Real estate investments in India have encountered numerous challenges in recent years, including insufficient returns, low liquidity, high maintenance costs, unfavorable taxation, and persistent issues such as scams and deviations from agreed-upon terms and conditions. Real Estate Investment Trusts (REITs) emerge as a practical solution, offering individuals an opportunity to invest in real estate while bypassing these challenges.
Unlike traditional real estate investments, REITs are publicly listed on the stock market, providing exposure to commercial properties renowned for delivering superior rental yields compared to residential properties. This comprehensive guide explores the fundamental aspects of REIT investments, encompassing their definition, operational mechanisms, performance, taxation implications, and key considerations for potential investors.
What are REITs?
A Real Estate Investment Trust (REIT) is a company that owns, operates, or finances income-generating real estate properties. REITs pool funds from investors and invest them in commercial real estate projects such as workspaces and malls. These stock market-listed entities offer investors the opportunity to participate in real estate ownership without the complexities of property management. REITs provide a means to invest in real estate by purchasing equity, offering better liquidity compared to physical real estate investments.
Eligibility Criteria for REITs
For a company to be classified as a REIT, it must adhere to specific criteria:
- Formed as a trust under the Indian Trust Act 1882 and registered under SEBI REITs Regulations.
- 80% of investments in income-generating properties, with 20% allowed in other instruments.
- Limit of 10% on investments in under-construction properties.
- Investment restricted to commercial real estate and office premises.
- 90% of total income distributed to shareholders as dividends.
- Minimum asset base of Rs. 500 crore.
- Biannual declaration of Net Asset Value (NAV).
- Mandatory stock market listing.
Types of REITs
Globally, various types of REITs cater to different real estate holdings:
- Equity REITs: Invest in income-producing real estate properties.’
- Mortgage REITs (mREITs): Lend funds to real estate companies, earning income through interest payments.
- Hybrid REITs: Combine benefits of equity and mortgage REITs, investing in both physical properties and real estate debt instruments.
- Publicly Traded REITs: Listed on stock exchanges with high liquidity.
- Public Non-Traded REITs: Registered but not listed, providing lower liquidity.
- Private REITs: Not listed on stock exchanges, available to selected investors with lower liquidity.
REITs in India
In India, the concept of REITs is relatively new, with guidelines introduced by SEBI in 2007 and updated in September 2014. Currently, there are three REITs in India: Embassy Office Parks REIT, Mindspace Business Parks REIT, and Brookfield India Real Estate Trust. The structure includes a Sponsor, Manager, and Trustee, each with defined roles and responsibilities.
How REITs Operate
REITs function similarly to mutual funds, pooling funds from investors and investing in income-generating assets. Investors receive dividends and interest payments from the rental income of these assets. Although investors don’t own physical properties, they hold units listed on the stock market, providing exposure to underlying real estate performance.
Why REITs are Created
REITs offer investors access to commercial real estate, and they also benefit real estate companies through tax exemptions. Interest payments and dividends from a Special Purpose Vehicle (SPV) are tax-exempt, reducing the tax liability for real estate companies. Additionally, listing a REIT on the stock market allows access to funds for future projects through an IPO.
How REITs Generate Returns
Returns from REIT investments come from factors such as property appreciation, rental income, and market conditions. Dividend and interest payouts constitute regular income for investors, and capital gains can be obtained by selling REIT units on stock exchanges.
Benefits and Limitations of Investing in REITs
- Diversification: Exposure to real estate without the complexities of property ownership.
- Small Initial Investment: Requires a smaller investment for portfolio diversification.
- Professional Management: Professional management of assets owned by the REIT.
- Regular Income Generation: Mandatory distribution of 90% of net rental income to investors.
- Capital Gains: Potential capital appreciation through stock market trading.
- Limited Options: Currently, only three REITs and one International REIT Fund are available in India.
- Low Liquidity: Limited market participants, especially among retail investors, can result in low liquidity.
- Taxable Dividend: Dividends and interest earned from REITs are taxable in the hands of investors.
Taxation of Dividends and Capital Gains
Dividends obtained from REITs are taxable in the hands of investors, and capital gains are subject to Short Term Capital Gains (STCG) and Long Term Capital Gains (LTCG) taxation rules. International REIT Fund of Funds follows non-equity Capital Gains taxation rules.
How to Invest in REITs
Investing in REITs involves purchasing units on stock markets through a Demat Account. Currently, three options are available in India: Embassy Office Parks REIT, Mindspace Business Park REIT, and Brookfield India Real Estate Trust. Mutual funds, such as Kotak International REIT Fund of Fund, provide an alternative investment avenue.
Should You Invest in REITs?
The decision to invest in REITs depends on the investors desire to diversify their portfolio with exposure to commercial real estate. While REITs offer benefits such as professional management and small initial investments, limitations like limited options and low liquidity should be considered. REITs are recommended to form a minor part (ideally no more than 10%) of an investors portfolio, contingent on optimized asset allocation across different asset classes.
In conclusion, understanding the intricacies of REITs and considering their benefits and limitations is crucial before deciding to invest in them.