REIT – What is there for investors?

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Real Estate Investment Trust (REIT) is an investment vehicle that invests in income generating real estate assets such as commercial and residential properties, etc. The introduction of Indian Real Estate Investment Trusts (I-REITs) serves as a new asset class for domestic as well as foreign investors to venture into Indian commercial real estate. REITs, having prominence in USA, UK, Australia, Singapore, etc are considered as an assortment of equity and bonds. As they are expected to give capital appreciation through the increased property prices, just like equity and generate rental income that is comparable to the interest income accrued from bonds.

The functionality of REIT is on the similar lines as that of mutual fund. They will be regulated by Securities and Exchange Board of India (SEBI) and traded as securities in dematerialised form rendering easy entry as well as exit for investors. However, it is mandatory for REITs to distribute 90% of the rental income generated from the commercial properties twice a year. As the major chunk of REIT i.e. 80% includes income generating assets, investors are expected to receive considerable amount of this rental income in the form of dividends. In contrast to mutual funds, where dividends are subtracted from the Net Asset Value (NAV), the rental income generated would not be deducted, hence preserving the NAV of the REIT fund. NAV is basically the value of the fund (assets minus liabilities) per share. Moreover, investment in REIT would be diversified, as REITs have to invest in at least 2 projects with up to 60% asset value.

Traditionally, investments in commercial or any real estate involves high capital. On the other hand, commercial REITs offer investment at a reasonably smaller capital of 2 lakh, which have similar rental yield as well as capital appreciation as that of a commercial property.

Currently, the rental yield from a commercial property is in the range of 7-9%, while the capital appreciation stands to be in between 4-7%. So, the total return expected from a REIT would be roughly around 11% to 16%. All the properties under REIT would be valued twice a year. Government has also exempted Dividend Distribution Tax (DDT) on REITs listed through Special Purpose Vehicle (SPV). However, earnings from REITs by individual investors would not have any income tax exemption. If any of the underlying assets of the REIT is sold, it would attract capital gain tax.

“With the advent of REIT, Net Asset Value (NAV) would be linked directly to the real estate valuation. Considering the cyclic nature of real estate market, investors buying and selling units as per these cycles are likely to reap the benefits,” said Ajay Sharma, Senior Deputy General Manager (C&V), HDFC Realty.

Risk comes implicitly with investments made in any asset class. Similarly, REITs carry certain risks with them! REITs are likely to incorporate office spaces present in matured markets. This may lead to shifting of occupiers to new and upcoming areas which may sabotage the earning potential of REITs and ultimately their NAV. Another risk would be the age of the asset, with construction becoming older and weaker, the maintenance expenditure of the building is likely to go up, marking a dent on Adjusted Funds from Operations (AFFO) of the REIT.

The first listing of the REIT is expected to happen by year end by Embassy-Blackstone. REITs are likely to bring about the much needed impetus to the commercial real estate sector in India. Retail investors should also consider REIT as an option to diversify their existing portfolio. It is also advisable for investors to gauge  other factors such as the quality of the lessee (grade A companies are more likely to make a prompt rental payment then other companies), gearing ratio (debt of a REIT as compared to its assets as it affects both risk and return), etc while committing an investment. India being an emerging economy is expected to attract significant global players as well as domestic players into its I-REITs.

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