Want a slice of real estate at affordable costs? Invest in REITs

Investment in the real estate sector in India has grown in recent times due to the demand for office and residential spaces. The pandemic has further led to properties being available at attractive valuations,  driving institutional demand. As per a report by Colliers India, institutional investments in this sector are forecasted to increase by 4 percent and reach ₹36,500 crores in 2021, despite the pandemic-induced downturn.

When we talk about real estate investment in India, it has traditionally meant purchasing physical property, usually residential property. But there is another way to gain exposure to the sector through investment in commercial property such as office spaces, malls, shops, etc. However, this includes large ticket loans and the hassle of getting all the required clearances, finding viable tenants and entering into leases, and then rent collection.

A less-known option is through the REIT route. With the Securities and Exchange Board of India's (SEBI's) recent initiatives to lower barriers to entry and deepen the market for small and retail investors, this mode of investment must be watched.

What is a REIT?

A REIT or Real Estate Investment Trust is unlike traditional property ownership. Consider it a special kind of mutual fund scheme, where money is pooled from various investors to invest in real estate or loans secured for real estate. Just like mutual funds, the assets are professionally managed by a designated manager.

How Does it Work?

REITs are backed by income-generating assets like commercial and residential properties. A real estate company might decide to form a REIT. It then becomes a Sponsor and appoints a Trustee, who then appoints a manager to manage the real estate assets and make investment decisions on behalf of the Trust. The REIT can then be registered. After that, the Trust can raise money, either publicly through the stock market or via private investors, through the sale of units.

After the appointment of a Trustee, the Sponsor doesn’t have any control over the assets. The real estate holdings might be controlled by the REIT, either directly or through a Special Purpose Vehicle (SPV). The SPV is a company in India that holds the assets on behalf of the REIT. As per the regulations, a 50 percent stake or more can be held by the Trust in the SPV.

So, a REIT unit means that investors have part ownership in the real estate assets held and managed by the Trust. The unit holder is eligible for a share of income generated by the assets. So, how do REITs generate income for investors?

Dividend and interest payouts: This is the income received by the REIT upon leasing or renting out the commercial properties. The net rental income, which is paid out to the investors, is done after deduction of key expenses like maintenance, management fees, etc.

Capital Gains: REITs listed on stock exchanges increase and decrease in value depending on market demand and performance. When there is an increase in the price of REIT units, they can be sold in exchange for capital gains for the investor.

Usually, a REIT is supposed to pay to its unitholders minimum 90 percent of its net distributable cashflows in the form of distributions. Investors usually get quarterly dividends/distributions.

Investors can invest in REITs through IPOs or the secondary market. In July 2021, SEBI reduced the minimum subscription amount and trading lot size for such publicly issued REITs. Now, the minimum subscription value of REITs is ₹10,000-15,000 and minimum trading lot is 1 unit. A Demat account is required to invest in REITs.

Benefits of Investing in REITs

Some of the major benefits of investing in REITs include:

Diversification: Investors can diversify their portfolio beyond equity and debt and gain exposure to real estate without the hassle of purchasing and managing a property. Moreover, small retail investors can invest in high-value properties with a small initial investment

Opportunity to Earn: REIT prices considers overall commercial market rentals and property valuation of office premises. An investor can gain from property valuation and unit price movement.

Regular Income Generation: REITs have to mandatorily distribute at least 90 percent of their rental income to investors as dividends and interest payments.

Reduces Portfolio Volatility: Having a portfolio of low-correlated assets can help investors gain market-like returns and reduce portfolio volatility.

Professional Management: An experienced and qualified manager takes care of the assets to ensure smooth operations.

What to Check While Choosing a REIT?

Before investing in REITs, here are some factors to consider.

Asset Portfolio: It is vital to look at the businesses occupying space in the properties and the clientele of the SPV. If properties are occupied by tenants (whose businesses are hurt by downturns) who default/delays on rent payments this can impact the returns for unitholders.

Geographical and Sectorial Diversification: Over-dependence on a particular sector is best avoided. Usually, the IT sector in India is a reliable occupier of high-grade leased properties. However, the work-from-home model is the new normal in many sectors. This may pose risks in the long term. It could be wise to look for a well-diversified portfolio including financial services, healthcare, IT, FMCG, etc. Also, investments across cities and towns are preferable.

Occupancy: The ratio of the used space to the total amount of space has to be considered.

Interest Rates & Taxes: The RBI’s monetary policy and the economic conditions impact the real estate sector. Also important to look at is the tax slab. The interest in all cases and dividend earned from REITs in some cases is taxable, according to the prevailing rate.

Lastly, it’s important to consider the brand’s reputation, the experience of the manager, consistency of income flow and distribution history while choosing a REIT. Investments in REITs are subject to market risks. So, study all terms and conditions before investing.