What are Real Estate Investment Trusts (REITs)? How do they work and is investing in REITs safe?

What are Real Estate Investment Trusts (REITs)? How do they work and is investing in REITs safe? | Vrid
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Some time back, we discussed whether we can consider real estate a good investment option. And we found that primary obstacles to real estate investment would be the requirement of huge capital, the selection of the right property at the right time and the management of the property.

And we always told you that the market functions in such a way that new investment products try to eliminate the problems of traditional investment methods.

Therefore, we have Real Estate Investment Trusts (REITs). REITs remove most of the problems with the traditional method of real estate investing. Let’s discuss how.

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What are REITs?

A Real Estate Investment Trust, or REIT, is a trust that owns and operates a portfolio of income-generating real estates assets, such as office buildings, shopping malls, and residential apartments. 

REITs pool capital from individuals and institutional investors and invest in a diversified portfolio of properties. Investors in a REIT receive dividends based on the rental income generated by the properties in the portfolio.

REITs are a relatively new investment option in India, as the first publicly traded REIT was launched only in 2019. As of April 2023, there are 3 REITs listed on the stock exchange. They are Embassy Office Parks REIT, Mindspace Business Park REIT, and Brookfield India Real Estate Trust.

How do REITs work?

REITs have a similar structure to that of mutual funds with a sponsor, a fund management company, and a trustee. 

The sponsor promotes the REIT with its funds, and the fund management company selects and buys properties for the portfolio. The trustee ensures the funds collected are utilised and managed, keeping the investor’s interest in mind.

REITs raise money from retail investors like us and from institutional investors. Then deploy that capital to acquire income-generating real estate assets. 

The income generated from these assets is distributed to investors through dividends. They are supposed to share 90% of their income with the investors through dividends, interest income or loan repayment. 

In India, the 3 REITs available only invest in commercial-office properties. You can invest in them through your broker, just like how you invest in individual stocks with a minimum investment of ₹300 to ₹400.

Thus, by investing in REITs, we are a part owner of the properties bought by the REITs. And we receive regular income every quarter through dividends. 

How safe is investing in REITs?

In India, REITs are regulated by the Securities and Exchange Board of India (SEBI). REITs must adhere to strict rules regarding portfolio diversification, leverage, and income distribution.

The SEBI has also set the below rules to safeguard the interest of retail investors like us. 

  • REITs should invest 80% of the total capital in completed properties/income-generating assets. Only 20% of the total capital can be invested in under-construction assets.
  • 90% of the net distributable cash flow should be distributed to unitholders (Investors) through interest or dividends.

What are the types of income generated from REITs?

We can receive four types of income from your investment in REITs. 

  1. Rental/ Interest income
  2. Dividend Income
  3. Loan Repayment
  4. Capital appreciation

The net distributable income of a REIT comprises the rental income received from the properties in the portfolio, minus the expenses incurred in managing the properties, such as property management fees, maintenance expenses, and property taxes.

REITs also invest in or give loans to multiple Special Purpose Vehicle (SPV) entities that own income-generating assets or in-construction assets. The income or loan repayment received from these SPVs is also shared with us. 

Whenever the REITs distribute the dividends, they provide the break-up, showing how much of it are interest income, dividend income, and loan repayment. 

Why this break up? Because this break up will determine how much tax you need to pay. Tax on income received through REITs is a little complicated. We discuss taxation in another post. 

As investors, we also earn from the value appreciation of the assets owned by the REITs. If the property value in the REITs portfolio appreciates over time, the value of the REITs shares may also increase. This allows us to earn a capital gain when we sell our shares. 

However, capital appreciation is not guaranteed. It is subject to market fluctuations and economic conditions.

What are the benefits of investing in REITs?

There are several benefits of investing in REITs, including:

  • Diversification: REITs offer exposure to a diversified portfolio of real estate assets, which reduces risk and volatility compared to investing in a single property.
  • High dividend yield: REITs distribute 90% of their income to investors through dividends. Also, they mostly invest in commercial properties with a high rental yield. 
  • Professional management: REITs are managed by experienced professionals with expertise in real estate management. You don’t have to worry about managing the properties.
  • Liquidity: REITs are traded on stock exchanges, which means they offer high liquidity compared to investing in physical real estate assets.
  • Low Investment: You can invest in REITs with just ₹300 to ₹400 and gain exposure to real estate. 

What are the risks of investing in REITs?

There are also risks associated with investing in REITs, including:

  • Market risk: REITs are subject to market risks and can be affected by changes in interest rates, economic conditions, and real estate market cycles.
  • Limited options: As REITs are new in Indian markets, we only have 3 options. Hence, our choices are limited.
  • Management risk: The performance of REITs depends on the quality of their management team and their ability to manage the portfolio effectively.
  • Liquidity: Though REITs provide better liquidity than physical real estate investments, their liquidity is low on the stock market because the number of active retail participants is low. Therefore, liquidating REIT investments can be challenging in times of emergencies.
  • Taxation: Taxation of REITs is very complicated. The interest or rental income from REITs is entirely taxable in the hands of the investor. Dividend income is taxed with conditions. This income will be a part of your taxable income. And it will be taxable as per the applicable tax rates.

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Still Curious?

If you are like us, who likes to analyse a little more or check out content in different formats, well you are in luck. Below you can find some suitable content we found.

Shankar Nath – Best REIT in India | 12% Returns | Real Estate Investment Trust | Embassy vs Mindspace vs Brookfield

CNBC – TV18 – Investing In REITs In 2023: A Masterclass By ASK Property Investment Advisors’ Amit Bhagat

Capitalmind – Which is the best REIT in India?

Note: We don’t have any affiliation with them. We are sharing links only for educational purposes. The opinions expressed by them belong solely to them and do not reflect the views of Vrid.

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DISCLAIMER: This newsletter is strictly educational and is not an investment advice or a proposal to buy or sell any assets. Please be careful and do your own research.

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