What Is a Real Estate Investment Trust? Whether To Invest or Avoid?

The rapid growth of the real estate sector in India led to an increase in the demand for commercial and residential properties. To allow corporates to raise capital to fund this demand and to provide investors with a regulated mechanism of making investments, the Securities Exchange Board of India (SEBI) introduced Real Estate Investment Trusts (REITs) as an investment tool. REITs were listed for trading on stock exchanges in India for the first time in 2019. REITs are private trusts registered with the SEBI, and they generate income for the investors in the form of dividends and capital appreciation. 

Like any other investment, REITs come with a set of risks. Therefore, it is important that you know about the pros and cons before deciding to invest.

To know more about REITs, please continue reading.

What Is a REIT?

REIT is a tool for investing in real estate without the need to own or manage any real estate property. These are trusts that pool money from investors and invest in income-generating real estate properties, much like mutual funds. REITs hold and manage real estate properties for investors. The income generated from these properties is distributed to the investors in the form of dividends.

Benefits of Investing in REITs

REIT is a comparatively newer form of investment tool in India, but they come with many benefits if invested wisely.

Here are some of the benefits they offer:

• Diversification: Investing in REITs allows diversification of your investment portfolio. You can invest in real estate without the burden of buying or renting properties.
• Regular income: Most REITs earn from continuous rentals, lease payments or loan instalments. 90% of these incomes are distributed among the investors as dividends on a regular basis. Therefore, you can receive regular income by investing in REITs.
• Capital gains: REITs are listed on the stock exchanges. You can trade them just like any other stock and generate income in the form of capital gains.
• Affordability: Compared to other real estate investments, you can invest in REITs with smaller capital as low as ₹ 300. Since they are listed on the stock exchanges, you can also add to your holding basis availability of capital.
• Liquidity: Compared to other real estate investments, REITs offer high liquidity as you can trade REIT units on the stock exchanges. 
• Safety: As REITS come under the purview of SEBI, investing in REITs in India offers added security.

Risks of Investing in REITs

Every form of investment comes with its own set of risks and challenges. Following are the risks of investing in REITs that you should know about:

Liquidity

While REITs are relatively more liquid than other real estate investments, it is still harder to sell a REIT unit than other equity shares. This is because the number of investors for REITs is lower than the number of investors for equity shares.

Tax Implications

Long-term capital gains exceeding ₹ 1 lakh on sale of REIT units through a recognized stock exchange will be taxable in your hands at the rate of 10% without indexation and 20% with indexation (plus applicable surcharge and cess). In case your taxable income as reduced by the capital gains is below the basic exemption limit, the capital gains will be reduced to the extent of the shortfall and only the balance capital gains will be taxable. REIT units qualify as long-term capital assets if they are held for more than 3 years. Short-term capital gains will be taxable in your hands at the rate of 15%.

Tax on dividend income depends on whether the REIT had obtained special tax concession from the government. If yes, then the dividend is taxable in the hands of the investor. If not, then no tax is applicable.

Limited Investment Options 

Since REITs are fairly new in India, they have low acceptance as a preferred asset class. At present, there are only 3 domestic REITs and 1 international REIT in India, making the investment options in REITs limited in nature.

Factors to Consider Before Investing in REITs

Before investing in REITs, you must consider the following factors:

• Portfolio: You must be aware of the real estate portfolio of the REIT before investing. The portfolio of a REIT may comprise real estate companies across different sectors. Therefore, it is important to assess the growth potential and risks associated with the portfolio. 
• Occupancy ratio: Occupancy ratio refers to the amount of space rented or occupied as compared to the total available space. The higher the occupancy ratio, the more income is generated for the REIT and hence more preferable it is for investing.
• Sector diversification: You must find REITs that have diversified sector occupancy. In most cases, IT companies rent the most premium spaces. However, a REIT must diversify its holdings and not depend on a single sector at a time.
• Geographical diversification: Real estate movements depend largely on state-determined rules and regulations. Therefore, REITs that only hold region-specific assets can be subjected to higher risk. Therefore, you must consider investing in REITs that have a higher geographical diversity. 
• Net Operating Income (NOI): It refers to the revenue as profits that a real estate investment can generate after deducting the operating costs. Therefore, it is better to consider a REIT that has a higher NOI. NOI factors that you can observe are:

1. Increase in the number of occupancies 
2. Escalation of contractual lease
3. Releasing of expired leases
4. Completion of under-construction assets

Also Read: A Beginner’s Guide to Equity Investment

How to Invest in REITs in India?

There are 2 ways in which you can invest in REITs:

1. Through Stock Market Exchanges

REITs are listed on the National Stock Exchange and the Bombay Stock Exchange. If you have a demat account, you can invest in your preferred REIT. The price of each unit also varies, just like an equity share.

You can also invest in  REITs that are about to get listed on stock exchanges through IPOs.

2. Through Mutual Funds

There are a few domestic mutual funds in India that invest in REITs. You can also invest in international real estate assets through these mutual funds. 

Eligibility Conditions for REITs

As per SEBI guidelines, trusts need to pass the following eligibility criteria to get registered as a REIT:

• 90% of its income should be distributed to the investors as dividends.
• 80% of REIT’s investment should compromise real estate assets.
• Only 10% of the total investment can be used for under-construction assets.
• The minimum asset base of the company should be ₹ 500 crores.
• The trust should abide by the standard structure with distinct trustees, sponsors and managers.
• They should be mandatorily listed on the stock market.
• REITs must update the net asset value of their units twice every financial year.

Final Word

This article illustrates the different aspects of REITs along with their benefits and drawbacks. REITs are attractive avenues for investments due to increased liquidity and easy exit options along with high returns. Investing in REITs can also be a convenient way to diversify your investment portfolio. Well-researched information about the real estate sector can help you make the right investment and generate a regular income. 

Frequently Asked Questions