Real Estate Investment Trust: What is REIT?

A multitude of investment options are available in India. From financial instruments like equity, bonds and fixed deposits to physical assets like real estate and gold, investors have a wide array of options. Real estate, however, attracts the bulk of investor attention as well as money. As per a report by the Reserve Bank of India, nearly 77% of the Indian household wealth finds its way to real estate. An enduring issue with real estate investments is the limited liquidity offered by it.

Real Estate Investment Trust or REIT is the answer to most of the issues associated with real estate investments. A REIT is a company that develops, owns or finances revenue-generating real estate.

What Is REIT?

If one asks what is REIT, the simplest answer would be that a REIT is a company that pools in funds from multiple individuals to invest in income-generating real estate. REITs are similar to mutual funds and allow people to invest and earn from real estate without the need to buy or manage it. Investing in real estate in India is a cumbersome process. One has to conduct thorough research and if you want to own rent-generating real estate, you will have to make substantial investments. In contrast, the structure and rules governing REITs make them extremely transparent and liquid. REIT investments can be easily liquidated as it is traded on exchanges, just like stocks. As per the rules governing REITs, 90% of the income generated has to be paid to investors as dividend and only 10% can be retained by the company. Most REITs invest in commercial real estate and lease it out. The income is distributed among investors. Mortgage REITs don’t own real estate, but finance projects. The interest earned is distributed as dividend. 

Types of Real Estate Investment Trusts (REITs)

REITs are categorised based on the type of business they focus on and how their shares are traded or sold. Below are the main types of REITs:

1. Equity REITs This is the most common type. These REITs deal with operating and managing properties that generate income, such as commercial buildings. Their income mainly comes from rents.
2. Mortgage REITs (mREITs) These REITs lend money to property owners or invest in mortgage-backed securities. Their earnings come from the interest generated on the loans they provide.
3. Hybrid REITs Hybrid REITs combine the features of both equity and mortgage REITs. Investors earn from both rental income and interest, offering diversification for their portfolios.
4. Private REITs These are not listed on stock exchanges and cater to a select group of investors. They are not regulated by SEBI and are often used as private placements.
5. Publicly Traded REITs These REITs are listed and traded on stock exchanges like NSE. They are regulated by SEBI, and individual investors can buy and sell shares easily.
6. Public Non-Traded REITs These REITs are registered with SEBI but are not listed on stock exchanges. They are more stable, less affected by market changes, but less liquid than traded REITs.

How Does a Company Qualify as a REIT?

To qualify as a REIT (Real Estate Investment Trust), a company must meet these basic conditions:

1. The business must be set up as either a corporation or a trust.
2. Its shares must be freely transferable.
3. It should be managed by a board of directors or trustees.
4. It must have at least 100 shareholders.
5. No more than 50% of its shares should be owned by five or fewer individuals in a taxable year.
6. At least 90% of its taxable income must be distributed to shareholders as dividends.
7. At least 75% of its total income should come from rents or mortgage interest.
8. No more than 20% of its assets can be in stocks of taxable REIT subsidiaries.
9. At least 75% of its investment assets must involve real estate.
10. A minimum of 95% of its total income should come from investments.

Advantages of REITs

Investors who choose to put their money into REITs can enjoy several advantages, including:

• Consistent Dividend Income and Growth Potential: REITs often provide steady dividend payments along with opportunities for long-term capital growth.
• Diversification Opportunities: Since many REITs are publicly traded, they offer investors the chance to diversify their real estate investments easily.
• Transparency: Governed by regulatory bodies like SEBI, REITs must submit audited financial reports. This ensures investors have access to clear information about taxes, ownership, and property details.
• Easy to Buy and Sell: REITs are traded on stock exchanges, making them highly liquid and easy to buy or sell as needed.
• Steady and Inflation-Resistant Returns: REITs provide risk-adjusted returns and stable cash flow, giving investors reliable income even when inflation is high.

Disadvantages of REITs

While REITs offer many advantages, they also come with some limitations:

• No Tax Benefits: REITs don’t provide significant tax savings. For instance, the dividends earned from REIT investments are subject to taxation.
• Market Risks: A major drawback of REITs is their exposure to market fluctuations. Investors with a low-risk appetite should carefully consider this before investing.
• Limited Growth Potential: The potential for capital growth is relatively low since REITs distribute up to 90% of their earnings to investors, leaving only 10% for reinvestment into the business.

Pros and Cons of REITs 

How To Invest in REIT?

Investors can buy shares in a REIT listed on major stock exchanges in three main ways:

1. Stocks: Investors seeking a direct way to invest in REITs can purchase them as they would buy regular stocks.
2. Mutual Funds: This option allows investors to diversify their portfolios through an indirect method. Investments are made via a mutual fund company.
3. Exchange-Traded Funds (ETFs): ETFs provide indirect ownership of properties and offer diversification benefits to investors.

REITs work similarly to mutual funds but hold properties instead of bonds or stocks. Investors can also seek advice from financial advisors to choose the right REIT for their goals.

Does REITs Investing Make Sense?

India is a relatively new market for REITs. The first REIT in India was launched in 2019, even though REITs in western countries have existed for over 60 years. Considering REIT investing is a new concept in India, does it make sense to opt for REITs? REITs offer a host of unique advantages.

Low capital requirement: Quality real estate in India is prohibitively expensive. A small investor cannot buy and operate a quality property that delivers adequate yield. REITs make investing in income-generating real estate possible as each unit of REIT is relatively cheap.

Suitable for small investors: Directly investing in real estate has a number of drawbacks, the primary one being facing the powerful builders’ lobby in the country. It is not easy for a small investor to conduct proper due diligence before investing in a project. REITs completely eliminate the need to interact with developers.

Transparency: REITs are traded on the exchanges, making price discovery easy. REIT units can also be easily bought and sold without any hassles.

Assured income: REITs have to distribute 90% of the income among investors as dividends, ensuring a steady source of income.

Conclusion

REIT investing is slowly and steadily gaining acceptance in India. The first Indian REIT has witnessed strong investor participation. Large REIT funds invest in commercial projects, hotels, data centres and warehouses, which may not be possible for a common investor. REIT funds can be used for diversification of the portfolio. Investors can use REITs as an alternative to physical real estate in their portfolio.  

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