Real estate and infrastructure are some of the important sectors that drive a country’s economic growth. The Indian real estate sector is not only the second-largest employment generator but is also poised to contribute 13% to India’s total GDP by 2025. However, a paucity of public funds and the need for continuous capital infusion remains a cause for concern. Thus, given the importance these sectors hold, it has become important to look for other viable funding sources.
The Real Estate Investment Trust (REIT) is an excellent alternative for attracting investments in the infrastructure and real estate sectors. These investment instruments relieve the public funding intuitions and and also allows investors to earn a share of the income through asset ownership. In this article, we will discuss what REITs are, their governing principles, and the benefits they offer.
What is a Real Estate Investment Trust?
Real estate investment trust or REITs are companies that own, finance, or operate properties which generate incomes. One of the advantages of this investment instrument is that both large and small corporations can pool their resources and invest in larger projects. Malls, shopping complexes, data centres, etc are some of the examples of properties that can be included in REITs.
Types of Real Estate Investment Trusts
Though REITs can be bifurcated into different sub-categories, there are three major types of real estate investment trusts:
1. Equity REITs
Equity REITs are classified as real estate companies that purchase, manage, construct, and rent out income-generating commercial spaces. The primary income source for this real estate investment trust category is through rents. The rents generated are then distributed as dividends among the stakeholders. Shopping complexes, office spaces, rental apartments, etc are some of the major examples.
2. Mortgage REITs (mREITs)
Establishments that finance the income-generating companies or invest in mortgage-backed securities are called mREITs. The interests generated on mortgage loans are the major income sources for such real estate investment trusts. It is important to note that mREITs face risks from interest fluctuations. An increase in interest rates can cut profits.
3. Hybrid REITs
When companies invest in both, mortgage- and equity-based REITs, they are categorized as Hybrid REITs. Here, the investors generate income from rents as well as interests.
Structure of REITs
The real estate investment trust comes under the Indian Trusts Act (1982) and is regulated by the SEBI. Investment can either be made directly, through Special Purpose Vehicles (SPVs), or in those SPVs which have invested in SPVs (holding real estate assets). Listed below are the main stakeholders in REITs:
- Sponsor: A sponsor is responsible for setting up a REIT and also appoints a trustee.
- Trustee: The trustee takes care of the assets on behalf of the investors.
- Manager: They assume the operational responsibility of a REIT
- Valuer: In terms of financial and technical asset valuation, a valuer ensures transparent valuation of the assets.
How to Invest in REITs?
The Securities and Exchange Board of India (SEBI) had introduced the concept of real estate investment trust back in 2008. But it was only until last year when India’s first REIT— The Embassy Office Parks— came into existence.
SEBI has mandated that REITs should be listed on stock exchanges and they must raise an Initial Public Offering (IPO) to raise money.
- A minimum of 80% can be invested in rent generating and completed properties.
- A maximum of 20% can be invested in other assets.
- The REIT should have an asset base of at least Rs 500 crores.
- One REIT cannot invest in units of other real estate investment trust.
- Though a maximum number has not been specified, a minimum of 200 investors is required.
Why Invest in REITs?
Although REITs open an avenue to invest in the real estate market, but are they beneficial in the long run? Enlisted are key take ways that will explain why one should invest in real estate investment trust.
- REITs augment capital-raising activities for stalled projects or those constructed by small developers.
- Real estate investment trust reduces the financial burden on banks, thereby allowing them to invest in other critical sectors.
- While buying, maintaining, and selling commercial properties can be tedious, purchasing publicly-traded REITs ensures liquidity.
- The stable dividend yields can generate steady income sources.
- Since REITs are regulated by SEBI, investors’ protection is assured.
- Just like mutual funds, REITs can be purchased like shares.
- Finally, REITs generate direct or indirect employment.
Disadvantages of REITs
While there are many positives of investing in REITs, there are a few downsides to this instrument. Not only are the real estate investment trusts susceptible to market fluctuations, but the dividends are taxed heavily. Plus, the growth prospects are limited as earnings are distributed as dividends amongst the REIT investors.
|Real Estate Investment Trust Pros||Real Estate Investment Trust Cons|
|Stable income||Market-linked fluctuations|
|Highly liquid||Growth prospect not high|
|Managed by experts||Management fees can be high|
|Diverse portfolios||Lack of tax benefits|
Tips to Invest in REITs
Based on the corporation’s profile, you can harness the potential of REITs by following these tips:
- Invest in REITs that have a broad pool of properties as well as tenants.
- Due to long-term capital appreciation, Real estate investment trusts offer excellent yields. Look for properties that have an excellent track record.
- By gauging into metrics like Funds from Operations (FFO), you should profile the REITs before investing.
- Strong management plays a pivotal role in handling the overall operations of the company. Hence, look for companies that have experienced and professional team of management.
A real estate investment trust can therefore pave way for a new class of real estate assets like co-living or working spaces. REITs not only guarantee high-income returns but, if encouraged, will also provide an avenue for small retail investors to invest in high-value real estate projects.