Real Estate Investment Trusts (REITs) are in the news, with analysts bullish about the potential in India and the Securities and Exchange Board of India looking to tweak norms – a process that will begin as early as next week including circulation of a consultation paper to amend the regulations of 2014, to encourage investments. Here is a ready-reckoner that will help in understanding what an REIT is, how it works, and the potential investment risks:
What are REITs?
REITs are similar to mutual funds. While mutual funds provide for an opportunity to invest in equity stocks, REITs allow one to invest in income-generating real estate assets.
How does an REIT work?
REITs raise funds from a large number of investors and directly invest that sum in income-generating real estate properties (which could be offices, residential apartments, shopping centres, hotels and warehouses).
The trusts are listed in stock exchanges so that investors can buy units in the trust. REITs are structured as trusts. Thus, the assets of an REIT are held by an independent trustee on behalf of unit holders.
What is the role of trustee?
The trustee has duties as laid out in the trust deed for the REIT. These typically include ensuring compliance with applicable laws and protecting the rights of unit holders as well.
An REIT’s investment objective
The investment objective of REITs is to provide unit holders with dividends, usually generated from rental income and capital gains from the profitable sale of real estate assets. Typically, the trust distributes 90 per cent of its income among its investors by issuing dividends.
Typical REIT structure
Typically, money is raised from unit holders through an Initial Public Offer (IPO) and used by the company to purchase a pool of real estate properties. These properties are leased out to tenants and the income generated via rent flows back to unit holders (investors) in return as income distributions (dividends).
REITs originated in the U.S. to give investors an opportunity to invest in income-generating real estate assets. After its introduction in the U.S., several countries such as Singapore, Australia and Hong Kong have implemented REITs.
Why now, in India?
REITs, as a concept, have been on the horizon for a while now. India’s regulations in 2014 for the sector have not been able to attract investor interest. REITs obtained exemption from dividend distribution tax in the Budget, a step towards making them attractive for the investors. A report by real estate consultancy firm Cushman and Wakefield estimates that Indian commercial real estate (like office, retail assets) offers investment opportunities for REITs worth $43 billion – $54 billion (Rs, 2.88 lakh crore – Rs. 3.60 lakh crore) across top cities.
Commercial, a priority?
Gautam Saraf, managing director (Mumbai), Cushman & Wakefield pointed out that the underlying strategy for REIT is to invest in rent-yielding assets and generate rental income for investors in the form of dividends. That explains why commercial real estate is seen as potential for REITs. Saraf adds that the predominant strategy to invest in residential assets is via rental housing schemes. However, rental housing schemes in India are still not prevalent and hence investing in residential assets would be challenging, he adds.
The current SEBI guidelines for REITs permitinvestments only in rent-yielding assets.
Why invest in REITs?
For investors who are averse to investing in physical purchase of property due to the risks involved, REIT is an alternative. Investors purchase units of REITs which are traded on the stock exchange, as against physical purchase of property. Therefore, investors can buy and sell units of REIT on the stock exchange as and when required, making investment easier to liquidate compared to physical property transaction.
Retail investors in REITs?
The minimum required to be put into an REIT is Rs.2 lakh. It could provide an opportunity for investors who, otherwise, do not get the opportunity to invest in commercial real estate because of high capital values. Since 90 per cent of the profit generated needs to be distributed as dividend in REIT, it could provide a stable income for unit holders.
Tax and other issues
Short-term capital gain tax is applicable for unit holders at the rate of 15 per cent. While nterest is tax-exempt for REITs, it is taxable for unit holders. The registration charges for every purchase and sale of property is still applicable. Saraf says such factors can impact the profitability and attractiveness of REITs in India.
Potential investment risks
REITs units are listed on, and are subject to the vagaries of the stock exchanges, resulting in negative or lower returns than expected. The MSCI US REIT index crashed from over 1300 points in 2007 to under 350 points in 2009. As in mutual funds, retail investors in REITs have no control over investments and exits being made by the trust.