Real Estate Investment Trust (REIT) is fairly new to the Indian markets. Embassy Office Parks REIT is the first REIT in India launched on 1st April 2019. But what is REIT? Do you know REIT investing can give you a backdoor entry to country’s best real estate projects?
In this article:
- What is REIT?
- The framework of REIT
- What are the different types of REITs?
- Why invest in REITs?
- Returns from REITs
- Taxation of REITs…And a lot more.
So, let’s begin.
Before we understand what is REITs, let’s quickly take a look at the traditional ways of investing in real estate:
- The first option is to purchase land or an apartment.
- The second alternative is to invest in stocks of listed real estate companies.
- In the first option, your returns like rental income is fixed and guaranteed. But buying a decent sized apartment requires a huge investment. Even if you take a home loan, you will still have to manage the 15-20% down payment yourself.
On the other hand, when you invest in stocks of real estate companies, you are prone to market ups and downs.
So, the traditional ways of investing in real estate is either costly or risky. This is where a third option of investing in real estate emerges – REITs.
What is REIT?
A Real Estate Investment Trust (REIT) is a trust or an entity which owns, finances and operates income generating real estate. It works just like your mutual fund. To understand the working of a REIT, let’s take a hypothetical example. Suppose you wish to buy office space in a prime location in Mumbai with the aim to earn regular rental income. To buy the property you will have to shell out crores of rupees. But you don’t have such a huge amount on hand. So, you ask your ten friends to invest in the property.
According to the partnership rule, the rental income you will earn after deducting maintenance costs will be equally distributed amongst all the partners. This is exactly how REITs work.
A REIT scheme will use your invested money to buy physical real estate assets such as shopping malls, commercial spaces, hotels, apartments, etc. The maintenance cost of the property is deducted from the rent earned and the remaining profits are distributed among all the REIT unitholders in the form of dividends in the proportion of units held by them. This type of REIT is known as equity REIT because it gives dividends and capital appreciation to its unitholders.
Now that you know what is REIT, let’s move ahead and understand the framework of a REIT company.
The Framework of a REIT Company
As the name suggests, a REIT company is a real estate trust registered with the Securities and Exchange Board of India (SEBI). So, there are many individuals involved in the process of creating a successful REIT company.
To begin with, a sponsor is someone who starts the REIT company. They hold a substantial stake in the REIT. A sponsor could be a builder or any other person who buys and sells properties.
Next is the trustees of the REIT which are appointed by the sponsors. The job of a trustee is to hold assets on behalf of the unitholders.
The next component of an REIT is the REIT manager. His role is similar to a fund manager of a mutual fund company. The REIT manager manages the REIT assets and is responsible to make investment decisions. In return, he receives management fees from the REIT company.
Next in line are the unitholders. These are investors like you and me who purchase the units of REIT. Unitholders can be resident Indians or even foreign investors.
Lastly, the REIT company hires a valuer who values the assets of the REIT’s at regular intervals as per the SEBI rule.
Apart from these, the REIT hires auditors, registrars, transfer agents and merchant bankers to carry out operational activities of the company.
Investors who think that the prices of real estate are going to rise in the future will invest in the REIT IPO. The accumulated corpus is then invested in buying commercial properties, malls and other real estate. According to SEBI, a REIT company must invest 80% of the accumulated corpus into properties which are fully constructed and could be given out for lease. And 90% of the income should be distributed to the unitholders in the form of dividends.
So when you invest in a REIT, you earn dual income in the form of –
- Rental income collected from properties and distributed in the form of dividends to the unitholders.
- Capital appreciation of the property in the form of increasing NAV of the REIT scheme.
What are the Different Types of REITs in India?
Even though REITs have been one of the preferred investment options in the U.S., India has welcomed REITs in 2019 only. The first REIT was introduced in India by Embassy Office Parks. It is an equity REIT. But there are many more types of REITs. So, let’s take a look at a few popular types of REITs across the world.
1. Equity REIT
In case of an Equity REIT, the trust purchases and rents out real estate on its own to generate income for its unitholders. It is known as an equity REIT because the income generated is distributed in the form of dividends. Equity REITs can be further divided into –
This REIT solely invests the accumulated capital in buying properties for retail businesses such as shopping malls, grocery stores, supermarkets etc. The property bought by the REIT is given on lease to run these retail businesses. The rental income they earn is the source of income for the unitholders.
These REITs own and operate residential facilities like apartments and gated communities. These properties are built and given out on rent. One thing to note here is…whenever you are looking to invest in a Residential REIT, carefully check if the REIT has invested in locations where the cost of living is high. So, more people are forced to rent a home instead of buying a new one. This will help the REIT to earn more income and you as a unitholder will have more benefits.
The healthcare industry is an everlasting industry to invest in. These REITs primarily invest and operate healthcare-focused real estate such as hospitals, nursing facilities, retirement homes and medical centres, etc.
2. Mortgage REIT
The second type of REIT is a Mortgage REIT. An equity REIT buys a property and then distributes the income generated in form of dividends. But a mortgage REIT disburses loans to developers and other individuals for them to purchase the property. So, the income generated is the interest earned on the loan offered and is then distributed among the unitholders.
3. Hybrid REIT
This REIT invests the accumulated corpus in a mix of equity REIT and mortgage REIT. So, you as a unitholder earn income from both the sources – dividends as well as interest.
Why should you invest in REITs?
REITs are still among the lesser-known investment options in India. But it has the potential to create wealth for you. So, if you are someone who believes that the prices of real estates are going to rise in the future and you have comparatively less capital to directly buy a property, then REITs can give you the benefits of investing in real estate. Let us look at the advantages of REITs:
1. A steady source of income
Apart from capital appreciation, you get a steady source of income in the form of dividends. Here are the dividends generated by three REITs listed on the stock exchange.
1. The embassy office park REIT has distributed an average dividend return of 5.72% from June 2019 to July 2021.
2. Brookfield India Real Estate Trust REIT has offered an average dividend return of 5.99% from June 2021 to September 2021.
3. Mindspace Business Parks REIT has offered an average dividend return of 6.9% from August 2021 to November 2021.
2. Low investing Threshold
To invest in a REIT, you don’t need to shell out lakhs and crores of rupees. You can start with as low as Rs. 10,000.
3. Professional management
In a REIT, you don’t need to worry about finding a property to invest nor do you have to go through the hassles of registration and finding tenets. The REIT fund manager does it all for you. In return, he gets paid by the REIT company.
REITs maintain utmost transparency in the investment process as they are strictly regulated by SEBI. Every year, the REIT company is required to file audited financial reports and disclose the real value of the assets post depreciation. These details also help the investors to analyse taxation opportunities, ownership of properties and a lot more.
Now you can easily diversify your portfolio towards real estate as REITs are listed and traded on the stock exchanges. Moreover, many debt mutual funds also prefer investing in REITs to earn safe returns and diversify the portfolio.
Limitation of investing in a REIT
1. No tax benefits
The returns you earn from REITs in the form of dividends are taxable. Moreover, while buying and selling properties, the REIT must also pay property tax which eats up an investors’ returns.
2. Less growth
A REIT must distribute 90% of the profits in the form of dividends. Hence, it leaves less scope for the fund to grow further. To purchase new properties, the REIT must come up with a follow on public offer (FPO).
3. No control over the returns generated
A REIT fund invests your accumulated money into buying properties at different locations. Some locations may earn high rental income while others might earn low rental income. Now, you don’t have the option to pick locations with high cash flow to invest your money in. This is solely done by the property manager. If at any point you are unhappy with the returns generated, then you have no option but to sell the unit of REIT on the exchange.
Taxation of REITs
There are two types of returns that an REIT provides – dividend income and capital appreciation. Both of these have different taxation.
1. Taxation on REIT Dividends
The returns you generate from dividends are taxable in the hands of unitholders. It is taxed as per your tax slab.
2. Taxation on Capital Gains
- If you sell the units of REIT within one year from the date of allocation, then the returns are taxed at 15%.
- If you sell the units of REIT after holding it for one year from the date of allocation, then the returns are treated as long term capital gains and are taxable at 20% with indexation or 10% with no indexation benefit.
How can you invest in REITs?
Before investing in any of the REITs you must carefully look at the history of the return distribution which could be easily found on their websites. Also, look for the properties held by them through recent audited reports. This information will help you in analysing the best REIT to buy for the long term.
Let’s take a look at capital appreciation of REITs since inception.
|REIT||NAV at inception||NAV as on 6th December 2021||Capital appreciation|
|Embassy Office Parks REIT||Rs 331.85 on 1st April 2019||Rs 360.22||8.55%|
|Mindspace Business Park REIT||Rs 303.7 on 3rd August 2020||Rs 320.98||5.69%|
|Brookfield India Real Estate Trust||Rs 266.67 on 8th September 2021||Rs 294.47||10.42%|
*Data as on 6th December 2021
Out of the three REITs listed on the stock exchange, Brookfield India has generated the highest capital appreciation of 10.42% since inception.
Apart from the stock exchanges, you can also invest in an REIT through a mutual fund.
Here is a list of few REIT mutual funds available.
|REIT Fund||Net Asset Value||Asset Under Management||Expense Ratio|
|Kotak International Reit Fof – Regular Plan – Growth||Rs 9.9531||202.43 Cr||1.38%|
|Mahindra Manulife Asia Pacific Reits Fof||Rs 9.5219||35.35 Cr||1.53%|
*Data as on 7th December 2021
To know the latest NAV and expense ratio of the above funds – Click here.
To conclude, the primary reason to invest in a REIT is to diversify your portfolio towards the growth of the real estate sector. Here, you can invest with a small amount and you don’t have to go through the hassles of registration, maintenance or finding tenets makes it a unique investment option in the real estate space.
Though not completely safe, you could consider diversifying a small portion of your portfolio towards REITs to balance out the risk and returns of equity investments. But, to invest in REITs you must have a Demat account. Don’t miss out on money-making opportunities and simply, open a FREE demat account today in less than five minutes with Samco and get started on your wealth creation journey!