REIT – Real Estate Investment Trust
REITs issue units or shares to investors and investors receive the rent received from the real estate properties under the REIT as dividends. REITs have a structure similar to mutual funds where they pool the money of investors and invest in real estate. Due to this, REITs are available in small units which you can purchase for around Rs.10,000 – Rs.15,000. This makes investment in real estate even possible for retail investors, who would otherwise have required huge amounts.
What are REITs?
A real estate investment trust (REIT) refers to an entity that either owns, operates, or finances real estate to generate income. Using mutual funds as a model, REITs pool the funds of many investors. This allows individual investors to earn dividends from real estate investments without having to buy, manage or finance any real estate themselves.
Assets in the REIT portfolio may include apartment buildings, data centres, healthcare facilities, hotels, infrastructure (in the form of fibre optic cables, cellular towers, and energy pipelines), office buildings, retail centres, self-service warehouses, woodlands, and warehouses.
Generally speaking, REITs focus on specific real estate industries. However, a diversified and professional REIT may hold different types of real estate in its investment portfolio, such as a REIT composed of office and retail properties.
How does REIT work?
Most REITs have a simple business model: REITs lease space and collect property rentals, and then distribute the income to shareholders as dividends. Mortgage REITs do not own real estate but provide financing for real estate. They earn interest income on the financing provided.
Some general requirements which a company must follow to qualify as a REIT are:
- The entity needs to be structured as a business trust or company.
- Become a taxable entity like a company.
- Managed by the board of directors or trustee.
- At least 100 shareholders after the first year of establishment.
- No more than 50% of the shares are held by five or fewer people.
- Pay at least 90% of taxable income in the form of shareholder dividends each year.
- Extend the fully transferable shares.
- There should be no less than five individuals holding 50% of their shares in each tax year.
- Get at least 75% of total income from mortgage interest or rent.
- Up to 20% of the company’s assets include shares of taxable REIT subsidiaries.
- At least 75% of investment assets must be real estate.
- At least 95% of the total income of REITs should be invested.
Many REITs are publicly traded on major stock exchanges, and investors can buy and sell them like stocks throughout the trading hours. These REITs usually have a large trading volume and are considered to be highly liquid tools.
Public Offer of REIT
The IPO of a REIT is accepted only if it meets certain conditions such as:
- Total Asset Value of REIT should be greater than Rs. 500 Crore
- Minimum Public Float: 25%
- Minimum Offer Size: Rs. 250 Crore
- Minimum Subscription Amount: Rs. 50,000 per applicant
- Minimum number of subscribers: 200
How to buy REITs?
You can buy REITs in IPO or in the secondary market. From June 2021, SEBI regulations allows you can buy a REIT at a minimum price ranging from Rs.10,000 – Rs.15,000 and even trade in a single lot.
Types of REITs
- Equity REITs: Most REITs are equity REITs, which own and manage income-generating real estate. Income is mainly generated through rent rather than through resale of properties.
- Mortgage REITs: Mortgage REITs lend to real estate owners and operators either directly through mortgages and loans or indirectly through the purchase of mortgage-backed securities. Their income mainly comes from the net interest margin: the difference between the interest they receive on mortgages and the financing costs of these loans. This model puts them at risk of fluctuations in interest rates.
- Hybrid REITs: These REITs use the investment strategy of equity and mortgage REITs. These types of REITs earn both rent and interest as sources of income.
REITs can be further classified according to how their shares are purchased and held:
- Publicly traded REITs: Publicly traded REIT shares are listed on the National Stock Exchange and are bought and sold by individual investors. They are regulated by SEBI.
- Public non-transactional REITs: These REITs are also registered with SEBI, but are not traded on the National Stock Exchange. Therefore, their liquidity is lower than that of publicly-traded REITs. Nevertheless, they tend to be more stable because they are not affected by market fluctuations.
- Private REITs: These REITs are not registered with SEBI and are not traded on national stock exchanges. They only cater to the needs of institutional investors and the transaction takes place through private placement.
Advantages of REIT
- Stable dividend income and capital appreciation: Investing in REITs can provide considerable dividend income and allow long-term stable capital appreciation.
- Diversified options: Since most REITS are frequently traded on stock exchanges, they provide investors with opportunities to diversify real estate.
- Transaction transparency: Regulated by SEBI, REITs must submit financial reports audited by professionals. It provides investors with the opportunity to use the information on taxation, ownership, and zoning, thereby making the entire process transparent.
- Liquidity: Most REITs are traded on public stock exchanges, so they are easy to buy and sell, which increases their liquidity.
- Generate risk-adjusted returns: Investing in REITs can provide individuals with risk-adjusted returns and help generate stable cash flow. It enables them to have a stable source of income even when the inflation rate is high.
Disadvantages of REIT
- No tax incentives: REITs are not very helpful in terms of tax saving. For example, dividends received from REIT companies are subject to tax.
- Market-related risks: One of the main risks associated with REITs is that they are vulnerable to market-related fluctuations. This is why investors with a weaker risk appetite should weigh the investment’s ability to generate returns in advance.
- Low growth prospects: The capital appreciation prospects of REITs are quite low. This is mainly because they return up to 90% of their earnings to investors, and only reinvest the remaining 10% in their businesses.
REITs in India
Currently, there are only 3 REITs available for investment in India:
- Embassy Office Parks REIT.
- Mindspace Business Parks REIT.
- Brookfield India Real Estate Trust.
Looking ahead, other leading companies in the real estate industry such as DLF and Godrej are also planning to launch REITs.