Traditionally most Indians have had a significant portion of their net worth in real estate but in recent times due to a rise of property prices investors have not been able to invest in real estate due to its high ticket size especially in Metro cities.
One option available for investors which provides exposure to real estate with a lower ticket size is the Real Estate Investment Trust which is generally known as “REIT”.
REIT is a company which owns or finances a portfolio of income generating real estate assets. REITs invest in a wide scope of real estate property types such as offices, apartment buildings, warehouses, retail centers, medical facilities, data centers, hotels etc. and Its business model is very simple: leasing space and collecting rent on its real estate, the company generates income which is then paid out to shareholders in the form of dividends.
Understand REITs and how they work:
REITs are very similar to mutual funds and like mutual fund investors pool their investment, they get units instead of share and both are professionally managed but one key difference is, in mutual funds the underlying asset is equity, debt or gold but here it is primarily real estate assets.
Any Real estate company cannot be classified as a REIT; it must fulfil criteria set up by SEBI such as:
- At least 80% of the REIT’s assets should be completed & income generating.
- At least 90% of the rental income earned by the REIT has to be distributed to its unit holders as dividends or interest.
- Stock market listing of REIT is mandatory.
- Only 10% of the total investment must be made in real estate under-construction properties etc.
The main object of a REIT is to provide income in the form of dividends to the investor by leasing or renting real estate assets in its portfolio.
Types of REITs:
Primarily there are 3 types of REITs based on the type of assets under its management:
- Equity REITs: They own and operate income-producing real estate. Their revenues are mainly generated through rental incomes on their real estate holdings.
- Mortgage REITs: Also known as mREITs, they don’t own the asset but they provide financing for income-producing real estate by purchasing or originating mortgages and mortgage-backed securities (MBS). Their revenues are mainly generated by income from the interest on their investments.
- Hybrid REITs: Their portfolio consists of both owned and financed real estate assets.
Advantages and Disadvantages of investing in REITs:
First let’s look at the pros:
- They are not as capital intensive as a direct investment in property.
- Provides steady dividend income as well as capital appreciation.
- It gives investors to diversify their investment and gain exposure to real estate.
- Provides better liquidity when compared to direct investments since it is publicly traded.
- It enables investors to have a steady source of income to rely on even when the rate of inflation is high since 90% of its income is distributed as dividends.
Now the cons:
- Taxation: Any dividend or interest earned from REITs is completely taxable in the hands of the investor according to the applicable slab rate.
- Since 90% of the income is distributed as dividends only 10% of the money is reinvested hence the growth prospect is low and hence capital appreciation is also low.
- Limited options for investing in REITs in India since we have only 3 REITs and 1 international REITs FoF.
- Market linked risks.
The bottom line:
REITs provide a new avenue for investors to gain exposure to commercial real estate without the hassles related to purchasing and maintaining one or more immovable property which was not easily available previously and It has also provided investors an opportunity to have a steady source of income hence it can be a part of the portfolio but Investors have to assess both the merits and risks of REITs and take decisions based on his/her risk appetite.
This article should not be construed as an investment advise, please consult your Investment Adviser before making any investment decision.