Is REIT a better way to invest in Real Estate?

Real Estate is an asset that one would find in almost every portfolio. Residential Home is the most common asset that people own. Besides that, investors have more residential properties and land parcels.

Properties are seen as sure-shot investments that will only appreciate. Most people have got into properties in the bull phase for properties which started in 2003 and lasted for about 8-9 years. Prices did shoot up during this time.

But after that period, the property prices have either stagnated, gone down in rupee value itself, or have shown small increases.

Most people do not invest in commercial real estate. It does offer better rentals; but investment quantum can be high, loans are not available at concessional rates and they are prone to even more volatility as compared to residential properties. That is where Real Estate Investment Trust (REIT) comes in.

What are REITs?

REITs, or real estate investment trusts, are entities that own, operate & manage income-generating real estate assets across a range of property sectors.

An REIT is created by a Sponsor who transfers the ownership of the assets to a Trust or a Special Purpose Vehicle (SPV) under a trust, in exchange for units. The trust invests in properties directly or could do so by investing in Special Purpose Vehicles (SPV) which own properties.

REIT structure is similar to an MF three-tier structure – Sponsor, Trust, and Asset Management Company. The sponsor will continue to own a certain percentage of the units all the time, to ensure skin in the game.

This is a wonderful tool in the hands of developers to build property, transfer it to a REIT and realise liquidity. This allows the real estate developer access to money without getting stuck with properties that are developed but have not found buyers.

The most common underlying property asset is commercial property, atleast as of now in India. REITs also lend to real estate firms and earn interest.

The good thing about REIT is that it allows a person to invest in a range of properties and get remarkable diversification with professional management, at very low investment levels. In that sense, REITs are like Mutual funds that allow you to invest in a diversified portfolio of equity of companies at a very low investment quantum.

Also, REITs are listed on the exchanges. This means one has liquidity at all times, unlike in the case of a property one may own ( which is notoriously illiquid ).

There are three REITs in India. Embassy Office Parks REIT, Mindspace Business Parks REIT & Brookefields India Real Estate Trust.

A bit more about REITs

As per the current guidelines, 80% of the assets must be invested in completed commercial real estate projects, and only 20% will be in under-construction projects, equity shares, money market instruments, cash equivalents, and real estate activities.

The regulations require that 90% of the distributable surplus to unitholders. That is a great thing as someone coming to REITs is looking for a regular stream of income.

During initial subscription, the initial investment can be just Rs.10,000. Further on, one can buy and sell even one unit on the exchange.

For whom is REIT suited?

REITs are suited for people who want to invest in commercial real estate assets but do not want the hassles of managing it and want professional oversight. People who are looking to invest in Commercial real estate will find this very appealing as REITs will own some high-quality rent yielding real estate assets, which may be virtually impossible to own on one’s own considering the investments involved.

Such high quality commercial real estate also have the chance of offering very good rental returns, with long lock-in tenures ( resulting in lower periods of vacancy ). This is suited to people who are looking at regular, reasonably stable returns from their investment.

However, we have found that most of our clients already own a good amount of real estate investments in their portfolio in the form of Residential assets and land parcels. Some even have commercial property in their portfolio. Hence, we can allocate this in some portfolios only.

Another reason is the return expectation from Real estate in general, which is in double digits. REITs primarily offer the returns based on the rental incomes.

Taxation stuff you need to know

The distributions to unit holders can be proceeds from Interest Income, Dividend Income or Repayment of debt.

The interest & dividend income received by the REITs from SPVs are tax free in its hands (assuming the SPV has not opted for concessional tax regime ) .  However, any capital gains from sale of assets and interest or investment income earned by REIT other than income from SPVs is taxed.

The investor would receive distributions from REITs, some of which would be income and others would be repayment of unit capital ( principal ). The Trust would have to intimate the unit holder of what is taxable and non-taxable to the unit holder. They are to deduct a TDS of 10% from the taxable portion.

Capital gains tax on sale of units is 10% after three years of holding and 15% before that.

In conclusion

REITs can be another way of investing into Real Estate which yields regular income; one cannot expect an order of magnitude returns here.

Investment in REIT could be considered as a diversification into commercial real estate which mostly investors do not have. The characteristics of REIT are quite different from a typical fixed income asset, which augurs well for diversification, though this also offers a regular stream of income like them.