The listing of India’s first Real Estate Investment Trust (REITs) by Blackstone-backed Embassy Group may now be a reality and it is good news for the real estate sector that has been experiencing severe liquidity crunch.
Currently, developers incur huge capital expenditure especially in Commercial Real Estate (CRE) on land, construction, interior fit-outs, etc. which remain locked, even after the asset is complete until it generates returns to break-even.
REITs are investment vehicles that own, operate and manage a portfolio of income-generating properties for regular returns. REITS able properties in our country include commercial assets – primarily office spaces – that can generate steady rental income. They will operate like mutual funds or shares. REITS will have to be mandatorily listed on exchanges and traded like securities. Small investors can buy units of REITS from both primary and secondary markets just as they buy shares or mutual funds. To qualify as REITS, a company must comply with certain provisions in the Internal Revenue Code, including requirements to primarily own income-generating real estate for the long term and distribute income to shareholder. REITS play an important part in an investment portfolio. As with all investments, they have their advantages and disadvantages.
On the plus side, REITS are easy to buy – sell, trading as they do on public exchanges. This mitigates some of the traditional drawbacks of real estate—its notorious illiquidity (buildings can take a long time to unload or purchase) and its lack of transparency. REITS are regulated by the SEC and must file audited financial reports.
Performance-wise, they offer attractive risk-adjusted returns and stable cash flow. And a real estate presence can be good for a portfolio, diversifying it with a different asset class that can act as a counterweight to equities or bonds.
On the downside, REITS don’t offer much in terms of capital appreciation: They must pay 90% of income back to investors, so only 10% of taxable income can be reinvested. Dividends are taxed as regular income. REITS do carry a risk: They’re subject to real-estate market slumps and, like most investments, don’t guarantee a profit or ensure against losses. Some have high management and transaction fees. REITS returns tend to “zig” when those of other investments “zag,” helping to reduce a portfolio’s overall volatility and improve its returns for a given level of risk
Why should one invest in REITS in India?
REITS are total return investments. They typically provide high dividends plus the potential for moderate, long-term capital appreciation. Long-term total returns of REIT stocks tend to be similar to those of value stocks and more than the returns of lower risk bonds. A realistic return on investment (RoI) expectation would be in the range of 7-8 percent annually, after adjusting the fund management fee. Investors can earn two types of income from REITS; through capital gains on the sale of REIT units and a dividend income.
Over all the success of REITS in India will depend on benefits to investors. Currently, a plethora of taxes may make REITs unattractive. For instance, when a REITS sells shares of assets, the capital gains are taxable.
In contrast, in the UK where REITs have been operating for over a decade, there is no taxation on income and gains from their property rental business. Instead, shareholders are taxed on REIT-related property income when it is distributed, and some investors may even be exempt from tax altogether.