What is Real Estate Investment Trust (REIT)?

Real Estate Investment Trust (REIT) is an investment vehicle that owns, operates and manages a portfolio of income-generating properties for regular returns. They are like mutual funds for the real estate sector. They collect funds from investors and put the money into real estate. These are usually commercial properties (offices, shopping centres, hotels etc.) that generate rental income. The returns they earn from rental income and sale of property is distributed as dividends to investors.

In India, SEBI requires REITs to be listed on exchanges and to make an initial public offer to raise money. Just like MFs, REITs are subject to a three-tier structure, the sponsor who is responsible for setting up the REIT, the fund management company which is responsible for selecting and operating the properties, and the trustee who ensures that the money is managed in the interest of unit-holders.

Difference Between REIT and Real Estate Mutual Funds

REITs and Real Estate Mutual Funds are different, yet they are similar in offering liquidity and a cheap way to get exposure to diversified & Large-Capital real estate assets. Long-term investors have the potential to reap the rewards of dividend income and capital appreciation over a long period of time.

For retail or short-term investors with a low investible surplus, these real estate funds create an opportunity to invest in properties that otherwise may not be feasible to invest in. A real estate fund can invest in a real estate Investment Trust to offer benefits to investors, making REIT a part of the investment.

  • Real Estate Mutual Funds offer wider diversification than the REITs based on the investment strategy and have the benefit of experts and professionals managing their portfolio, unlike the REITs
  • REITs distribute a higher amount of dividend each year to its shareholders or investors than the Real Estate Mutual Funds
  • The value of real estate tends to increase during times of inflation as property prices and rents go up, thus giving a better return to the REIT investor
  • REIT or the Real Estate Mutual Fund investment should be spread across several real estate categories or funds to minimize the risk and it should not be more than 10% of the portfolio

Working Process of a REIT

A typical REIT structure works like this:

  • Money is raised from unit holders through an Initial Public Offering (IPO) and used by the REIT to purchase a pool of real estate properties.
  • These properties are then leased out to tenants.
  • In return, the income flows back to the unit holders (investors) as income distributions (which are like dividends)

Most REITs have annual REIT managers’ fees, property manager’s fees, trustees’ fees and other expenses that will be deducted from their profits before distributions are made.

Some REITs which hold properties in foreign jurisdictions may also be subject to taxation by the relevant jurisdictions. Investors can find information on these fees in the REITs’ prospectuses and financial statements.

The figure below shows a typical REIT structure.

Importance of REIT In India

The Indian real estate sector has been facing a liquidity crunch on account of unsold inventory and low demand. REITs can help cash-strapped developers to monetise their existing property. Indian investors do not have too many regular income options. SEBI requires REITs to distribute a minimum 90 per cent of their income earned to investors on a half-yearly basis. Similarly, 90 per cent of sale proceeds too are to be paid out to unit holders unless the amount is reinvested in another property. Thus, you get to receive regular income and get to benefit from price appreciation, thereby boosting your returns. In real estate sector, both rent and capital appreciation from property depend on the location, infrastructure and industrial development around that area. REITs juggle these risks through a diversified portfolio of properties.

Objectives of REITs

The main crux of REITs is to give investors dividends generated from capital gains that are accrued from the selling of commercial assets. The REIT allocates 90 percent of its income as dividends to its investors. It provides a safe and diversified investment opportunity.

  • The REITs are transparent. There is a full valuation of the REIT on a yearly basis along with a half-yearly update
  • Diversification: As per the guidelines, REITs must invest in at least two projects with the value of one asset comprising 60 percent of the investment
  • Low Risk: There is low risk involved in REITs as a minimum of 80 percent of the assets are invested in revenue-generating projects that are completed. The rest 20 percent are allocated to investments in equity shares of properties that are listed, mortgage-based securities, equity shares deriving at least 75 percent of income from real estate activities, government securities, money market instruments, cash equivalents, etc

Why to invest in REIT

Investment in real estat be market through REITs will give the accessibility to common, to invest in properties developed by the quality builders. The following are the reasons why you should invest in REITs.

  • Less Capital Intensive: Direct investment in real estate property is very capital intensive. But each shares of REITs will be comparatively more affordable (it will not require large capital outflows).
  • Suitable for small Investors: Moreover, buying property directly exposes common men to the POWERFUL BUILDERS. Investing through REITs will eliminate dealing with builders altogether.
  • Transparency: REITs stocks are listed in stock market. Hence all relevant details will all be available online for its investors.
  • Assured Dividends: REITs generates income in .form of dividend. REITs dividend payment is relatively assured. Why? Because most of their income is in the form of rental (lease) income.
  • Tax Free: Dividend earned by the investors of REIT will be tax free.
  • Fast Capital Appreciation: As Embassy REIT is first of its kind in India, its capital appreciation in next 5/7 years can be phenomenal.
  • Easy to buy: REITs will also easy the whole process of investing in Real Estate Properties.

Different Type of REITs

Equity REITs

They are owners of the real estate properties and lease it to companies or individuals to make money. The income is then distributed among the REIT investors as a dividend.

Mortgage REITs

They are not the owners but get EMIs against the property from the owners and builders. The earnings are via Net Interest Margin (difference of interest earned on mortgage and cost of funding the loan) which they distribute among the REIT investors as a dividend.

Hybrid REITs

Invest in both Equity and Mortgage REITs.

How to Invest in REITs

  • IPOs: A new REIT comes out with an Initial Public Offer (IPO) open to investors. You can apply for the IPO, and if your application is accepted you will be allotted units in the REIT. According to SEBI regulations, you will have to invest a minimum of Rs 2 lakh in the REIT.
  • Secondary market: After the IPO, the REIT will be available on the secondary market. That is, it will be listed on the stock exchange like shares. You can purchase them on the stock market too.
  • Funds from operations (FFO): This is the cash flow of a REIT, calculated by adding depreciation to the REITs earnings, and deducting gains on sales. It is also calculated on a per share basis like FFO per share, like earning per share, and used to gauge a REIT’s performance.

Choosing the right REIT

Like shares or equity funds, REITs are subject to market risk, so you must read the offer document carefully. While the real estate market has good potential, certain segments, like in some metros, could be saturated and scope for appreciation low. Make sure the segments the REIT is investing in has good potential, like some metro suburbs, affordable housing, smaller cities with growing industries etc.

Ranjith

Dilzer Consultants Pvt Ltd