Infrastructure and real estate contribute heavily to any developing economy and are therefore critical for the economy’s growth. One of the key drivers of a holistic development of any country is its infrastructure. Real estate and infrastructure go hand-in-hand in India, and these receive regular boosts from the government to ensure continued economic progress.
A well-planned infrastructural set-up contributes to a continued inflow of foreign investments and adds to the capital base required for a sustainable growth of every economy. Real estate sector growth complemented by development in the corporate environment helps in increasing demand for office space and accommodations. Because of the lack of availability of public funds, the sector constantly needs additional channels of financing. This is when REIT or Real Estate Investment Trust comes into the picture.
Here, we will discuss everything that investors should know about REIT, from its meaning, evolution to some of its major benefits.
What is REIT?
A Real Estate Investment Trust (REIT) is an investment instrument that offers proportionate ownership of an income-generating real estate asset to retail investors. Historically in India, investors have been investing in real estate by purchasing a property or land via real estate developers and property brokers. In such investments, investors had to rely on long-term market value appreciation of the property to generate a return on investment. This, however, was only possible when real estate markets would be on an upswing.
Developers also had to fund projects by sourcing money through loans from banks, PE firms, etc and this usually meant high-interest rates. In 2008, the Security and Exchange Board of India (SEBI) came up with draft guidelines that allowed investors to establish REITs as an asset class. The intent was to make it easier for foreign investors to invest in the Indian real estate market and make funding easily available for local developers.
How did REITs evolve?
REITs were first introduced in the USA back in the 1960s on similar lines as mutual funds. These were initiated to boost real estate development through existing investments from investors who were interested in real estate exposure.
At the time, since the real estate market was booming, it presented many opportunities to reap large dividends on the investments made. This paved way for real estate development projects and also rewarded the investors financially.
As far as the Indian market is concerned, REITs were first introduced here by the Securities and Exchange Board of India (SEBI) in 2007. As the investment vehicle started gaining popularity, there were many regulations announced to facilitate smooth operations of these investment funds. Today, REIT companies that are listed on the Indian stock exchanges are constantly monitored and fall under the regulation of the Securities and Exchange Board of India or SEBI.
How do REITs work
The flowchart below shows the basic process of a REIT transaction:
Investment in REIT————->
Ownership of assets————>
Net property income
What are the Types of REITs?
Mentioned below are some of the commonly available varieties of REITs in India:
- Equity REITs: These REITs primarily invest in offices, residential complexes, industrial estates, hotels etc. They buy, manage, set-up and sell real estate. The income earned is distributed to investors as dividends. Income is mostly generated through rentals and sale of properties.
- Mortgage REITs: These REITs loan out money to buyers of real estate, and some may even buy-out existing mortgages. They are also referred to as mREITs. These derive income from the interest received through mortgage loans. They work somewhat like a debt mutual fund, however, the risk component is often higher in REITs.
- Retail REITs: Retail REITs invest in the retail segment like shopping malls, grocery stores, hypermarkets, supermarkets, etc. However, retail REITs do not run these retail outlets. They only focus on renting out the space to various retail tenants. Returns in this case depend on the performance of the retail sector.
- Residential REITs: Residential REITs buy and operate apartment buildings, gated communities, and other such housing establishments. Whenever the residential property demand in India grows, these REITs reflect a positive growth.
- Healthcare REITs: Healthcare REITs invest in real estate for hospitals, medical establishments, health clinics, etc. Since the demand for healthcare services has been on a rise in the last few years, these REITs present a good investment opportunity for investors.
- Office REITs: These REITs focus on office properties and earn through rental income.
Performance of REITs in India
As per a report, listed Real Estate Investment Trust (REITs) in India saw a 6.85% year-on-year (YoY) growth in the total leasable area. From only 87.6 million square feet (msf) in Sep’21 to 93.6 msf in Sept’22.
Mindspace REIT was one of the top performers with absolute returns of 8.11% in the YTD Oct’22 period. Brookfield India REIT came in second with 7.30% absolute returns. These two were followed by Embassy REIT with 1.40% absolute returns during the same period.
(Source – moneycontrol)
Taxation on REITs
Investors must consider the below points about taxation on REITs before investing in them:
Income from sale of REIT units
- Capital gains from sale of Indian REIT units are subject to short-term capital gains tax at 15% if held for less than one year.
- Units held for more than three years (36 months) are subject to LTCG tax at 10% if they result in an income over Rs.1 lakh.
Additional points on taxation:
- Interest income from REITs is taxable.
- Dividend income from REITs is taxable depending on the REIT’s special tax concession status.
- If special tax concession has been obtained, dividend income is taxable in the hands of the investor.
- If not, dividend income is not taxable.
- Income from amortisation of SPV debt is not taxable in the hands of the investor.
Advantages & disadvantages of investing in REITs
Investors can avail below-mentioned advantages from REIT investments:
- Investment in real estate properties can be very capital intensive. However, shares of REITs are comparatively affordable, as investors can purchase few units at a time without worrying about large capital outflows.
- REITs are suitable for small Investors too, as these eliminate direct dealing with property builders. Also, REITs come with lower liquidity risk as compared to direct property investment.
- REITs are listed in stock exchanges. Hence all pertinent details can be checked online by investors before making an investment.
- REITs offer income to investors primarily through dividend. The dividend payment in most REITs is relatively assured. This is because the primary source of earning is through rental (lease) income.
- REITs are regulated by SEBI, and therefore the chances of fraud are low.
Investors must take note of these drawbacks of Investing in REITs:
- Limited growth potential due to large distributions to investors
- Higher taxes on dividends compared to other investments
- Potentially high fees and increased risk
- Vulnerability to real estate market trends and fluctuations
- Lack of control over performance and management decisions
- Potential restrictions on selling shares for a set period of time.
How to Invest in REITs in India?
Investing Through Stock Exchanges
Similar to ETFs, REITs are listed and traded on stock exchanges. Thus, purchasing REIT units is easy as long as an investor has a Demat Account. The price of a REIT unit can change depending on the demand for these on the stock exchanges. Prices are also influenced by the performance of the REIT. At present, there are 3 options of REITs in India–Embassy Office Parks REIT, Mindspace Business Park REIT, and Brookfield India Real Estate Trust.
Investing Through Mutual Funds
In India, very few domestic Mutual Funds invest in REITs, and the actual exposure to real estate is very limited. One can also invest in REITs through mutual funds. In India, investors looking for exposure to international real estate can invest in Kotak International REIT Fund of Fund as it invests mainly in International REITs.
Investing Through IPOs
Investors can be on the lookout for REIT IPOs and invest in these when they are launched. This requires thorough research and understanding of all the risk factors of REITs. Since Indian REIT market is still evolving and there are only few REIT options available, investors have to wait for the next IPO to be launched.
Which REIT is best in India?
Here are some of the important milestones of REIT investment options in India:
- Blackstone Group-backed Embassy Office Parks REIT (Embassy) launched India’s first REIT back in April 2019.
- Mindspace REIT was oversubscribed 12.96 times at the time of its IPO in June 2020.
- Embassy and Mindspace were the two main listed REITs in India till early 2022. These traded at approximately 10%-20% premium of their respective listing prices. This is apart from the periodic interest payments which yield about 6%-7.5% post tax returns.
- 2022 also saw the launch of Brookfield India Real Estate Trust’s Rs. 3,800 crore REIT issue.
How does a company qualify as a REIT?
Here are the criteria for a company to qualify as a REIT:
- Must distribute 90% of income to investors as dividends
- At least 80% of investments must be in income-generating properties
- No more than 10% of investments can be in properties under construction
- Must have a minimum asset base of Rs 500 crores
- NAVs must be updated twice annually.
REITs are making real estate participation for novice investors smooth and easy. Apart from the benefits of dividends, these also offer liquidity to an investor’s portfolio. Investors who are looking for real estate exposure must explore these investment vehicles, especially through IPOs.
Frequently Asked Questions
Millennials who want to gain real estate exposure but are not comfortable investing a bulk amount can explore REITs. These also offer far more liquidity as compared to property investments and can therefore benefit millennials.
REITs are listed and traded on stock exchanges, and investors can purchase units through a Demat account. Investors can also explore IPOs to make the most of new REIT launches.
REITs let investors gain money through real estate investment without worrying about owning or managing physical properties.
Real estate investment trusts (REITs) pay dividends to investors as per their earnings. Publicly traded REITs come with the risk of losing value in case interest rates rise. Also, there is a risk of losing money on non-traded / non-listed REITs which can be difficult to research.
REIT investments are similar to any other form of investment that comes with its set of benefits and risks. Investors must carefully explore the available REIT options before making an investment decision. It is wrong to assume that REITs will always provide positive returns, since these too are influenced by many market factors.