (equity fundraising)
Take on more debt (if leverage ratios allow)
Either option can hurt existing investors:
Equity issuance: Dilutes your ownership percentage
More debt: Increases financial risk and interest costs
Red Flags to Watch For Globally
1. Short Remaining Leases
Check the weighted average lease expiry (WALE) of the REIT’s properties:
Strong: 60+ years remaining
Moderate concern: 40-60 years
High risk: Under 40 years
2. High Yields with Declining NAV
A 7% yield looks attractive until you realize:
Net Asset Value (NAV) has declined 15% over 3 years
Your total return is actually negative
Always check NAV trends over 3-5 years, not just distribution yields.
3. Frequent Portfolio Turnover
Constant buying and selling might indicate:
Management scrambling to maintain lease life
Fee generation taking priority over investor returns
Difficulty finding quality long-lease assets
4. Related-Party Transactions
Watch for situations where:
The REIT sponsor sells properties to the REIT at questionable valuations
Management fees go to related entities
Conflicts of interest aren’t properly managed
This is a global issue but particularly common in Asian markets where sponsors often control both the developer and the REIT manager.
What Smart Global REIT Investors Do
Focus on Total Return, Not Just Yield
Total Return = Distributions + Change in Property Value + Currency Effects
For international investors, add currency risk to the equation:
A Singapore REIT paying 7% means nothing if the SGD depreciates 5% against your home currency
Consider hedged vs. unhedged exposure
Compare Across Markets Appropriately
Don’t compare yields in isolation:
Market Context Matters:
US freehold office REIT yielding 5%
Singapore leasehold retail REIT yielding 7%
UK long-leasehold industrial REIT yielding 4.5%
The lower-yielding options might actually provide better risk-adjusted returns when you account for:
Lease decay
Currency stability
Market liquidity
Regulatory environment
Check the Lease Profile
Look for REITs with:
Long remaining leases (60+ years average)
Mix of freehold and long leasehold properties where possible
Active portfolio refreshment strategy documented in annual reports
Geographic diversification if investing in a multi-country REIT
Understand the Business Model and Local Context
Ask yourself:
Does this REIT mainly hold short-lease properties?
What are the local laws regarding lease renewals or extensions?
How does management plan to handle expiring leases?
Are distributions sustainable without constant dilution?
What’s the political stability and land policy of the country?
Regional Differences That Matter
Asia-Pacific Markets
Higher leasehold prevalence: Most properties are leasehold
Government land ownership: State controls land policy
Limited renewal options: Extensions aren’t guaranteed
Higher yields to compensate: Markets price in the risk (sometimes)
Western Markets
More freehold options: US, Canada, much of Europe
When leasehold exists: Often very long terms (125-999 years in UK)
Different risk profile: Lease decay is slower but still present
Emerging Markets
Policy uncertainty: Land laws can change
Currency risk: Often paired with volatile currencies
Higher headline yields: Compensate for multiple risks, not just lease decay
Interest Rate Impact: A Global Phenomenon
Rising interest rates amplify the leasehold problem worldwide:
When rates are low: Property valuations stay elevated, masking lease decay
When rates rise: You get hit multiple ways:
Higher discount rates lower all property values
Lease decay continues regardless
Refinancing costs increase
This multiple impact can be particularly painful in markets like:
Singapore (where rates track US Fed)
Hong Kong (USD-pegged currency)
Emerging markets (often higher rate volatility)
Case Study: What Can Go Wrong
Hypothetical Asian Retail REIT:
2018: Trading at $1.00, yielding 7%, WALE of 45 years
2019: Interest rates rise 1%, property values drop 10%
2020: COVID impacts retail, occupancy falls
2021: Needs to refinance debt at higher rates
2022: Forced to sell properties at depressed prices
2023: Rights issue at $0.65 to repair balance sheet
2024: Unit price at $0.70, yield now 6% but you’re down 30% in capital
Your “stable 7% income” turned into significant capital loss because:
Lease decay wasn’t priced in
Interest rate risk wasn’t considered
Sector-specific risks materialized
Management had no flexibility to weather the storm
The Bottom Line for Global Investors
Investing in REITs with significant leasehold exposure isn’t necessarily bad, but you must:
Know what you’re buying: Understand both the lease profile AND the local market
Price it correctly: Demand higher yields for leasehold risk don’t pay premium multiples
Watch the NAV: Track whether property values are holding up over time
Calculate true returns: Look beyond advertised yield to total return in your currency
Diversify wisely: Don’t overweight leasehold markets in your portfolio
Have realistic expectations: Accept that some “income” is capital return
Questions to Ask Before Investing in Any REIT
Property-Level Questions
What’s the weighted average lease expiry of the portfolio?
How many properties have less than 40 years remaining?
Are properties freehold, long leasehold, or short leasehold?
What’s the management’s strategy for refreshing leases?
Financial Questions
Has NAV been stable or declining over the past 5 years?
Are distributions covered by actual operating cash flow?
What’s the debt level and refinancing schedule?
How have total returns (not just yields) performed?
Market and Governance Questions
What are the local laws on lease extensions or renewals?
How aligned is management with unit holders?
What percentage of fees go to related parties?
Is there a history of dilutive capital raises?
Currency and Macro Questions
What’s my currency exposure?
How do local interest rates and economic conditions look?
Is the regulatory environment stable?
What’s the political risk around land policy?
Portfolio Strategy for Global REIT Investors
Balanced Approach
Core Holdings (60-70%):
Freehold REITs in developed markets (US, Canada, Western Europe)
Long-leasehold REITs with strong sponsors
Diversified by geography and property type
Opportunistic Holdings (20-30%):
Shorter leasehold REITs IF yield compensates adequately
Emerging market REITs with high yields (understand the risks)
Specialized sectors with strong fundamentals
Avoid or Limit (10% maximum):
REITs with WALE under 30 years
Highly leveraged leasehold REITs
Markets where you don’t understand land policy
Rebalancing Discipline
Review annually:
Has lease decay eroded value faster than distributions?
Are you still being compensated for the risk?
Have better opportunities emerged?
Don’t fall in love with high yields, be willing to sell when the math no longer works.
The Sponsor Dropdown: A Critical Issue
One of the most problematic structures in global REITs is the “dropdown” model:
How It Works
A developer/sponsor builds or acquires a property
They sell it to their own REIT at an aggressive valuation
The REIT pays with investor money (yours)
The sponsor collects management fees on the inflated asset
Why It’s Problematic
Conflicts of interest: The sponsor benefits from high prices; unit holders need fair prices
Fee multiplication: Sponsor profits from sale AND ongoing management
Quality concerns: Sponsors may offload their weakest assets to the REIT
Valuation games: Independent valuations can still be influenced
What to Look For
Independent board oversight: Strong independent directors who challenge transactions
Fair valuation processes: Multiple independent valuers, conservative assumptions
Track record: Has the sponsor historically been fair or aggressive?
Unit holder protections: Are there caps on related-party transactions?
This issue exists globally but is particularly prevalent in Asian markets where integrated developer-REIT structures are common.
Understanding Distribution Sustainability
Not all REIT distributions are created equal. Here’s how to assess sustainability:
Healthy Distribution Signs
Covered by operating cash flow: Not relying on asset sales or borrowing
Stable or growing occupancy rates: Tenants are staying and paying
Reasonable payout ratio: Not distributing 100% of available cash
Consistent NAV growth: Property values holding or increasing
Warning Signs
Distributions exceed cash from operations: Where’s the money coming from?
Declining occupancy: Future distributions at risk
Asset sales to fund distributions: Eating the seed corn
NAV declining while distributions maintained: Unsustainable trajectory
The Sinking Fund Question
Some REITs set aside funds for:
Major capital expenditures
Lease renewal costs
Property upgrades
This is responsible management but reduces current distributions. A REIT paying 6% while funding capital needs may be better than one paying 8% while deferring maintenance.
Tax Considerations for Global Investors
Different countries treat REIT distributions differently:
Withholding Taxes
Singapore: Generally no withholding tax on distributions
Hong Kong: No withholding tax for most investors
United States: 30% withholding (or lower if tax treaty applies)
Europe: Varies widely by country (0-30%)
Your Home Country Treatment
Some countries treat REIT distributions as ordinary income
Others may treat them as dividends with preferential rates
Capital gains treatment varies
Important: High yields can be reduced by taxes. A 7% Singapore REIT might net you more after-tax than a 7% US REIT depending on your situation.
Final Thoughts
Leasehold REITs are common worldwide, particularly in Asia-Pacific and parts of Europe. They can be part of a diversified income portfolio, but they require more careful analysis than freehold property investments.
Key Takeaways
Not all yields are equal: A 7% yield on melting assets may be worse than 4% on stable ones
Geography matters: Leasehold risk varies dramatically by country and legal system
Read the fine print: Understand local lease laws and renewal prospects
Watch NAV trends: Capital preservation matters as much as income
Diversify intelligently: Don’t concentrate in short-leasehold markets
Consider currency: For international investors, FX can overwhelm property returns
Question the sponsor: Understand who benefits from the REIT structure
Calculate total returns: Distributions minus NAV decline minus currency loss equals your real return
The Ice Cube Analogy Globally
The attractive yields can be seductive, especially when comparing global REIT markets. But remember: you’re not just collecting rent, you’re also watching your capital slowly tick down toward lease expiry.
Like an ice cube in your drink:
In tropical markets like Singapore and Hong Kong, that ice melts faster (shorter leases, less renewal certainty)
In cooler climates with 999-year UK leases, it melts slowly
In freehold markets like the US, you own the ice maker
But physics always wins eventually.
The Key Is Awareness
Once you understand the mechanics across different markets, you can make informed decisions about whether the yield justifies the decay, or whether you’re better off seeking more stable investments.
Never mistake the meltwater for sustainable income and always know which market’s ice you’re buying.
Remember
Early investors in a leasehold REIT enjoy high yields on eroding assets. Late investors often inherit the wreckage. The market rarely prices terminal risk properly—it treats a 20-year lease like a 20-year bond, forgetting that bonds mature into cash while leaseholds mature into nothing.
Your job as an investor is to be smarter than the market’s assumptions. Demand compensation for the risk. Understand what you own. And never confuse a high yield with a good investment.
Analyst Aaron’s views
For property and REIT investors, capitalization rates are a key valuation metric. It acts like a “dividend yield” on real estate assets and investors use this metric to determine if an investment is worthwhile compared to other opportunities.
Cap (capitalization) rate = Net operating income / Market value of property
When the Fed hiked rates, borrowing costs increase and investors demand higher returns (risk premium + risk free rate) to justify holding property assets. This forces cap rates to move higher.
An increase in cap rate mechanically lowers a property’s valuation, even if the NOI is stable. For example, a property producing $10 million in NOI is worth:
At a 4% cap rate → $250 million valuation, vs 5% cap rate → $200 million valuation
A %1% rise in cap rate results in a 20% decline in valuation. This directly affects the REIT’s NAV, which is the total market value of the REIT’s underlying assets minus liabilities. NAV decreases because asset value fall while liabilities remain the same
The above would explain why REIT prices fell after the Fed announced rate hikes in 2022. Conversely REIT prices moved up when the Fed started cutting rates in 2024.
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All information here is for educational purposes only. This is not financial advice. Please do your own research and speak with a licensed advisor before making any investment decisions. Past performance is not indicative of future returns. How we invest may not suit your investment goals and risk management profile.
interesting! never heard this perspective!
Very educative!