REITs (Real Estate Investment Trusts) are new asset classes that have hit the market in recent years, giving an opportunity for retail investors to gain exposure in real estate as an asset. As physical properties (commercial or residential) require a huge cash outflow, REITs can be relatively cheaper as an investment avenue. However, before investing in a REIT it is important to understand the nuances of these instruments.
A REIT invests the funds collected, from multiple stakeholders including the public and institutions, in income-generating real estate properties. These properties can be commercial spaces including office spaces, residential properties, malls, or even hotels. In India, so far, there are three REITs listed in the bourses and all of them are into commercial properties, predominantly, office spaces.
One can thus draw parallels between mutual funds and REITs as an entity that pools money from investors to invest in the intended asset. The REITs are mandated, by SEBI, the market regulator, to invest 80% of their investment in income or rent generating properties. Also, as per SEBI’s guidelines, REITs need to mandatorily distribute 90% of their income to unit-holders. The distribution could be in the form of dividends or interest income or both.
All three listed REITs – Embassy, Mindspace and Brookfield, have so far been distributing dividends and interest to their unit-holders every quarter. Given that retail investors may not be able to invest in office spaces directly, considering the huge cash flow requirement, REITs could be an investment platform to gain exposure to ‘Grade A’ office space commercial properties where investors could make money in the form of dividend and enjoy capital appreciation.
Many REITs are likely to hit the markets soon, especially after the recent reduction in the unit of investments to one unit from 200 units earlier. All three listed REITs have a strong market presence in respective regions of operations aided by favourable locations of their properties.
Take Embassy REIT for instance, it is among the largest players in commercial spaces, particularly in the Bengaluru region. It has properties in prime locations (in Bengaluru). In the case of Brookfield REIT, it has little over 10 million square feet of income-generating commercial properties spread across the micro-markets of Noida, Gurugram, Kolkata and Mumbai. The presence in SEZ (special economic zone) for Brookfield also works out in favor of this REIT.
Thus, all three REITs in India are located in key office market regions where demand for quality office space is high with large multinational clients.
India’s REITs are also consistent in distributing the income generated so far. Embassy REIT, one of the first to be listed on the bourses, had been distributing regular interest and dividend income. Despite the Covid uncertainties, the REITs continued to pay their investors each quarter. For instance, the recently listed Brookfield REIT was able to pay Rs 6 per unit to its unitholders in the June quarter and is expected to pay Rs 6.75 per unit in the September quarter as well.
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Investments in physical real estate require a huge cash outlay and could dent your finance. Finding the right property for investment is also a tall task involving hours of research and multiple property visits. The legal and other paperwork involved in physical real estate too is vast. While owning your home cannot be replaced by investing in REITs, any investment in physical real estate beyond your dream home can be replaced conveniently by investment in REITs.
One should also keep in mind the various costs involved in the upkeep of the property including maintenance cost, property tax, water tax, transaction cost on registration, etc.
Many also consider buying more than one property in the hope of generating rental income. However, the rental yields have not been very impressive in the country, particularly in the residential category. Any capital appreciation requires a lot of patience, more so in a residential property. Liquidity is another factor that does not work in favour of physical real estate. Further, policy changes and crises affect the value of the underlying asset drastically.
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While REITs could be an alternate investment platform, there are a few risks associated with REITs as well.
One, the underlying projects may have legal complications and may take longer for the asset to become operational and start generating income.
Two, the rental yields are still low when compared to international markets. The average yield from the existing REITs is around 5-6%, whereas the rental yields in the international markets are higher.
Three, since the outbreak of Covid-19 last year, many organizations have been working from home. While there is no huge impact on the occupancy as of now, any prolonged working from home could affect the rental income as new leases could be put on hold by the clients. When occupancy is affected, the rental income (paid by the tenant to the REIT) could take a hit and which in turn affects the distribution income to the investors.
But having said that, REITs are more accessible, simple investment options compared to physical real estate. Investment in REITs cannot supplement investing in your dream home, however, any additional exposure that you may intend in physical real estate can be done through REITs.