From Dividend Stocks To Property: How Singapore Investors Fall Into Yield Traps

Passive income appeals to many Singapore investors. Regular dividends, REIT distributions and rental payments can supplement our salaries or help fund retirement, without requiring us to sell our investments.

The tax treatment adds to the appeal. Dividends from Singapore-resident companies under the one-tier corporate tax system and REIT distributions received by individuals are generally exempt from Singapore income tax, subject to exceptions. Rental income from investment property, however, is taxable after allowable deductions.

But an investment that pays a high income is not necessarily a good investment. When we focus too heavily on the payout and overlook whether it is sustainable, or how much our capital has fallen, we risk falling into a yield trap.

High Yields Can Be A Red Flag

Yield is calculated by dividing the annual income paid by the current price of an asset. This means a higher yield can result from a falling price, even when the investment is paying exactly the same income.

For example, a REIT unit that pays 6 cents in annual distributions and trades at $1 has a distribution yield of 6%. If its price falls 40% to $0.60 while its historical distributions remain unchanged, its trailing yield rises to 10%. While it’s income has not improved or may have even fallen (which explains the decline in price), the lower price makes the yield look more attractive.

This is however, how a yield trap can develop. Investors may see the higher percentage as an opportunity without examining why the price has fallen or whether future distributions can be maintained.

A high yield alone does not prove that an investment is in trouble. However, it may reflect concerns about a future distribution cut or a deterioration in the underlying business that historical payouts do not yet show.

Read Also: How Much Dividends Do Stocks In The STI ETF Pay Out Each Year?

REITs: Where Singapore Investors Fall Most For Yield Traps

REITs appeal to income investors because of their regular distributions. But when one offers a substantially higher yield than comparable REITs, we need to understand what accounts for the difference.

The properties a REIT owns, the markets it operates in and the sustainability of its rental income all matter. Investors should consider the conditions affecting its properties and tenants, rather than assess it solely by its distribution yield.

The point is that an elevated yield needs an explanation. If distribution per unit (DPU) is declining, investors should examine whether the underlying pressures are temporary or likely to persist. A yield calculated using past distributions may overstate the income they can expect to receive.

Dividend Stocks: The Income Obsession

The same problem applies to individual stocks. A company earning $0.30 per share and paying a $0.20 dividend distributes about 67% of its earnings. At a share price of $5, its dividend yield is 4%.

If its share price falls to $2.50 because earnings are declining and investors anticipate a dividend cut, the historical yield rises to 8%. Someone buying for that yield may still receive the previous payout for a while, but it may not be sustainable. If the dividend is subsequently cut and the share price falls further, the investor faces both lower income and a loss of capital.

This risk is particularly relevant to cyclical businesses, including those in shipping, commodities and construction. Generous dividends during strong years may reflect unusually high profits rather than a payout the company can sustain throughout the business cycle.

Warning signs include dividends that consistently exceed earnings, operating cash flow that does not comfortably cover payouts, and declining earnings alongside an unchanged dividend. None guarantees a cut, but each gives investors a reason to investigate whether the income they are buying can last.

Bonds: Yield As A Proxy For Credit Risk

For conventional bonds, the yield trap works slightly differently. These generally have a defined maturity and contractual coupon payments, but investors still depend on the issuer’s ability to meet its obligations.

A bond offering a much higher yield than otherwise comparable bonds may reflect greater concern about default or restructuring. The additional yield compensates investors for taking on that risk; it should not be assessed purely as extra income.

It is also important to distinguish between a bond’s coupon and its yield. The coupon is based on its face value, while the yield also depends on the price paid. Comparing the two interchangeably can give a misleading impression of the return on offer.

Hyflux’s 6% perpetual capital securities illustrate the danger of focusing on income without understanding the instrument. The company entered compulsory liquidation in July 2021 after unsuccessful restructuring efforts. Its perpetual securities also differed from conventional bonds because they had no fixed maturity date.

An attractive payout cannot compensate for every risk. Investors need to understand the issuer’s finances and the security’s terms before deciding whether the potential income justifies the possibility of losing capital.

Read Also: Complete Guide To Start Your REITs Investing Journey In Singapore

Property: The Rental Yield Illusion

Investment property presents another version of the same problem. A gross rental yield of 5% may sound attractive, but it does not show how much income the owner actually keeps.

Net rental yield accounts for expenses such as property tax, maintenance fees, agent commissions, vacancy periods and repairs. Renovations between tenants can further reduce returns. For a financed purchase, mortgage interest also affects how much rental income remains.

Property also concentrates a large amount of capital in a single asset that can take time to sell. Unlike a portfolio of listed investments, an owner cannot sell a small portion of the property to free up cash when circumstances change.

Consider an illustrative investor who buys a $2 million property and sees its value fall 15% over three years. That represents a $300,000 decline in value. Even if the property generates $60,000 in net rental income over those three years, the combined result is a $240,000 loss before transaction costs.

The regular rental payments may feel like a return, but they do not necessarily offset a fall in the property’s value. Looking only at income can therefore give an incomplete picture of the investment’s performance.

Entry and exit costs also matter. Residential Buyer’s Stamp Duty uses progressive rates ranging from 1% to 6%, while Seller’s Stamp Duty may apply depending on the purchase date and holding period. Legal fees and agent commissions further affect the eventual return.

Additional Buyer’s Stamp Duty, where applicable, is another substantial acquisition cost that should be included in the calculation. These expenses raise the return needed for a property investment to be profitable.

What To Look At Instead Of Yield

Across all four asset classes, yield is a starting point for assessing an investment. We also need to ask whether the income is sustainable, how earnings or distributions are changing, and what is happening to the value of our capital.

This is why total return matters. It combines the income received with the change in the investment’s value, giving us a fuller picture of whether our money has grown.

Regular income can still play a useful role in a portfolio, particularly for investors who rely on it to meet expenses. But judging an investment mainly by its payout can lead us to overlook losses elsewhere. The goal is to understand both where the income comes from and what we are risking to receive it.

Photo Credit: iStock/Prelevic Milos