TTraditionally people used to invest in apartments, land, shops etc. with the idea of renting it out and also enjoying capital appreciation. But investment in property would typically involve a good chunk of investment. Many times, one may be taking a loan to buy these properties.

Properties tend to be illiquid, suffer from concentration-of-capital risk, taxes and maintenance payouts, legal tangles arising out of incomplete paperwork, encroachments etc. Even properties that can be rented out have periods of vacancy that brings down the overall returns, unlike in case of a financial asset.

Also, properties that an individual can buy are limited to residential homes, shops, small pieces of land etc. But the main action in properties is happening in high end commercial property, be it top-tier office spaces, malls, hotels etc., which an individual cannot afford.

Enter REITs

Real Estate Investment Trusts (REIT) are pooled investments that will have offices, retail spaces, malls, hotels, etc. where normal investors could invest, which are otherwise off-limits for them. This is a great concept where the sponsors ( who may be builders/ developers ) will be able to offload their property to REITs, get liquidity so that they can move on with other projects. SEBI has specified that the sponsor should hold at least 15% stake in REITs as a commitment for at least for a three year period to ensure skin in the game.

The objective of the REITs is to lease out the properties and earn rental incomes out of it. For simplicity and ease of understanding, one can consider REIT to be a Mutual Fund with underlying assets as properties. These are listed on a stock exchange and can be bought and sold like an equity share.

The properties in REITs are held in a trust ( just like in a MF). The properties are carefully selected, put out on rent and a professional agency maintains the property. REITs invest in A grade large commercial properties that are strategically located, fetch good rentals and show good capital appreciation as well. This will be done by a professional team for a fee. As per the regulatory requirement, REITs need to distribute at least 90% of the taxable revenue that the entity receives. REITs endeavour to distribute the rent in the form of dividend to unit holders.

Investors can hence enjoy regular returns with the prospect of potential capital appreciation of the underlying asset that reflects in the value of units.

Returns from REITs

Considering that the underlying asset in an REIT is high grade commercial property, the rental yields would be very good. They can be as high as 6-9% pa or even more. Most of the properties are on long leases with appropriate escalation clauses which brings in certainty to the lease rentals over long periods and consequently to the income distribution to unit holders.

Apart from this, there would also be appreciation of property over time. There will be periodic assessments of the property which will lead to value revisions. That will show up in the Net asset values of the units being held.

Overall REITs can offer high single digit returns for the unit holder, considering the income distributions and capital appreciation of the property.

Taxation

The taxation of REITs should be understood properly. There is income distribution, usually monthly, which can be through dividends, capital return ( some portion of investor money can be borrowings by the REIT ) and interest on such borrowed capital.

Dividend distributed by a REIT, especially one that has not opted for any special tax concessions, is pass-through to the firm and not taxable in the investors hands too. Interest income is taxed as per slab rates of the investor. Capital returned will not be taxed; however, it will be adjusted against the buy price of the units ( which means the capital gains will be calculated on the adjusted buy price).

If one were to sell the units of a REIT, Short and long term capital gains tax applies. Units of listed REITs held for more than 12 months will attract 12.5% Long-term capital gains tax, above annual gains exceeding Rs.1.25 Lakhs. If sold within 12 months of buying, the gains will attract 20% Short-term capital gains tax.

The accounting and clear enumeration of the various components of distribution ( like Dividend, capital returns, interest etc. ) will be done by REITs to each unit holder based on which they can calculate their applicable tax.

For whom is REIT suitable

Most people own property of one or the other type as property is part of most peoples' investments. But the property most people own will be residences, land parcels and maybe small commercial property which will be in specific locations.

REITs own multiple properties of various types, across geographies with tenants from various industry verticals. This diversifies the underlying asset risk to the investor and delivers stable income and long-term growth.

REITs are hence useful for those who do want a diversified holding of property assets, which are professionally managed, have unparalleled liquidity due to the listing on the exchange and want to move away from direct property holdings.

For such people, REITs would be a good fit since the underlying in REITs are top-notch commercial property that are curated well and managed professionally

REITs can be pegged in between equity and debt, in terms of risk and returns. It has the potential to offer returns somewhat above debt and below Equity. The taxation is also benign as explained above.

Our take

REITs are a relatively new investment product that needs consideration. Since most people have real estate assets ( apart from their own residence ) in their portfolio, REITs will need to come in somewhat later, when the investment portfolio reaches a certain size, as a diversification measure. We would put that as Rs.6 Crores or there abouts.

We may suggest REITs to others below this threshold if they do not have properties in their portfolio or want property exposure through liquid financial assets.

This will again be very useful for those who are looking for consistent income, with some capital appreciation.

Currently, there are just 5 REITs in India most of which are operating in commercial office spaces with a combined Assets under management of Rs.2.3 lakh crores. There is one operating in malls and retail spaces. We will need to pick from the available choices for now. In the future, many more such REITs would come up giving us far more choices.

REIT investment may be a great choice for at least some investors - those that want exposure to property investments, without investing directly in one!