In accordance with the traditional Indian ideology, the three foundations of a successful life are Roti, Kapda, Makaan, or Food, Clothing, and Housing. So, it is no herculean task to comprehend why the first thing that comes to the majority of Indians’ minds when we talk about investing is Makaan or Real Estate. But don’t real estate Investments require humongous capital? Aren’t they very less liquid? Doesn’t it require huge maintenance costs? Yes. There are many perplexities in Real Estate Investing. However, it is rightly said, “If there is a problem, there is a solution” and this solution is called Real Estate Investment Trust (REIT). It must be a new jargon for many people. So, let us delve into what REIT is.
REITs is that mechanism that helps you invest in A-grade real estate properties with as little as 50,000 – 75,000 rupees and not only that, one need not deal with the renovation, maintenance, tenants, and other complexities of maintaining a property. The cherry on the cake is without taking any of these troubles, one can earn a rental income.
A REIT is nothing but an investment company that majorly owns, operates, or finances real estate assets such as land, apartments, office parks, real estate securities, etc. with the intent to get returns and generate income. Like Mutual funds are a pool of assets, REIT is a pool of Real Estate properties may it be residential or commercial.
Now, let us understand the REIT mechanism with the help of the diagram given above. These Investment trusts pool the money that they receive from Investors who do not have the adequate capital to invest in good profitable properties. They use this pool of money and invest it in acquiring real estate properties that require huge capital. After this, the investment Trust earns income by renting out these properties or by earning capital gains ie: profit on purchase and sale of properties.
REITs allow you to own property without physically owning any real estate at all, and as a shareholder within a REIT, you can collect scheduled income in the form of dividends. In such a way, through small amounts REITs give you access to the best properties developed by quality builders at prime locations, managed by professionals.
Many REITs are publicly traded on major securities exchanges, and investors can buy and sell them like stocks throughout the trading session. These REITs typically trade under substantial volume and are considered very liquid instruments.
Its rightly said, “Do not put all your eggs in a single basket” This is where REITs come in and play a major role. Instead of investing a large chunk of money in a single property, you may invest it in REITs which is managed by professionals who properly allocate the amount among various properties ranging from restaurants to malls to corporate offices and residential apartments and thereby earn profits out of it.
Now, let us understand with a case study how REITs can be beneficial.
Ramu and Shyam are two friends who reside in Kolkata. Both have 20 lakh rupees with them and they want to invest it in Real Estate. Now with mere 20 lakhs, one cannot find a good property at a good location but Ramu is adamant about buying a property. He goes to a bank, takes a loan, and purchases a property. Now, he has to pay interest on the loan, make sure that he can put the property on rent. Not only this, he has to verify the tenants, ask for monthly rent, make sure that the tenants are maintaining the property, and whatnot.
On the other hand, Shyam invests 20 lakhs in REITs which is traded on the stock exchange. By paying a very little maintenance fee (less than the interest that Ramu is paying on the bank loan), Shyamu has secured
the investment and has a regular flow of income through the dividends being paid by the firm.
If there is any financial emergency, Shyamu can easily liquidate his holdings. What about Ramu? He will probably be taking more loans from family members or banks.
Okay, so REITs are liquid. They give good dividend income and one can invest in it with a very little amount. If this is the case, why not buy the shares of Real Estate companies like Godrej properties or DLF, or Oberoi reality? I agree with you. Both these options are viable and similar too. However, the main difference here is security.
Let’s say, you bought shares of DLF. Now the management of the company enjoys the freedom in deciding in what ways those funds will be utilized whether they will be used for acquiring properties or for repaying their debts or just wasting it acquiring lands and then sit idle. You do not have any say as to how the funds must be utilized.
However, REITs, are regulated by the Securities Exchange Board of India (SEBI) and according to their guidelines, a Real Estate Investment Trust is required to invest at least 80% of the total value in completed and income-generating properties 1 and further it imposes restrictions on speculative land acquisition. Other than this, a REIT has to distribute at least 90% of its taxable income to its shareholder semi-annually 2. In such a way, you will be getting a guaranteed dividend income. Hence, REITs are a safer option as the SEBI regulations prevent the misutilization of funds.
Apart from the Dividend Income, investors may also benefit from capital appreciation, with the hike in the price of properties.
Now, every coin has two sides. And if a glass is half-filled, it Is also half empty. So, it is necessary to analyze both the pros and cons of REITs.
The first disadvantage of REITs is that it does not offer as much capital appreciation as shares of Real estate companies. The major reason being that 90% of its taxable profit is to be distributed among shareholders and it is left with only 10% to scale up the business.
Another disadvantage is that dividend income from REITs is charged as per normal income tax norms 3. Hence, investing in the best REITs for income will result in larger tax consequences. One also needs to pay capital gains tax on it. Additionally, some REITs might have higher maintenance charges. So, although REITs are safe investment options with regular income, they have their disadvantages as well.
While Investing in REITs, investors need to be nimble and do a basic analysis of the properties and portfolio of the particular REIT because 80% of their income comes from renting properties. So, it is essential to have an idea about the locations and properties it puts for rent and has in its portfolio. Lastly, individuals should make a point to find out how their investments would be compensated. For instance, they should scrutinize the management team of REIT and their performance record with the help of metrics like fund from operations or financial management rate. Similarly, it would prove beneficial to factor in a REIT’s growth in EPS and current dividend income before investing to maximize returns.
Currently, the top 7 cities of India have around 550 million sq ft Grade A office supply, of which 310-320 million sq ft is REIT-able. Indian REITs are still at a nascent stage with immense potential even in other asset classes going forward, including 43 million sq ft of Grade A mall spaces,110 million sq ft Grade A warehousing stock, and residential rental housing market 4.
In addition to the above traditional asset classes, India is a booming market for ‘new-age’ asset classes such as student housing, co-living, and senior living which have inherent potential to be developed as REITs, albeit it appears to be several years away as of now.
In a nutshell, REIT is a new product in the market with more safety and regular returns. It has far been a success story in India. Analysts believe that REITs have the potential to lend better security, thereby, organizing the real estate sector even more. Since REITs only own or capitalize on profitable properties, the concept can be a great boon to real estate investors. The trust will enable investors to get capital appreciation and income from the property, without having to purchase and maintain it.
Currently, there are three listed REITs in the Indian market, Embassy Office Park, Mindspace, and Brookfield REITs.
For retail investors today, the stock market is a preferred choice and the safest among stock options are REITs. HNIs, pension funds, sovereign funds, and institutional investors, are latching onto REITs, seeking yields, conscious of the fact that the long-term growth of office spaces remains intact. Additionally, the budget 2021, gave a boost to the affordable housing sector which may prove to be beneficial for REITs. In the upcoming future, we may expect the market regulator to reduce the lot size of investing in REITs, post which, investors can buy single units of REITs, instead of buying lots. This move might open up the market for investors with very little capital as well 5.
So, while concluding, I would like to state that REITs are a good form of long-term investments for people with limited capital, who want to avoid the complexities of maintenance of a property. With low capital requirements, it provides common man and retail investors a greater diversification along with guaranteed returns, making Real Estate investment a viable option for them. So, now you can invest in real estate at a price lower than that of an iPhone 12.