Although relatively new in India, did you know that Real Estate Investment Trusts (REITs) have been a popular global investment vehicle for many years?
in India are
This $2 trillion1 asset class has historically been among the best-performing asset classes, allowing investors to benefit from real estate growth across multiple sectors and geographies. So, what are REITs? Real Estate Investment Trusts are investment funds that pool money from different investors to purchase income-generating real estate properties such as shopping centres, hotels, and office buildings.
The REIT structure has transformed India’s office market since the listing of Embassy REIT in 2019. In the past two years, India has listed three REITs with a total market value of $7.6 billion1 or ₹55,267 crores, which shows that investors are interested in the growth and development of the office market in India.
Unlike conventional real estate, REITs are traded on public stock exchanges. This means you can buy and sell them just like stocks. So, if you’re looking to diversify your investments for the long term, REITs can be a significant component in your overall portfolio.
Evolution of REITs in India
Now that you know what are REITS, llet’sunderstand how they came into being. Real Estate Investment Trusts’ journey began in India in 2007, when SEBI introduced the first draft of its new REIT regulations. The objective, of course, was to provide a safe and organised way for people to invest in real estate without having to own property themselves.
After several discussions and changes, the regulations were accepted in September 2014. The Embassy Office Park REIT was the first Real Estate Investment Trust listed on the Indian exchanges in 2019. Investors flocked to this new asset class, and the fund raised more than ₹4,750 crores2!
This success story opened the door for more potential REIT offerings in India, such as Mindspace Business Parks REIT in 2020, Brookfield India Real Estate REIT in early 2021, and Nexus Select Trust REIT in 2023. This route has made it easier for real estate developers and investors to earn money and raise capital for further growth.
Tax reforms exempted REITs (Tusts/SPVs) from dividend distribution tax 2016, essentially removing double taxation. Thus, REITs have become more tax-efficient and attractive to investors. This exciting new asset class can potentially bring about a significant change in the Indian real estate sector.
How REITs Work?
We understood what are REITs and their evolution. Now, we will discuss how REITS work. REITS offer the best of both worlds – they help you invest in income-generating properties without the hassle of ownership. You get regular returns on your investment in the form of dividends. Plus, as the value of the underlying properties increases, you can even benefit from the capital appreciation.
REITs are registered with SEBI as trusts. This structure allows real estate developers to raise funds by transferring their assets to the trust. The stakeholders involved include:
1. Sponsor: This person creates the REIT and transfers their real estate assets to the trust. Typically, a builder or developer will take on this role when they want to raise funds through REIT.
2. Trustee: The sponsor appoints the trustee and holds the assets in trust for the unitholders.
3. Manager: The manager makes investment decisions and manages the RREIT’sassets. They are appointed by the trustee and are often a private company closely held by the sponsor.
4. Unitholders: The trust’s beneficiaries indirectly own the RREIT’sassets by subscribing to its units. They can be Indian residents or foreign investors.
5. Independent Valuer: The REIT appoints an independent valuer to regularly value its assets. This valuer is a credible, unbiased party who accurately assesses the fund’s assets.
After registration, REITs can launch an IPO and list their units on the stock exchange. Through this process, developers can easily access capital. This brings some much-required liquidity to their operations. Subsequent stock market issues can be addressed through follow-on offers, preferential issues, qualified institutional placements, rights issues, bonus issues, or offers for sale.
What conditions must a company adhere to be a REIT?
A company must adhere to certain conditions to be recognised as a REIT.
- Must have at least 75% asset investment in real estate and derive a minimum of 75% of its gross income from interest on mortgages, rental income, or sales of properties
- Must be taxed as a corporation and managed by trustees or a board of directors
- Must have a minimum of 100 shareholders, with no more than 50% of its shares owned by five or fewer individuals
- Must distribute at least 90% of their taxable income to investors as dividends every year.
However, a company can choose not to opt for the ” EIT ” Status even if it meets these requirements, enabling it to avoid corporate taxation and provide substantial dividend payouts.
How REITs Make Money?
When you invest in REITs, the returns are impacted by various factors such as the appreciation of property value, rental income, and market conditions. Ideally, most types of REITs make money in two ways:
- Dividend Income
REITs make money by renting out and leasing real estate. After subtracting the expenses for managing and maintaining those properties, the Net Rental Income is what is left. The fund distributes dividends to investors from this.
- Capital Gains
REITs are traded on stock exchanges, and their prices change based on performance and market demand. If they perform well, the cost of the units increases, and investors can make capital gains by selling them.
Unlike other REITs, Mortgage REITs do not own real estate properties. Instead, like other financial institutions, they lend money as loans to people who want to buy properties, like homebuyers or real estate developers. They earn money from the interest on these loans.
Who can invest in a REIT?
- Investors from all groups (foreign/domestic/retail/institutional) can invest in REIT units.
- No minimum trading lot size is required
- Investors can purchase and trade units via Demat like any other listed securities on the exchanges.
Benefits of Investing in REITs
- High Dividend Yields
REITs offer pre-tax dividend yields of 7-10% annually, making them an attractive option for income-seeking investors. Investors generally pay 90% of their net income as dividends.
- Diversification
It allows you to own dozens or even hundreds of properties, which reduces your overall investment risk. Thus, if one property in your portfolio is not performing well, others can help offset any losses.
- Lower correlation with other assets
REITs also correlate less with other assets, reducing the portfolio’s volatility. When stocks are down, REITs may not be affected as much or perform better, reducing overall investment risk and providing a more stable ROI.
- No Self-Management
Owning real estate may require the owner to engage in periodic renovations and upkeep. This can be time-consuming and expensive. REITs offer the benefits of investing in real estate without the hassle of physical ownership.
- No Commissions
Unlike traditional real estate investments, investors can easily buy or sell REITs without incurring additional costs, which can cost up to 6% for every sale. Hence, REITs are a cost-effective investment option.
Risk of Investing in REITS
- Market Volatility
Market changes, such as economic conditions, interest rates, consumer demand, and competition, affect REITs. They are also vulnerable to industry trends, unexpected events like pandemics or natural disasters, and regulation changes. These factors can cause significant price swings and losses during market uncertainty or turmoil.
- Liquidity Issues
REITs have some advantages over directly buying and selling real estate. However, sometimes, few people buy or sell REIT shares, which can make it hard or costly to sell your shares. Some REITs may have a lock-in period that limits access to one’s money when needed.
- Tax Implications
The dividends are usually taxed as regular income, which can be higher than the tax rate for long-term investments. This can make them less tax-efficient for some investors.
- Management Quality
The quality and performance of the management teams can greatly affect the REIT’s Performance and growth. Some firms may charge higher fees or take riskier bets. So, it’s advisable to look into the team’s reputation, history, and management before deciding to invest.
- Limited Options
Only ~3 REITs and 1 international REIT fund of Funds are available in India, drastically reducing investors’ investment options.
Conclusion
Investing in real estate was complex and challenging, especially for new investors. However, thanks to REITs, the investment process has become more accessible. These funds provide benefits such as dividend income and liquidity.
Regulation changes have made it easier for retail investors to participate and invest in REITs.
The ~4 REITs in India saw an influx of 2,00,0003 investors in August 2023. Compared to the 30 million mutual fund investors, however, this is just a mere fraction! This indicates the immense opportunity for future growth.
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