REIT: Real Estate Investment Trust; Gateway to Invest in Commercial Real Estate

REIT: Real Estate Investment Trust; Gateway to Invest in Commercial Real Estate

?REIT an attractive Investment Avenue in Volatile Market Conditions.

?Investment in Commercial Real Estate in India is a great avenue for investment for HNI investors by virtue of having a good rental yield and potential for capital appropriation and a portfolio diversification in volatile market conditions. REITs give an excellent avenue for smaller investors to participate in the Commercial Real Estate growth story in India.

?Commercial real estate is one of the attractive avenues for investment in India. With a rental yield of 7-10% depending upon the nature of the commercial space and location with a fairly high chance of capital appreciation, investment in commercial real estate should be explored by investors at a portfolio level. However, the biggest issues that investors face is the ticket size for entry. In most cases in India the minimum price of commercial space that would be in a good location and have a decent potential of rental income would be extremely high running into few crores. In order to overcome this issue, a collective investment vehicle wherein investors pool their investment and invest in good quality rental earning assets which also holds the potential of capital appreciation in the future.

?Real Estate Investment Trusts (REIT) are regulated investment vehicles that pool money from multiple investors and use that to buy income-generating real estate properties. REITs manage these assets so that they can earn from capital appreciation and rental income. The Indian REITs invest the capital in commercial office spaces that generate a rental income. SEBI the market regulator governs and regulates the REITs in India. As per SEBI regulations REITs to pay-out 90% of distributable cash flows to unit holders. REITs must have at least 80% of their assets to be completed and are income generating. The units are offered to potential investors via an IPO and are listed on the stock exchange. Post listing, they serve as permanent vehicle to raise debt and equity in the capital markets to acquire new assets and increase the investment accordingly. In order to encourage small retail participation in commercial real estate via REITs, SEBI has brought down the minimum investment to INR 10,000-15,000 with a lot size of one unit. This was to increase liquidity in the REIT space and also encourage more listings.

?REITs have a similar structure to that of mutual funds with a sponsor, 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 that the funds collected are utilized and managed, keeping the investors mandate and interest in mind thereby making it a well-managed and professionally run and helping the investors get the best possible returns.

?It is important for investors to analyse the performance of REITs which can be measured and accessed on the following parameters:

?·??????Weighted Average Lease Expiry (WALE)

?WALE is used to calculate the time left for property to go vacant. It is measured in years. The higher the better, as the biggest risk in case of commercial property is lying vacant. Higher the WALE in case of a REIT better it is and safer on the whole for the investors in the REIT.

?·??????Diversified portfolio

?Quality of the asset in terms of location, sector that will utilize the space like IT, high end commercial etc. matter a lot. REITs having diversified portfolio across geographies and tenants?are less prone to oversupply and concentration risk.

?·??????Geographical Diversification

?Commercial assets focused on one city or one state can be of high risk. A REIT having assets across geographies will be a better well diversified proposition than asset concentration in one location.

?·??????Sector Diversification

?A REIT having assets that it has leased across sectors like IT, FMCG, Retail, Banking, Healthcare, Entertainment etc. is much better than having a REIT having a single sector exposure like IT sector. The pandemic has been a big learning for the commercial real estate sector and risk of concentration on a specific sector. Hence diversification across a couple of sectors is the key in a good REIT.

?·??????Loan to Value

?Loan to Value (LTV) measures how much debt was borrowed compared to the underlying asset value. Leverage is a double-edged sword. During periods when the occupancy is good in terms of overall office space a higher leverage would be beneficial, but at times when the occupancy falls leverage becomes a big issue in terms repayment and overall solvency.

?·??????Distribution Yield

?As per SEBI regulations, REITs have to pay 90% of distributable cash flows to the investors. Distribution yield is a metric to measure these payments. However, this is not a guaranteed pay-out. If the REIT is unable to match the 90% pay-out it is considered as a negative in overall performance.

?Returns for investors in REITs are of two types:

?·??????Dividend and Interest Pay-outs:?Dividends and Interest are paid out by REITs from their Net Rental Income. This refers to income that a REIT receives by renting out and leasing Commercial Real Estate after deduction of some key expenses related to management and maintenance of the facilities. Some of the charges that are deducted from Gross Rental Income to arrive at the Net Income of a REIT include management fees, depreciation, maintenance charges, etc.

?·??????Capital Gains:?REITs are listed and traded on stock exchanges, so the price of individual unit changes depending upon their performance as well as market demand. Hence increase or decrease in unit value of the REIT which is traded on the stock market results in a capital gain or loss for the investor from time to time.

?Just as other investment instruments, REITs are also taxed as follows:

?·??????Taxation of Dividends:?As per current rules, dividends obtained from REITs are completely taxable in the hands of the investor. Dividend pay-outs from REITs are included in the annual income of the investor and taxed according to the investor’s slab rate for the applicable financial year.

?·??????Taxation of Capital Gains:?Capital Gains from the sale of REITs units are covered by Short Term Capital Gains (STCG) and Long Term Capital Gains (LTCG) applicable to equity investments. STCG is applicable if the holding period of units is 1 year or less from the date of unit allocation.

?In these turbulent market conditions wherein there is a lot of volatility experienced in the stock markets, the key to survive the period is to conserve capital and have a well-diversified portfolio across asset classes. India having one of the largest and most successful vaccination drives in the world, the economy has completely opened up and most companies are moving away from the hybrid mode of working and getting back to office on a full time basis, thereby resulting in office space absorption picking up to a large extent. Hence investing in REITs which are professionally managed and well governed in India make a lot of sense for the HNI as well as retail investors in an increasing interest rate scenario in these turbulent and volatile market conditions. With India growing at a fast pace and the economy marching towards a USD 5 trillion economy, commercial real estate especially good office space requirement demand will only keep rising, thereby making REITs an investment avenue to recon with in years to come in India.

?_Dr. Farzan Ghadially.