Indians love to invest in real estate, so much so that nearly 80 percent of household wealth in the country is still tied to real estate. But from an investment perspective, it is difficult for small investors to get hold of high-end commercial real estate directly. According to estimates, the minimum investment size for a grade-A commercial property is 50 million rupees, which makes it beyond the reach of most investors.
Moreover, liquidity is always an issue with direct real estate investments, exiting large investments is time-consuming. Despite several issues, real estate as an investment cannot be ignored. The sector is a vital cog of the economy and has generated excellent returns in the past. The advent of a new financial instrument—Real Estate Investment Trust (REIT)—can give small investors an opportunity to meaningfully invest in good real estate projects.
What is a Real Estate Investment Trust(REIT)?
REIT is an investment vehicle designed on the lines of mutual funds, with the major difference being in the nature of underlying assets. REITs have physical real estate as the underlying asset, unlike mutual funds where the underlying asset is bonds, stocks, and gold. After listing, units of a REIT are traded on the stock exchanges like equity shares. The tradable nature of the securities enables small investors to earn income from the underlying commercial asset, without actually owning it. As per Securities and Exchange Board of India’s rules, a REIT has to invest 80 percent of its funds into completed and revenue generating properties.
Are real estate investment trusts active in India
Source: Griffin Capital
First REIT in India
Embassy Office Parks, a Bengaluru-based real estate developer backed by Blackstone Group LP is the first REIT to be listed in India. The REIT had listed at 312 rupees on April 2 and is already trading around 370 rupees in June. Investing in REITs is not for very small investors as SEBI has mandated a minimum investment limit of 50,000 rupees for REITs. Before an amendment in March, the minimum limit was 200,000 rupees.
What REIT Investors Earn
REITs earn through rentals, dividends or interest income and distribute their earnings among the unitholders. Rental income can be earned through the properties a REIT invests in, while dividend income is generated if a REIT invests in real estate through a Special Purpose Vehicle. Interest income may be earned through mortgage-backed securities or money lent to real estate owners. According to SEBI rules, REITs are required to distribute at least 90 percent of their net distributable cash flows at an interval of not less than six months. REITs are considered to be less volatile than stocks and can generate steady returns in the long run, but you should consider other factors too before investing.
REITs are considered to be relatively less volatile than other securities due to the relative stability of the underlying assets. REITs invest in commercial spaces, which typically have a long lease of six to nine years, with a rent escalation clause. Commercial properties also have better return capabilities, according to industry estimates, commercial real estate provides returns between 8-10 percent annually. Moreover, 80 percent of REITs’ funds are invested in rent-generating assets. On the flipside, nothing can eliminate the risks of investing in a market-linked product. If you want to actually own a physical asset, you can invest in a house with home loan interest rates likely to fall after the rate cut by the Reserve Bank of India. At Finserv MARKETS, you can receive custom-made home loans with minimal documentation.
Are real estate investment trusts active in India?
Source: Financial Times
Choice of REIT
Indian investors are new to REITs, which brings with it a two different set of risks. Embassy Office Parks is the first REIT listed in India, therefore there are no peers to compare and judge its performance. The lack of peers makes it very difficult for a retail investor to judge the risk profile of an investment. After more REITs come to the Indian market, investors will have to keep a keen eye on the quality of underlying real estate assets. For example, if a REIT invests in suburban malls and the malls are witnessing a decline in footfalls, it will lead to a slump in rental incomes, which will ultimately hurt the unitholders of the REIT.
There are some unresolved tax issues with REITs. A unitholder will receive returns through rental income, dividend and interest income and all these funds will be deemed as a dividend, rental and interest income, respectively, in the hands of the unit holder and will be taxed accordingly. In case of interest income, a non-resident Indian is charged just 5% tax, while a resident investor will be charged 30% of the income. While some taxation issues are still not clear, you can invest in your dream home and claim several tax benefits on your house loans. You can learn about various home loans on Finserv MARKETS and apply for a tailor-made housing loans in a few clicks.
The introduction of REITs has brought grade-A commercial real estate within the reach of small investors. It has also solved the limitations of affordability and liquidity related to real estate investments. Retail investors will, however, be better off waiting and watching and let a few more REITs list on the exchanges before investing.
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