At a recent Sebi-NISM research conference, Madhabi Puri Bach, the Chairperson of the Security Exchange Board of India (Sebi), said that investors should have a positive view of assets such as real estate investment trusts (REITs), infrastructure investment trusts (InvITs), and municipal bonds, realizing their role for the nation’s development. Henceforth, the regulator’s focus would be on enabling broader ownership of smaller units within REITs and InvITs, Buch stated. "These products were considered sort of high-risk and therefore the minimum entry price was kept high. We have steadily brought it down and the intention is to bring it down even further," said Buch.
REITs and InvITs, both in essence, are investment vehicles that support developers to leverage revenue-generating real estate and infrastructure assets. These instruments mainly achieve this by securitizing and issuing units to the investors, without the need for physical asset transfers. Most importantly, Buch emphasized the fact that the strength of the nation lies in fractional ownership of real estate and infrastructure. Sebi has proactively undertaken certain initiatives, to facilitate this and lay the groundwork for such growth.
“The first thing is for us as a regulator to get the comfort to go to retail investors, to go to our parents, in-laws, uncles, aunts, nieces, and nephews to say, this is a very good product, you should invest in it," she said.
According to experts, the recent call from Sebi's top brass urging investors to explore asset classes like REIT has stirred up quite a buzz. The question on many minds is whether it's the right time to dive into REIT investments, and what factors to consider before taking the plunge.
Here are some factors investors should consider before investing in REITs:
Smaller Universe To Choose From: “REITs offer a much smaller range of options with just three listed choices available, a significantly limited selection for investors when compared to mutual funds (MFs), which have an extensive array of choices offered by 44 AMCs offering over with more than 600 equity MFs, 400 debt MFs, etc,” Hrishikesh Palve, director, Anand Rathi Wealth said.
Higher Concentration Risk: Moreover, while REITs solely focuses on real estate investments, MFs automatically diversify across multiple sectors including finance, automotive, and real estate, etc. thus mitigating concentration risk. For example, during periods such as the COVID-19 pandemic where certain sectors, like real estate, experienced a substantial downturn, a portfolio having a higher exposure in REITs would have suffered considerable losses, emphasizing the importance of diversified investments.
Returns: In the last 23 years, NIFTY has consistently delivered a CAGR of 13 per cent with only four instances of year-on-year declines, exhibiting an 80 per cent probability of positive returns. “Within the MF universe, investing across diversified categories is a strategy aimed at mitigating exposure risk. Whereas, opting for REITs, exposes investors to heightened risk as the return range is very high for the listed ones. Moreover, they are fairly new to the market a lack sufficient data as well whereas Nifty in the same time frame has delivered significantly higher returns,” added Palve.
Cost: “The cost to invest in MFs ranges between 0.5-1.5 per cent whereas the cost of the three REITs is: Embassy, Mindspace, and Brookfield- three per cent, 2.7 per cent, and one per cent respectively. And these numbers depict they are not as cost-efficient as MFs,” said Palve.
Taxation: Taxation on MFs depends on the type and holding period. Equity funds held for over a year get tax benefits from LTCG exemptions up to Rs 1 lakh. Exceeding this limit, gains are taxed at 10 per cent. Debt funds and others are taxed on capital gains according to your income tax slab if held for less than three years. REIT units are taxed based on the period they are held for. If held for more than three years, it is taxed at 10 per cent, and if less than three years, it is taxed at 15 per cent.
“Sebi’s introduction of regulations for small and medium REITs (SM REITs) allows investment in smaller real estate projects, potentially making REITs more accessible to retail investors with lower investment amounts. However, since SM REITs are new, their risk profile might differ from established ones. However, careful research is still crucial. Consider your investment goals and risk tolerance before making a decision. For individuals with longer-term financial objectives, it is advisable to diversify assets between equity and debt in the ratio of 80:20 is recommended for the long term,” added Palve.
REITs is relatively new in India, unlike other countries where REITs is considered a mature asset class. India witnessed its first REIT in 2019 with a listing of Embassy Office Parks REIT. Since then, three more have been added to the list - Brookfield India Real Estate Trust, Mindspace Business Parks REIT, and Nexus Select Trust. These four have a combined market capitalization of around USD 10 billion as compared to over USD 1 trillion market capitalization of REITs in the US. This showcases a huge upside potential to grow.
“Three out of the four REITs have generated positive returns on the stock market in the past nine months, in the range of 14 per cent-30 per cent. However, the BSE realty index generated higher returns of 57 per cent compared to REITs in the same period stated above. As demand for commercial assets is likely to grow in the future, specifically office spaces, on the back of ‘Return to Office’ mandates, office asset occupancy levels are likely to improve. This may lure investors to invest in commercial REITs, improving prospects for future growth,” says Shrinivas Rao, CEO, Vestian, an international real estate property consultant.
According to research data shared by Vestian research, here are some of the returns of REITs on the Bombay Stock Exchange (BSE) since July 2023: Embassy Office Parks REIT - 30 per cent; Brookfield India Real Estate Trust- six per cent; Mindspace Business Parks REIT - 14 per cent; Nexus Select Trust- 18 per cent; BSE Realty Index- 57 per cent.
Col Sanjeev Govila (retd), certified financial planner, and CEO, Hum Fauji Initiatives, a financial advisory firm said, “Sebi’s move to lower the minimum investment threshold to Rs 10 lakh for medium and small REITs is a significant step towards democratizing access to this asset class. This adjustment not only opens doors for retail investors but also injects a healthy dose of liquidity into the market. Against India's increasing focus on infrastructure development and a promising economic outlook, REITs presents an enticing opportunity. They offer a range of benefits, including transparency, liquidity, and diversification, making them an attractive alternative to direct property ownership. Also, the real estate sector, along with REITs, could see a boost, on the back of expectations of declining interest rates.”
However, potential investors should tread carefully and be mindful of key considerations before committing funds to REITs. “Having said that, potential investors must watch their steps and be careful of key factors before committing funds to REITs. “There is a significant amount of influence of economic and market dynamics over the performance of this REITs. Hence it’s very important to be cautious about investing. Moreover, the fluctuating interest rates induced volatility poses a significant risk to REIT prices. One should ideally invest in funds that won't be needed for immediate financial needs, given that REITs are also best suited for long-term investment horizons,” added Govila.
People like to use REITs for investment purposes, from a diversification point of view. “Theoretically speaking, the real estate sector has a poor correlation with other asset classes viz. equity, debt, and gold. Whether or not such diversification will add value to the overall portfolio is an aspect that demands in-depth analysis. The time horizon of investment along with other factors is an important factor in choosing between equity REITs, mortgage REITs, and hybrid REITs. The potential to generate high dividend yields is a driving factor to invest in REITs in India and overseas as well,” says Arijit Sen, a Sebi-registered investment advisor and co-founder of Merry Mind, a Kolkata-based financial advisory firm.
Although the cash flow of REITs is more or less predictable, there is a major threat to liquidity. Therefore, it would not be wise for regular income-seeking investors to depend on predictable cashflows solely. Besides taxation, the dependency on tenants plays the most important role in yields from REITs.
“REITs are annuity, consistent cash flow yielding product. As REITs guidelines are well established by Sebi, the norms provide comfort to the investors that REITs shall invest majorly in completed assets and distribute a majority of income earned quarterly. To assess the quality of REITs, Investors should study key parameters such as the background of the sponsor, quality of assets owned by REITs, tenant profile, micro market, income distribution, and the nature track record in which the assets are located. By comparison across these various parameters, investors shall get a perspective to choose among various REITs to invest in,” says Piyush Gupta, Managing Director, Capital Markets & Investment Services, Colliers India.
One important aspect where retail investors could get confused is to directly equate REITs to real estate purchases. They should keep in mind that, as per Sebi-mandated criteria, at least 80 per cent of investments made by a REIT need to be in commercial properties that can be rented out to generate income. The remaining assets of the trust (up to the 20 per cent limit) can be held in the form of stocks, bonds, cash, or under-construction commercial property. Additionally, at least 90 per cent of the rental income earned by the REITs has to be distributed to its unitholders as dividends or interest.
Thus, the capital appreciation potential would be quite limited in REITs as the rental income being earned is being continuously distributed. This feature indicates that one should not compare REITs with the purchase of real estate directly. Also, the dividend or interest earned from REITs is completely taxable in the hands of the investor according to the applicable slab rate. Thus, those in the 30 per cent tax slab will lose a substantial portion of their dividend income as taxes.
In essence, while the allure of REITs is undeniable, investors should approach them with a balanced perspective, weighing the potential rewards against the inherent risks. With prudent decision-making and a long-term mindset, investing in REITs could prove to be a rewarding addition to one's investment portfolio.
What Should Investors Keep In Mind:
As REITs are relatively new in India, the data for long-term historical gains is unavailable. Other than returns, there are several other factors that an investor should consider before investing in REITs.
One should consider the occupancy levels of real estate properties owned by REITs along with the quality of tenants that ensure a consistent inflow of funds for the company.
Long-term leasing commitments from tenants and rolling renewals showcase robust income sources and potential for future growth.
Moreover, diversification across property types (office, retail, residential, and industrial) and geographies are valid points to mitigate risks while investing in REITs.
A strong management team is capable of improving the performance of REITs by finding good tenants, negotiating leases, and keeping properties well-maintained. One should also consider the management fees associated with investing in REITs.
