Are Real Estate Investment Trusts (REIT’s) a worthy investment option?

Guys, Welcome to VRD Nation. We are back with a new topic and one that will serve as an additional investment option in the fixed income universe.

So, what is a REIT?

Before we understand what a REIT is, let us step back and focus on what is a Mutual Fund?

As you all know, a mutual fund is an investment vehicle that pools money from various investors and lets them invest in stocks without having to go through the pain of investing in stocks directly.

What else do you get by investing in a MF? Apart from returns in the form of dividends and redemption of mutual fund units once you sell them, what is it that attracts investors to Mutual funds?

Am sure you would all agree that in addition to Convenience and ease of access during investing, we have liquidity, professional fund managers to track your portfolios and the ability to use them as a long term investment platform to achieve your goals.

The biggest advantage of a mutual fund is you can start investing in the stock market with an amount as low as Rs.100/-.

To broaden the investment venues for fixed income investors, SEBI introduced guidelines for the establishment of REIT’s in India in 2014 and India saw its first Real Estate Investment Trust in 2019.

In this video, we are going to discuss the following.

•         What are REIT’s?
•         What is their composition?
•         How do they work?
•         Investment in REIT’s from a taxation perspective
•         Should you invest?
•         Performance of REIT’s in India

So, what is a REIT?

Real Estate Investment Trust (REIT) is a tax-efficient vehicle that owns a portfolio of income-generating real estate assets. REITs are investments listed on the stock market that allow investors exposure to Real Estate without having to purchase or manage properties by themselves.

A REIT is created by a sponsor, who transfers ownership of assets to the trust in exchange for its units.

Think of it as a mutual fund, where money is pooled from investors who are then offered mutual fund units. Instead of shares of public companies, REIT units represent ownership of real estate assets.

While the underlying asset of Mutual Funds is Equity, Debt, Gold, or a combination of these, the underlying asset in the case of REITs is primarily Real Estate Holdings or loans secured by Real Estate.

The profits to investors from REIT’s come in the form of dividends and capital appreciation.

Composition of a REIT:-

A Real estate company, for example, Builder A decides to form a Real Estate Investment Trust. It then becomes the Sponsor for the REIT and appoints a Trustee, for example, Axis Trustee Services Limited.

The Trustee holds the Real Estate Assets of the Trust in its Trusteeship and these assets are no longer directly controlled by the Sponsor.

The sponsor also appoints a REIT Manager which is a company that specializes in Facilities Management. Its job is to manage the assets of the REIT, make investment decisions, and ensure timely reporting as well as disclosure by the REIT.

SEBI rules for the creation of REIT’s

• At least 80% of investments made by a REIT need to be in commercial properties that can be rented out to generate income. The remaining assets of the trust (up to the 20% limit) can be held in the form of stocks, bonds, cash, or under-construction commercial property.
• At least 90% of the rental income earned by the REIT has to be distributed to its unitholders as dividends or interest.
• Stock market listing of REIT is mandatory

How do they work?

For investors:-

• When a REIT rents or leases out its commercial property, it receives income. This is then distributed to investors in the form of dividends and interest. As per SEBI rules, at least 90% of the net rental income received by REIT’s should be paid out as dividends and interest.
• Similar to Stocks and Mutual funds, if a REIT performs well, it leads to an increase in the price of its units which the investor can sell and book a profit. This leads to capital gains for the investor.

For Real Estate Companies:- What’s in it for them?

• REITs get a few tax exemptions that are not available to other types of Real Estate companies
• Any income obtained from renting or leasing Real Estate Assets that are owned by the REIT directly is also exempt from tax which is generally not given to other real estate companies in India
• These in turn allow these real estate firms to reduce their tax liability and generate higher profits
• Further, by listing their REIT on the stock market, they get access to additional funds

Investment in REITs from a taxation perspective

• Since investors receive both dividends and also capital gains on the sale of their units in the REIT, they are taxed accordingly for both
• Dividends received by the investor from a REIT are included in their annual income and are fully taxable as per their applicable tax slabs
• If an investor redeems his units in the REIT before 1 year, he is charged STCG (Short Term Capital Gains) at the rate of 15% of the capital gains from the sale proceeds. Again, if he holds them for more than a year and redeems his units, he would be charged LTCG (Long Term Capital Gains) at the rate of 10% of the capital gains from the sale. Another point to be noted is unlike the sale of residential property, the investor is not given the indexation benefit in this case.
• If an investor invests in an International REIT Fund of funds which is similar to investing in a Mutual Fund (FoF), the STCG is applicable if the holding period is 3 years or lower.LTCG is taxed at 20% if the investment is redeemed after 3 years.

Should you invest?

Now after all the above, the only question that is in your mind is should we invest or give it a pass?

Well, as in the case with any other investment product on earth, REIT’s too have their share of pros and cons.

The pros in this case are:-

1. Diversification of portfolio through exposure to Commercial real estate without the hassles of investing directly
2. Minimum investment of only Rs.50,000/- compared to the lakhs of rupees required to invest in a commercial property
3. A professionally managed team without any effort on your part to take care of your  investment
4. A regular mode of income through dividends and interest
5. Capital gains through the redemption of units

So, it all looks good, but what are the practical problems investors can face in a REIT?

1. The first problem is low liquidity as the number of market participants among retail investors is quite low compared to equities and derivatives
2. Options are quite limited in India since there are only 3 REIT’s and 1 International REIT Fund of Funds
3. Since both the dividends and capital gains are taxed at the hands of investors, a lot of dividend income is lost as taxes, especially for those in the highest tax slab

Now that you understand how a REIT works and its advantages and disadvantages, how do you invest?

REITs are listed and traded on stock markets just like Exchange Traded Funds (ETFs) and hence you need a Demat Account to invest in REITs in India.

Similar to Exchange Traded Funds, the price of units of the REITs depends on both the demand for units as well as the performance of the REIT and changes accordingly. Currently, you have 3 options – Embassy Office Parks REIT, Mindspace Business Park REIT, and Brookfield India Real Estate Trust.

You also have the option of investment in REITs through mutual funds and Kotak International REIT Fund of Fund is the only International Mutual Fund in India that invests exclusively in International REITs.

Performance of REIT’s in India:-

Brookfield India Real Estate Trust (NSE Code in Zerodha: BIRET) has given the highest return among the 3 REIT’s at 11.34% since inception.

However, one important point to be noted is that Embassy Office Parks REIT was the first REIT to launch in India in 2019 and hence BIRET’s performance is less than a year old as it was launched in February 2021. Mindspace Business Park REIT, on the other hand, was launched in August 2020.

So, how do you pick the right REIT?

The traditional valuation metrics like PE, EPS growth, etc cannot be applied here and there are certain parameters to consider while evaluating REITs. Let’s understand each of them.

1.Weighted Average Lease Expiry – It is used to calculate the time left for the property to go vacant and is measured in years. Yes, the higher the better.

2.Distribution Yield – Since REITs have to pay 90% of distributable cash flows to the investors, it is a metric to measure these payments. Again this is not guaranteed as it depends on the performance of the trust. So, again the higher the better.

3.Loan To Value – measures how much debt was borrowed compared to the underlying asset value. A higher LTV is a warning sign for investors to move away from it.

4.Net Distributable Cash Flow – is a key metric to show how much money is left to distribute to the unitholders and hence it is an important metric to be followed.

5.High occupancy – is the percentage of the square foot available in the portfolio of REIT and is an important metric of its performance. The higher the occupancy, the better it is for the REIT as it guarantees cash flows.

6.Portfolio  Diversification – REIT’s should have a diversified portfolio and should not restrict their cash flows from rents or leases from properties in  one or two cities. This increases concentration risk. The more diversified their properties are, the better is the stability and consistency of their cash flows

7.Net Asset Value – is one of the best ways to assess REITs and is calculated as the estimated market value of the properties minus all liabilities. This number is again divided by the number of shares outstanding.

8.Attributes of the Sponsor – A strong sponsor will have many advantages like brand recognition, trust factor, on-time delivery etc.

9.Taxation regime –  works the same for all REITs except for Dividend income and it depends on the tax regime the SPVs had opted for. Unitholders are taxed at the same rate at which REITs are taxed. REITs having the highest non -taxable portion of NDCF are likely to gain higher interest among investors.

Now that you know all about REIT, remember that liquidity is a key concern in a REIT in India and unlike shares or mutual funds, you cannot sell them whenever you like as the REIT market is quite illiquid and hence it carries an element of risk.

However, with all its advantages of diversification and stability of income, it is advisable to put not more than 10% of your portfolio in a REIT.

Well, this is it, guys. Hope you learned something new which will also help you in your investment journey. All the best..

Disclaimer: We would like to mention again that we are not affiliated with any marketing firm or commercial organisation and this helps us to be extremely unbiased and independent in whatever we present to our students and viewers. By now, you would have seen that in none of our videos, we promote the products or services of anyone or any firm and we intend to keep it that way. Further, remember that the above article is in no way to be treated as investment advice and hence please check with your registered financial advisor for any investment-related advice.