Buying real estate overseas is not new to rich Indian investors. But buying physical real estate can be cumbersome. Apart from a physical recce of available properties, it entails managing the documentation, specific licenses and repairs -- a taxing process.
Nevertheless, if you have financial interests overseas, investing in real estate may hold long- term appeal. One way to get exposure to overseas real estate without having to buy physical property is investment in REITs.
REITs, or Real Estate Investment Trusts, are special companies set up to own and manage real estate assets. REITs do not invest in just one property. Think of REITS like a mutual fund. A REIT invests in a portfolio of properties across sectors.
Typically, these assets are properties on lease that are designed to earn a rental income. There could be sector-specific REITs and they can even be defined by the type of ownership. Some REITs actually own the assets that they manage and operate. Others finance these real estate assets.
In most cases, once a REIT is set up, it is listed on stock exchanges just like any other company. Individual investors can now buy units of REITs just like they would buy individual stocks or shares from an exchange. Rental income generated by the portfolio properties is distributed to the investors as dividend income, making REITs a stable, income-generating option to invest in.
Global REITs may work for adding diversification to your portfolio, but they don’t really substitute physical real estate assets.
What are your options?
Investing in international REITs can add flavour to your global portfolio if you are looking for additional yield.
The US and Singapore are two geographies that offer the most choice in REITs; there are also REITs listed across global exchanges. In India, you can only invest in domestic REITs; these earn their income from yields in commercial properties. Global REITs have several other types of real estate like hotels, hospitals, warehouses, residential space and so on.
However, yields on such REITs may have a wide range. Currently, the yield on overseas REITs is around 2%-4.5% (in the US) a year. For an Indian investors, the yield is added to income for the purpose of taxation.
“Investors view REITs as quasi-fixed income instruments. Asset quality (which assure occupancy rates and stable rentals), optimal funding mix, management competence and a sound regulatory environment are some key factors that determine stability of dividend payouts," said Asheesh Chanda, founder and chief executive officer, Kristal.ai, a global digital private wealth platform,
"Singapore is unique in that 13%-15% of SGX's market cap is made up of REITs, by far the highest in the world; their dividend yields can range from 5.5% to 12%,” he added.
No matter what segment of real estate a REIT is structured around, the basic principle is to earn yield through the committed rental contracts that the property has. So it becomes a source of stable income for the foreseeable future.
“Indian HNIs who understand the real estate markets in certain overseas geographies, are looking for yield and even capital gains. If they already have money abroad, they even indulge in directly investing in new construction, small sized property. REITs on the other hand are an allocation in lieu of bonds rather than being a pure play real estate investment,” said Munish Randev, founder and chief executive officer, CERVIN Family Office.
You also have an alternative to consider at fund of funds on the domestic mutual fund platform which give you access to REIT funds listed overseas. You invest here in rupees and redeem in rupees; the money from investors in pooled in the mutual fund scheme and then invested in an overseas REIT or REIT Fund.
Kotak International REIT Fund of Funds, Mahindra Manulife Asia Pacific REITs Fund of Funds, PGIM India Global Select Real Estate Securities Fund of Funds are some such options available for Indian investors who want to hold their investment in rupees.
What is the risk-return balance?
The return experience with overseas REITs through domestic feeder funds has not been favourable so far (See Table). There could be low yield from underlying rental income. These funds come with expense ratios as well. One may argue, though, that it’s too early to judge the progress of such recently launched investments.
Moreover, domestic REIT fund of funds aren’t tax-efficient. These are treated on par with debt funds for taxation purposes; if you sell them before three years, capital gains are taxed in line with your income-tax bracket.
If you want to buy REITs directly from the overseas exchanges, you will have to open a broking account that allows you to trade in international stock exchanges and you can invest with the Liberalised Remittance Scheme (LRS) limit of $250,000 a year.
“From a macro perspective, higher interest rates would hurt REITs as investors would balk at receiving 5.5% as dividend yield when 2-year Treasury is 3.8%," said Chanda. "Over the long run, REITs' dividend usually is at a healthy premium to risk-free treasuries because rental yields keep pace with inflation (rentals are a key component of inflation). Moreover, investors also participate in any increase in the value of the underlying assets. However, in a stagflationary environment there may not be enough demand for real estate space and that could impact the dividends and value of REITs.”
The risks should not be ignored. Investing in real estate is a long-term proposition and driven largely by local factors of demand and supply. Sitting in India, you may not be able to judge the overseas market dynamics suitably, leaving room for negative surprises on the expected returns.
Currency risk is also one thing to watch out for. A lot of the returns generated by REITs depend on the underlying portfolio of properties and the type of long-term lease contracts. Adverse economic or regulatory conditions in an overseas geography can also impact the capital value of the REIT or its listed share price. If this is negative, then you can lose capital too. Examining these and how airtight rental payments are across market cycles is also a difficult task.
International REITs look good from a diversification perspective, thanks to the structure and the regular rental arrangements. However, keep in mind that it is your bond allocation that you must compare returns with, rather than expecting capital enhancement as we see in growth assets.
Randev said: “Assessing whether there is quality and longevity in the REIT is key to evaluating the risk to regular payouts and hence, the yield you make.”
Should you invest in REITs?
You cannot use these as a substitute for real estate income or buying property for self-use overseas.
Randev also pointed out that direct buying of real estate is usually a choice for a city or a country and that should not disrupt the financial thesis for investment. REITs work as a diversification tool, but they are impacted by the overall interest rate trends in the global economy.
“REITs offer a painless and liquid route to investing in real estate. They can be bought piecemeal and sold piecemeal at the click of a button. Investors in direct real estate enjoy a higher return, if things go well, but it comes with all the attendant risks of management, income tax, local council taxes, management of tenants etc. Further, unless the investor has a vast corpus, it is difficult to build a diversified basket. Tokenisation seeks to marry the advantages of REITs and direct ownership; this is an interesting trend which we at Kristal are seeking to bring to our clients,” said Chanda.
Investing in global REITs requires broad-based research and diligence in choosing an advisor who can help make the most tax-efficient and balanced choice keeping in mind the expected yield versus local geography risks.
Given the complexities, in the absence of a credible advisor, adding global REITs can become a high-risk transaction for your portfolio. In such cases, simpler solutions in fixed income may be more worthwhile.As an alternative, if you are keen, you could begin testing waters with domestic fund of funds that invest your money in global REITs. But keep your expectations in check.