What are REITs and should you invest in them?

With the launch of the first REITs IPO in India by the Embassy Group in partnership with Blackstone of the US, the focus is back on REITs as an investment product. SEBI permitted REITs in 2014 but there were a lot of procedural and tax related grey areas which delayed the actual launch of REITs in India.

REITs promises to be a game changer for the investors and for the real estate developers. For the investor, this is an additional asset class to invest in; and for the real estate developers REITs offer an opportunity to monetize their portfolio of commercial assets and also to give a viable exit route for the investors who had committed money to the project. But first, let us look at what this concept of REITs is all about?

What REITs are all about?

Real Estate Investment Trusts (REITs) are securities that are linked to a portfolio of real estate properties in India. Generally, the REITs make more sense in properties that are revenue generating and hence REITs are more popular on commercial property; and not so much on residential property. These include malls, commercial offices, industrial units, special economic zones, and other commercial spaces. The role of a REIT fund is exactly like that of a mutual fund. Just as a mutual fund creates a diversified portfolio of assets by purchasing equities selectively across the spectrum, the REIT fund does a similar job with realty. Commercial property is owned by the REIT fund and the income accruing from the property in the form of rentals on property and capital gains (if any) are distributed to the REIT holders. The REIT fund just acts as an intermediary to pass through the benefits of owning the property to the investors.

Is there a case for investing in REITs?

• Unlike in the case of equity and bonds, there is no history of performance available since the first REIT IPO has only just been launched. However, there are some important considerations for investors in REITs.

• REITs offer a good way to hold real estate as a financial asset. Normally, realty does not fit into your portfolio of investments as it is a hard asset. With the launch of REITs it is possible to hold real estate as an asset class in the form of financial securities.

• REITs offer a good way of diversifying your portfolio risk. Normally, realty as an asset class is extremely regional in India and it is not impacted by the vagaries of equity and bond markets. This helps in diversifying the risk of the investor due to its low correlation with existing asset classes like bonds and equities.

• The REIT Fund is mandatorily required to distribute 90% of income earned in the form of rentals and capital gains to the unit holders in the form of dividends. Being pass-through investments, the dividends received by investors are entirely tax free in the hands of the investor. That makes it more tax efficient than equity and debt funds.

• Effective March 1^st 2019, SEBI has reduced the minimum investment stipulation in REITs from Rs.2 lakhs to Rs50,000. This will make REITs more widely accessible. REITs are financial securities and its units can be held in your regular demat account and no additional administrative support is required for that.

• While there is no history of REIT returns in India, one needs to remember that rental yields are relatively lower in India. However, experts estimate that the returns on REITs could range from 8% to 12% on an annualized basis and investors should take a long term approach to invest in REITs.

• Lastly, REIT returns are expected to be less volatile compared to equity returns due to the long term nature of most commercial lease contracts. This will help the REIT investor to reduce the volatility in the overall portfolio.

REITs have surely emerged as an interesting addition to the investment portfolio.