Should I Invest in Real Estate Investment Trusts – REITS

2019 introduced a flashy new investment option for Indian investors – Real Estate Investment Trusts. The first entrant into this space was Embassy Office Parks in April 2019, followed by Mindspace in July 2020 and Brookfields in Feb 2021. If some of you are wondering – this is the same office space name where I go to work – you may be right.

What is a REIT

In the simplest form – REITs is a mutual fund which holds Real Estate assets as the investments. An investor who is buying units of a REIT is hence indirectly buying a proportionate share in the real estate pool of the respective REITs.

In REITs, a real estate developer transfers one or more real estate properties to a Trust. The Trust issues Units of the REITs to the investors. The money obtained from the investors is then used to pay the developer for the properties put into the Trust. From here on, the Trust owns & manages the assets in the REIT. All benefits / risks associated with the underlying real estate are shared by the unit holders.

Looking Inside an Illustrative REITs – Embassy Office Parks

As an illustration, we have put an extract below from the Quarterly investor presentation of Embassy Office Parks REIT. You would notice that the current portfolio of underlying real estate properties include a range of Commercial Offices, Hotels and even an Energy asset. They do take loans to fund the development of the properties. Finally the total value of all assets less the loans is INR 289,100 million. When this is divided by the total number of units issued by the REIT, the per Unit value as of 31 Mar 2020 is Rs 374.64.

Source – Quarterly Investor presentation of Embassy Office Parks REIT

Underlying business parks / properties are held in individual private limited company structure and the final owership is with the Embassy REITs. The ownership of the REITs is via the units held by a combination of its Sponsors and public investors.

Source – Quarterly Presentation – Embassy Office Park REIT ownership structure

Are REITs Regulated ?

REITs are regulated by the Securities & Exchange Board of India (SEBI). Amongst all regulations, two noteworthy regulations for REITs are :

  • REITs to distribute atleast 90% of its earnings to the unitholders. This ensures that the REITs is not hoarding up cash to the detriment of its investors.
  • A REITs must have minimum 80% of its underlying assets in income generating assets. In order words, this reduces the risk of a REIT sitting with non income producing assets.

Type of Returns Expected from REITs

Like any investment structure, one should look into the underlying asset within an investment to identify its characteristics. Once the characteristics of the returns are understood, it would assist an investor in allocating an investment product as per their asset allocation needs. A REITs primarily has two types of returns :

  • A. Appreciation in the value of the underlying real estate properties in a REIT. This could result in the value appreciation of the Unit price of REITs. As you would see in the illustration above, the gross value of all assets of the REITs as of 31 Mar 2020 was INR 331,683 million resulting into a NAV of Rs. 374.64. As time & economic environment progresses, the overall value of the real estate properties may go up or down. This could be a major driver of a return experience for an investor. On top of it, since the REITs are listed, the value of the Units will fluctuate daily depending upon the sentiments, making it a relatively high volatile real estate asset. The chart below shows the price movement of all three REITs, with relatively longer history for Embassy Office Parks REITs. Embassy came up with its IPO of Rs. 300 in Mar 2019. Its Unit price went upto Rs 486 in Mar 2020 and then to a bottom of 300 in April 2021.
Price chart of Embassy (Blue), Mindspace (Amber), Brookfield (Aqua blue) and Sensex (Yellow)
  • B. Distribution Income – This could also be loosely called as recurring Dividend Income. While a REITs would like to have a consistent and steadily growing distributions to its Unit holders, its fate is heavily linked to economic environment of its tenants. For ease of reference, the last distribution histories are noted below :
Dividend per unit paid by Embassy & Mindspace

Taxation

Taxation for REITs may not be straight forward unlike other financial products. Gains / Incomes arising from REITs are broken down into

  1. Rental & Interest income – Fully taxable in hands of the unit holder in their respective tax slab
  2. Dividend Income – Tax free if the REITs Company has not obtained beneficial tax structure. This is disclosed in the distribution communication by the REITs. For example, Embassy Office Parks disclose that they don’t take beneficial tax structure and hence their dividend incomes are tax free in hands of the investors.
  3. Amortisation of SPV debt or in simple words loan repayment – Tax free
  4. Capital Gains – associated with the sale of Units on a stock exchange will be dependent upon the holding period of an investor. If held for more than 36 months, the gains will be considered as a long term capital gain and be subject to 10% tax. If held for less than 36 months, the gains will be considered as a short term capital gain and will be subject to 15% tax.

A detailed tax legal guidance can also be read at the following link > CLICK HERE

Pros of REITs as an investment option

Investments via REITs bring in similar advantages of a Mutual funds. Top three could be:

  1. The best advantage of a REITs is that it converts a big block of a real estate property in smaller chunks which can be easily afforded by an investor and also provide diversification benefit. Any worthy commercial property would cost in multiples of a million rupees. Most sought after property in commercial hubs will be in 10s of million of rupees. How about if you get a part ownership a pool of properties with a budget as low as sub Rs. 75,000 ? This also significantly reduces the concentration risk of an investment in one single big property going sour.
  2. The REITs manager takes care of all hassles which comes up with ownership of a real estate. These include managing the property, vetting tenants, collecting rents, legal issues, security, maintenance, etc.
  3. REITs are required to distribute incomes to the investors. They ideally aim to distribute this on a quarterly basis. Hence, they can become a good source of recurring income for the investors. However, all three REITs in India haven’t yet built a long term track record and hence it may take time to build conviction on their distributions.

Possible Challenges with REITs

REITs are hybrid products. Their actual assets are the underlying properties and hence the driver of the risks are similar to a real estate investment. These could include :

  1. Most of REIT assets are predominantly commercial properties whose fortunes are heavily dependent upon the underlying economic affairs in an economy. After all, if businesses are not flourishing, they won’t expand or hire commercial office spaces;
  2. Transparent Market pricing – A usual real estate property may have an apparent ‘stable market value’ as there isn’t a transparent & liquid market of it. However for a REITs, its units are actively traded on a stock exchange and hence are subject to a transparent and liquid market. As a result, the market value of REITs is very volatile and hence may be considered more riskier than its underlying real estate.

How to Invest in REITs

REITs are listed on stock exchanges and can be bought like other stocks or ETFs on NSE / BSE. Hence, you need to have a stock brokerage and a demat account as a prerequisite. Owing to regulatory restrictions, one needs to buy REITs in multiples of 200 units.

Disclaimers – The blog post discusses and names specific REITs only for knowledge sharing purposes. They must not be considered as an investment advice.

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