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Real estate investments cost a lot of money; be it residential property, office space, or a shop and in the big metro cities it can be difficult to afford one. If a person wants to include property in his portfolio he can invest in real estate company stocks that are volatile or the other way is to invest in the Real Estate Investment Trusts (REITs). These are the investments listed on the stock exchange that get people exposure to real estate without buying the property itself.
REITs are managed by a professional manager and they are a type of pooled investment vehicle that own, operate and finance real estate investments that generate income. The pooling of money is similar to mutual funds but the underlying asset in REITs is the real estate, unlike some mutual funds that invest in debt, gold, or equity.
Which are the REITs in India?
There are at present 3 REITs in India:-
- Brookfield India Real Estate Trust REIT.
- Embassy REIT- It is sponsored by Embassy and Blackstone and is Asia’s first and largest REIT (by area).
- Mindspace REIT sponsored by K. Raheja Corp and Blackstone Group.
REITs are a means for a retail investor to diversify their investment and if you are already invested in stocks, bonds, and gold you can consider investing in REITs too.
Structure of REIT–
The structure of a REIT is similar to a mutual fund and it has a three-tier structure-
The sponsor is responsible for promoting the REIT with his money and he appoints the trustee. The REIT sponsors are required to hold 25% of the units for the first 3 years and after that, they can reduce their holdings to 15% of the units.
The fund management company is responsible for managing the assets of REIT i.e. selecting and operating the properties as well as reporting and making disclosures by the REIT.
The trustees are there to ensure that the funds are managed in the interest of the unitholders. They keep an eye on the activity of the management company and ensure the timely distribution of dividends.
Types of REITs-
The different types of REITs available globally are-
Residential REITs– The Residential REITs own and operate housing and residential apartment buildings.
Retail REITs– These REITs invest in supermarkets, shopping malls, and grocery stores and rent space to retail tenants.
Healthcare REITs– The Healthcare REITs invest in the property of hospitals, medical centers, nursing facilities, and
Office REITs- These REITs invest in office properties and their main source of income is the rental received from the tenants.
Mortgage REITs- Mortgage REITs acquire existing mortgages and their income is derived from the interest they earn on the mortgage loans.
The company should meet the following criteria to be qualified as a REIT-
- 90% of the income earned by REITs has to be distributed to the investors as dividends.
- 80% of the investments by the REITs must be in properties that can generate returns by renting them out. The other remaining 20% can be invested in stocks, bonds or kept as cash or even in under-construction projects.
- The company must have an asset base of Rs 500 crores.
- REITs should be listed on the stock exchanges.
Advantages of investing in REITs-
- A person can diversify and maintain asset allocation in his portfolio. He can invest in gold, debt funds, equity as well as REITs. The overall risk is reduced in the portfolio and asset allocation is essential in meeting the financial goals. Asset allocation helps in reducing volatility and maximizing returns.
- Investing in real estate requires a large sum of money which everyone doesn’t have especially in metro and Tier 1 cities. If a person wants to invest in real estate he can do so by investing in REITs where the minimum application amount is between Rs.10, 000 to 15,000 in the Initial public offerings (IPOs) and Follow-on-offers (FPOs).
- There are professional managers who manage the REITs thereby reducing botheration for the investors. Purchase of property is a time consuming process and moreover there is the aspect of maintenance as well. Sometimes the purchase can get mired in litigations which are well handled by the professionals.
- REITs are regulated by SEBI and disclose their portfolio annually and semi-annually.
- REITs provide regular income to the investors as they distribute 90% of the income collected from rentals to their investors.
- The REITs invest in properties in many cities and across various spectrums that includes residential, commercial, hospitality, rental and retail sectors. This helps the investors to reap the benefits of growth in various segments.
Risks of investing in REITs-
- In India there are only 3 listed REITs and 1 International fund of funds thus offering limited choice to the investors.
- If the real estate markets are doing well REITs will offer good returns as compared to the sluggish markets. When there is vacancy in property occupation it is not good for REITs.
- At present the number of retail investors investing in REITs is quite low resulting in low liquidity.
- Real estate is subject to state level regulation and there is no national policy. Till the time it is done the spread of REITs may be a challenge.
- REITs distribute a great part of their earnings to the unit holders. This reduces their ability to put back the money in the business for further growth.
How to invest in listed units of the REITs-
REITs are traded on the stock exchange like equity shares. There is a requirement of a Demat account and you can invest in the REITs. The price of REITs depends on the performance of the REIT as well as the demand for the units. The minimum lot size that can be traded has been reduced from 100 units previously to 1 unit now.
Things to consider before investing in REITs-
There are certain things that have to be considered before investing in REITs and they are-
- The occupancy is an important criterion to be checked before investing in the REITs. A high occupancy leads to a stable cash flow and results in consistent payout of dividend and increasing rentals when required.
- The portfolio of REITs should be well diversified across geographies and sectors that will make it less susceptible to oversupply and concentration risks. Overdependence on a single sector is not good and the person who is purchasing units should check that the REITs are diversified across various sectors like IT, hospitality, pharmaceuticals, banking, and insurance to reduce dependence on a single sector.
A strong sponsor will be useful and have brand value and would be highly trustable.
- One of the best ways to evaluate REIT is to consider the Net Asset Value (NAV). It is the estimated value of the assets minus the liabilities, divided by the number of outstanding shares.
- The consistency of the net distributable cash flow has to be taken in to account as it is the money that is distributed to the unit holders.
International REIT Mutual Fund-
Kotak International REIT fund of funds launched in December 2020 is the only International REIT mutual fund in India. It is an open-ended mutual fund scheme that invests in a diversified portfolio of listed REITs that invest in residential, retail, hospitality, office, warehousing, and data centers projects. Its investment is in a portfolio of real estate projects in the Asia Pacific region through the listed REITs.
Taxation on REITs Income-
The REITs distribute 90% of their income earned and the dividend is taxed as follows-
The dividends that are received from REITs are taxable in the hands of the investors. These dividends have to be included in the annual income and taxed as per the tax slab of the investor.
- As the REITs are listed they are covered by long term capital gains (LTCG) and short term capital gains (STCG) when you sell them. When an investor sells the REITs before 3 years the gains will be short term and taxed at 15 percent and when sold after 3 years the gains would be long term and above Rs 1 lakh will be taxed at 10 percent.
REITs provide high dividends and have the potential for moderate long-term capital appreciation. There is transparency and liquidity in the REITs as they are listed on the stock exchange as compared to the real estate investment where a person may not be able to carry out thorough research. Professional managers are involved in running the REITs and there is less botheration for the investors as they are not involved in the maintenance aspects. A person can follow asset allocation and allocate 10 percent of his portfolio in the REITs.