The best way to invest in top notch property

The world loves property. It is considered to be a solid asset that does not easily lose value. In fact, many aver that real estate is the only asset that always goes up and gives great returns!

While there are strong advocates of real estate, it is an asset where investment amounts can be quite high. Liquidity is low and price discovery is a problem. Properties can give rental incomes, especially if they are commercial or residential real estate. However, properties require management, rents need to be collected, repairs and maintenance need to be carried out when tenants vacate and there could be periods of non-occupancy in between. This means that property is a high involvement asset, which may suit some people only.

Add to that the fact that residential properties can offer between 3-3.5% pa gross rental yields is a dampener. Commercial real estate has the potential to offer more – but good commercial properties cost  a lot more too. This makes commercial properties out of reach of most people.

That is where fractional ownership of good quality commercial real estate, along with management of the property makes sense. Real Estate Investment Trusts (REIT) help normal investors own a fraction of top quality commercial property and get commensurate returns.

What are REITs

Real estate investment trust (REIT) can be described as a company that owns, operates & professionally manages diverse real estate properties across geographies, leases them out and generates income. Investors in REITs are called unitholders who have a fractional ownership of the underlying properties that entitles them to receive a share of the income, usually in the form of dividends.

This allows investors to participate in high quality real estate without purchasing or managing them. REITs are listed in the stock markets and allows investors to buy/sell units.

Especially, high quality commercial real estate is very expensive and is out of reach of all but the very rich investors or corporates. REITs allow investors to put in even small sums of money. Investors can park their funds in REITs and reap the benefits of owning high quality real estate. Properties included in REITs comprise data centres, commercial real estate, retail spaces, healthcare units, apartment complexes, etc.

The property values can also appreciate which is the other way unitholders can benefit from their investment in REIT. Hence, investors in REITs have the opportunity to generate income and have a chance to participate in the capital appreciation.

REITs in India

REITs are a new phenomenon in India and has gained traction only in recent years. The Securities Exchange Board of India (SEBI) introduced the first guidelines for REITs in 2007, and the current SEBI guidelines, approved in September 2014, govern the operation of REITs in the country.

Until a couple of months back, there were only three REITs available for investment in India, namely Embassy Office Parks REIT, Mindspace Business Parks REIT, and Brookfield India Real Estate Trust, all of which have predominantly commercial real estate.

It is anticipated that other prominent players in the Real Estate Sector will also introduce their own REITs in the future as it helps them monetise the properties they have built and move on.

India recently welcomed its inaugural retail REIT, Nexus Select Trust REIT that is owned by the global private equity firm Blackstone.

Nexus is a prominent player in the Indian mall industry and is one of the largest mall operators in the country. With an impressive portfolio, Nexus Select Trust oversees approximately 10 million square feet of retail space spread across 17 malls, known as Urban Consumption Centres (UCCs), located in 14 cities nationwide. In comparison, the closest competitor, Phoenix Mills, manages 9UCCs across 6 cities.

Structure of REITs in India

REITs in India has a three-tiered structure where there is a sponsor, trustee and asset manager.

The sponsor would usually be the real estate company that will setup the REIT. The assets may directly be in REITs or may be held in a Special Purpose Vehicle (SPV), created for the purpose. The REIT needs to hold at least 50% stake in the SPV. The sponsor needs to hold at least 25% of the units for the first three years after the REIT formation and 15% at least from thereon.

Sponsor will appoint a Trustee, who will hold the assets in the Trust for the benefit of unitholders and will ensure proper management of assets by the asset manager, distribution to unitholders and proper conduct of the REIT as per the regulations.

The Asset manager is responsible for managing the portfolio and making appropriate investment decisions. They will also need to report their activities in line with regulatory/ compliance requirements. They may involve a third party for facilities management.

Conditions which REITs need to follow in India –

1. At least 80% of properties in REITS need to be commercial properties that can be rented out for income generation. The remaining can be in other investments, including under construction properties.
2. 90% or more of the income generated needs to be distributed to the unit holders.
3. REITs need to be listed in the stock market to provide liquidity

Tax treatment of distributions from REITs

Tax treatment for unitholders is somewhat complex. Let us understand this –

Dividend paid by the REIT (by the SPV) are exempt from tax, as long as the SPV does not claim any special tax status.

Rental income & interest income received by investors from the REIT are taxed at one’s slab rates.

Repayment of loans are not taxable till the loans repaid do not exceed the issue price. However, when the loans repaid in a year exceeds the issue price, it will be taxed in that year as income.

However, capital gains taxes would apply while selling the unit when the loan repaid needs to deducted from the cost of acquisition and the new cost is arrived which will be deducted from selling price.

Capital gains – STCG is 15% till 36 months; LTCG – 10% ( beyond Rs.1 Lakh ) after 36 months

Points to ponder over before investing in REITs

REITs should be considered for investment if one wants to diversify into real estate, away from Equity, Debt and Gold.

REITs can be treated as somewhere in between an equity and a debt product. REITs have assets that have the potential to appreciate, which is like Equity. REITs are dependant on rental yields

Overall taxation can be termed as moderate. It has the potential to deliver 6-7% pa post tax returns

Capital appreciation are a possibility, which is like the icing on the cake

You can go through these articles for more details on REITs –

Real Estate Investment Trusts (REITs) – Everything You Need to Know by ET Money

How your income from REITs & INVITs will be taxed

How income from REITs are taxed – Podcast

India’s first retail REITs

Taxability of Business Trusts

Disclosure – I do not have any REIT investment right now in my portfolio but may invest in the future

Authored by Suresh Sadagopan, MD & Principal Officer, Ladder7 Wealth Planners. P. Ltd