REITs

Contents

Overview of REITs

Real estate is a very popular investment instrument in India. Especially in the older generations, we have seen a lot of people buying lands, properties and flats and then renting them out. We have also been often advised by our elders to invest in real estate. One good reason is the steady flow of income generated from the rental yield every month. Another is the capital appreciation of the property over a period of 10-15 years.

But we all know that investing in real estate usually calls for a large lumpsum investment upfront. And that is where it becomes challenging for most of the millennials. Also once your purchase the property, selling it is not easy. Liquidity is a big issue with traditional real estate properties. Finding a buyer who is ready to pay the right price is a big challenge in itself. This is why although many people want to invest in real estate, they are unable to do so.

Here comes in REITs or Real Estate Investment Trusts that addresses most of these concerns.

What is REIT?

REIT(Real Estate Investment Trust) is a company that owns and operates real estates to generate income. REITs are trusts that pool in money from a wide avenue of investors and then use that money to buy income generating real estate. The investors include big institutional investors, retail investors(like you and me), mutual funds, etc.

History of REITs

Although REITs have been newly launched in India, they are not new when compared to the rest of the world. REITs were first launched in US in the year 1960. Congress decided to give a chance to the masses to diversify their portfolio by making real estate available to all.

How do investors make money in REIT?

The trusts purchase income generating properties from the money collected from investors. The real estate is then rented out and the monthly rent is distributed among the unit-holders in the form of dividends(after deducting all operational expenses). So investors usually make money from REITs in the below two ways:

Rental income in the form of dividend

The tenants of the rented properties pay monthly rent to the REITs. The REITs then deduct all the operational expenditures from it. The remaining amount is known as Net Distributable Cash Flow(NCDF). Per SEBI regulations, REITs are bounded by law to distribute at least 90% of the NCDF to unitholders at least twice a year in proportion to the number of units held by them.

Capital appreciation in the price of the property

Similar to equity shares in a company, real estate also appreciates in its worth over the years. Especially if the property is in a good location then its value over a period of 10-15 years may well appreciate by more than 3X. So as an investor you will have an opportunity to grow your money by investing in real estate for the long term.

Structure of REITs

Other than its investors, a REIT is a company that usually consists of the below stakeholders:

Manager

Think of the REIT manager as a mutual fund manager. The main role of the manager is to allocate funds into different income-generating properties and other projects that the manager deems fit.

Trustee

A trustee is similar to the Board of Directors of a company. Its job is to oversee the functioning of the REIT and ensure that the manager acts in the best interest of the unitholders.

Where do the REITs invest your money?

REITs invest minimum 80% into completed & revenue generating properties. The remaining 20% can be invested into under construction properties, equity shares of companies that derive most of their income from real estate, corporate debt of real estate companies,Government bonds, etc.

REITs available for investment in India

Currently in India there are only two REITs available for investment: Embassy Office Parks REIT(launched in 2019) and Mindspace Business Parks REIT(launched recently in 2020). These 2 REITs are listed on the stock exchange & trade daily. However the minimum amount of investment in REITs is Rs.50,000 unlike stocks. This amount was Rs.1 lacs when the first REIT was launched in 2019. The Government is working towards reducing this amount further to make it similar to stock trading.

Tax treatment for REITs

REITs enjoy a pass-through status for taxes. That simply means that they don’t have to pay any taxes, only the investors have to based on the dividend they received.

Also read: Taxpayers’ charter-Know your 5 key rights and obligations

Types of REITs

REITs can be broadly classified into the below categories:

Equity

This type of REIT is among the most popular ones. Typically, it is concerned with operating and managing income-generating commercial properties. Notably, the common source of income here is rents.

Mortgage

Also known as mREITs, it is mostly involved with lending money to proprietors and extending mortgage facilities. Further, REITs tend to acquire mortgage-backed securities. Mortgage REITs also generate income in the form of interest accrued on the money they lend to proprietors.

Hybrid

This option allows investors to diversify their portfolio by parking their funds in both mortgage REITs and equity REITs. Hence, both rent and interest are the sources of income for this particular kind of REIT.

Private REITs

These trusts function as private placements, which cater to only a selective list of investors. Typically, private REITs are not traded on National Securities Exchanges and are not registered with the SEBI.

Publicly traded REITs

Typically, publicly-traded real estate investment trusts extend shares that are enlisted on the National Securities Exchange and are regulated by SEBI. Individual investors can sell and purchase such shares through the NSE.

Public non-traded REITs

These are non-listed REITs which are registered with the SEBI. However, they are not traded on the National Stock Exchange. Also, when pitted against public non-traded REITs, these options are less liquid. Plus, they are more stable as they are not subjected to market fluctuations.

Advantages of REITs

Investors who invest in REITs can benefit in the following ways.

Steady income through dividends

REITs provide a steady flow of passive income in the form of dividends.

Diversification of portfolio

An investor can diversify their portfolio by including real estate in it as well.

Liquidity

Investors can easily buy/sell REITs anytime similar to stocks in the popular stock exchanges such as NSE and BSE

Professional expertise

The managers of REITs are experts in the real estate industry. So if someone invests in REITs they get the benefit of the guidance of an expert. The managers will take care of choosing the right property for investment and the paperwork for the same. So the investor is saved all the hassles of investing in an actual property by himself. Also the managers will periodically review the portfolio and make necessary modifications as and when required

Ease of investment

Investing in real estate through REITs is very easy and less cumbersome as compared to the process of investing in a property all on your own.

Disadvantages of REITs

There are however some downsides to REITs as well as follows.

Limited growth prospects

Since REITs are mandated by law to distribute minimum 90% of the dividends to unitholders they cannot reinvest that money into the business for future growth. Hence the capital appreciation for REITs will be comparatively much less as compared to stocks and mutual funds

Risks similar to overall real estate market

When you invest in REITs, your investment will mirror the performance of the real estate market in general. This means that whenever the market is doing good, your investments will generate good returns. On the other hand when the market is down, your returns will also get impacted accordingly

Lack of transparency and control(like mutual funds)

The REIT managers have full control over how investors’ money is managed, without any obligations to consider investor opinion or make any unnecessary disclosures to the investors – and this setup is very similar to a mutual fund. Hence, investors lack transparency and control.

No tax benefits

Investors will have to pay taxes on the dividends which they receive from REITs. This will be treated as regular income and added to the income slab for the individual and taxed accordingly.

My final take on REITs

I think its a good idea to start with the minimum possible investible amount if you are interested to invest in REITs. Observe how the investment performs over a period of 6-9 months. And then if you still feel good about it, you can further increase your investment. That is the approach I take for any new investment. Personally I feel REITs are a great way to add some real estate to your portfolio at really low prices as compared to what you would have paid had you gone the traditional way. It adds diversification to your portfolio plus you also start getting regular income from dividends. And if you are lucky, you may also get a good capital appreciation on the amount invested into REITs. Overall I feel its a nice instrument that will help retail investors(like you and me) access to real estate at low prices.

REITs: A good way to invest in Real Estate