A Beginner's Guide To Reit Funds In India

Real Estate Investment Trusts (REITs) are a type of investment vehicle that allows investors to own a portfolio of income-generating real estate assets without the need to purchase or manage properties directly. This model was first introduced in the United States in the 1960s and later adopted by India, with the Securities and Exchange Board of India (SEBI) introducing regulatory frameworks in 2014.

REITs pool capital from multiple investors to invest in large-scale, high-value income-producing real estate, such as office buildings, apartments, malls, and healthcare facilities. They are required to distribute a significant portion of their income as dividends, providing investors with a steady income stream.

In this article, we will explore the process of investing in REIT funds in India, including the different types of REITs available, the benefits and risks associated with this investment option, and the key considerations for investors.

Understanding REITs: What they are, how they work, and their benefits

REIT stands for Real Estate Investment Trust. It is a company that owns, operates, or finances income-producing real estate across various sectors, allowing investors to earn a share of the income produced without having to manage any properties themselves. REITs were conceptualised in the United States in the 1960s to democratise real estate investment and quickly gained traction globally.

REITs pool capital from numerous investors to invest in large-scale, high-value income-producing real estate. In India, a REIT has a three-tiered structure comprising a Sponsor, a Manager, and a Trustee, each of whom performs key functions. The Sponsor sets up the REIT and transfers the properties/real estate owned by them to the trust. The Trustee holds the assets on behalf of the unitholders, while the Manager manages the assets and makes investment decisions.

REITs generate returns for investors in three ways:

• Dividend Income: REITs distribute at least 90% of their net distributable cash flow (rents minus expenses) as dividends.
• Interest Income: REITs can distribute interest income earned on loans given out to their subsidiaries.
• Capital Appreciation: The price of a REIT's units can rise or fall over time, resulting in capital gains or losses for the investor.

Benefits of REITs

Diversification

REITs allow investors to diversify their portfolios by providing exposure to real estate without the hassles of owning and managing commercial property. This helps investors go beyond the usual asset classes of equity, debt, and gold.

Small Initial Investment

REITs require a much smaller initial investment (around Rs. 50,000) compared to traditional real estate investments, making them accessible to small investors.

Professional Management

Properties owned by REITs are professionally managed, ensuring smooth operations with no effort from the investors.

Regular Income Generation

REITs provide regular income to investors as they are required to distribute 90% of their net rental income as dividends and interest payments.

Capital Gains

REITs are traded on stock markets, so well-performing REITs can increase in value over time, providing capital gains to investors when sold at a profit.

Limitations of REITs

Limited Options

Currently, there are only a few REITs in India, limiting investment choices.

Low Liquidity

While REITs are traded on stock markets, the number of market participants is low, especially among retail investors, which can make it challenging to sell REIT investments profitably.

Taxable Dividend

Dividends and interest earned from REITs are taxable in the hands of the investor according to the applicable slab rate.

REIT investment options in India

Overview

Real Estate Investment Trusts (REITs) are companies that own and operate income-generating real estate. They allow investors to pool their money and invest in commercial properties, providing an opportunity to earn dividends and interest from rental income without the hassle of direct property ownership and management. The concept of REITs was introduced in India by the Securities and Exchange Board of India (SEBI) in 2007, with the first REIT launched in 2019.

Investment Options

There are currently three REIT funds in India:

• Embassy Office Parks REIT
• Mindspace Business Parks REIT
• Brookfield India Real Estate Trust

These REITs can be invested in through the following options:

• Stock Exchanges: Similar to ETFs, REITs are listed and traded on stock exchanges. Investors can purchase units through a Demat Account, and the price of a REIT unit is influenced by both demand and the REIT's performance.
• Mutual Funds: A small number of domestic mutual funds in India invest in REITs, but the exposure to real estate is limited. The Kotak International REIT Fund of Fund is an example of a mutual fund that invests primarily in international REITs.
• Initial Public Offerings (IPOs): Investors can also participate in REIT IPOs when they are launched, although this requires thorough research and understanding of the risks involved.

Benefits and Limitations

Benefits:

• Diversification: REITs allow investors to diversify their portfolios by providing exposure to the real estate sector without the need for direct property ownership and management.
• Small Initial Investment: REITs require a much smaller initial investment compared to purchasing real estate directly, making it more accessible to small investors.
• Professional Management: REITs are managed by experienced professionals, ensuring smooth operations without the need for investor involvement.
• Regular Income: REITs provide regular income through rental collections, and at least 90% of this income is distributed to investors as dividends and interest payments.
• Capital Gains: REITs are traded on stock markets, and their value can increase over time, providing the potential for capital gains if sold at a profit.

Limitations:

• Limited Options: With only three REITs and one international REIT fund currently available in India, investors have limited choices.
• Low Liquidity: While REITs are traded on stock markets, the number of participants is low, especially among retail investors, which can make it challenging to sell investments profitably.
• Taxable Dividends: Dividends and interest earned from REITs are fully taxable according to the applicable slab rate, which can result in a substantial portion of dividend income being lost to taxes.

REITs in India offer investors an opportunity to gain exposure to the real estate sector and benefit from regular income and potential capital gains. However, it is important to carefully consider the benefits and limitations before investing and ensure that REITs form only a small part of a diversified portfolio.

How to invest in REITs: Stock exchanges, mutual funds, and IPOs

Real Estate Investment Trusts (REITs) are a great way to invest in real estate without the hassle of purchasing or managing properties. In India, there are three ways to invest in REITs: through stock exchanges, mutual funds, and initial public offerings (IPOs). Here's a detailed guide on how to invest in REITs in India:

Investing through Stock Exchanges:

REITs are listed and traded on stock exchanges, similar to Exchange-Traded Funds (ETFs). Therefore, you will need a Demat account to invest in REITs. The price of a REIT unit depends on the demand for these units on the stock exchanges and the REIT's performance. Currently, there are three REIT options available in India: Embassy Office Parks REIT, Mindspace Business Park REIT, and Brookfield India Real Estate Trust. You can buy and sell these units through online platforms provided by stockbrokers.

Investing through Mutual Funds:

Mutual funds provide an indirect way to invest in REITs. In India, there are very few domestic mutual funds that invest in REITs, and the exposure to real estate is limited. However, if you are looking for exposure to international real estate, you can invest in the Kotak International REIT Fund of Fund, which primarily invests in international REITs.

Investing through IPOs:

You can also invest in REITs by participating in their IPOs when they are launched. This requires thorough research and understanding of the risks associated with REITs. Since the Indian REIT market is still evolving, there are only a few options available, so you may need to wait for new IPOs to be launched. Keep an eye out for upcoming REIT IPOs and conduct your due diligence before investing.

Before investing in REITs, it is important to consider the benefits and limitations. REITs offer diversification, small initial investment requirements, professional management, and regular income generation. However, there are limited options available, low liquidity, and taxable dividends. Ensure that you understand the risks and potential returns before investing.

Taxation on REITs: Dividend income, capital gains, and other tax implications

Real Estate Investment Trusts (REITs) in India are structured to be relatively tax-efficient. Here's a breakdown of how different types of income from REITs are taxed:

• Dividend Income: Dividends distributed by REITs are generally exempt from tax for unitholders, provided the REIT has not opted for a concessional tax regime. However, if the REIT pays tax under Section 115BAA, dividends will be taxable according to the tax slabs. A Tax Deducted at Source (TDS) of 10% will be applicable in such cases.
• Interest Income: Interest income received from REITs is taxable at the applicable tax rates for investors. The REIT may withhold tax on this income, typically at 5% for non-residents and 10% for others.
• Amortisation of Special Purpose Vehicle (SPV) Debt: Any income from the amortisation of SPV debt is exempt from tax for unitholders.
• Capital Gains on the Sale of REIT Units:
• Short-Term Capital Gains (STCG): Gains from selling REIT units within 12 months are taxed as short-term capital gains at a rate of 20%.
• Long-Term Capital Gains (LTCG): Gains on units held for more than 12 months are taxed as long-term capital gains. If the gains are below Rs. 1.25 lakh, they are tax-free. If the gains exceed Rs. 1.25 lakh, the gains will be taxed at 12.5% without any indexation benefit. The Union Budget 2024-25 reduced the holding period required for LTCG tax benefits from 36 months to 12 months, enhancing liquidity and investor interest.
• Loan Repayment Distribution: The Finance Act 2023 amended the previous budget proposal, providing relief to investors. The 'loan repayment' distribution component from REITs need not be treated as income from other sources but instead attracts capital gains tax treatment for a certain number of years. This means that capital gains are taxed at 10% if the investment is held for the long term (36 months), compared to income from other sources, which can be taxed at slab rates of up to 42% for those in the higher tax bracket.
• Other Tax Implications:
• Pass-Through Deduction Complexity: While REITs qualify for a 20% pass-through deduction, it adds tax complexity, especially for investors with standard brokerage accounts.
• Tax on Distribution Income: Distribution income, which includes dividend, interest, rental income, or loan repayment to unitholders, is taxed differently depending on the structure of the Special Purpose Vehicle (SPV). If the SPV opts for a lower tax regime, dividends, along with interest or rental income, are taxed at the slab rates applicable to the investor.
• Tax on Sale of Units: The sale of REIT units may result in either long-term or short-term capital gains tax, depending on the holding period.

It is important to note that the taxation rules and regulations related to REITs in India may change over time, and investors should consult the latest official sources and seek professional tax advice before making any investment decisions.

Risks and limitations: Market volatility, low liquidity, and more

Investing in REITs in India comes with certain risks and limitations that investors should carefully consider. Here are some key points to keep in mind:

Market Volatility

REITs are susceptible to market-linked fluctuations, which can impact their performance. Investors with a low-risk appetite should carefully evaluate the potential return-generating capacity of REITs before investing. While REITs can provide a hedge against market volatility, they are still influenced by overall market trends and economic conditions.

Low Liquidity

Non-traded REITs, also known as non-exchange-traded REITs, are not publicly traded, making it difficult for investors to research and determine their value. These REITs are also illiquid, meaning there may not be buyers or sellers in the market when an investor wants to transact. In some cases, non-traded REITs cannot be sold for an extended period, such as up to 10 years.

Tax Implications

REIT dividends in India are typically subject to taxation, and they may not qualify for lower tax rates. This can affect the overall returns on REIT investments. Additionally, REITs qualify for a 20% pass-through deduction, but this adds tax complexity, especially for investors with standard brokerage accounts.

Interest Rate Sensitivity

REIT prices are sensitive to changes in interest rates. An increase in interest rates may reduce demand for REITs as investors may opt for other investment vehicles, such as government-guaranteed bonds with fixed interest rates. However, it is important to note that rising interest rates can also indicate a strong economy, which could lead to higher rents and occupancy rates, resulting in better-performing REITs.

Property-Specific Risks

Different types of REITs carry unique risks. For example, REITs focused on retail centres or malls may be risky due to the rise of online shopping. Similarly, Hotel REITs may underperform during economic downturns. Therefore, it is crucial for investors to carefully research and understand the specific risks associated with different sectors before investing.

Other Considerations

Other risks and limitations to consider include the potential for fraudulent REITs, where bad actors attempt to sell scam investments. Additionally, REITs may have complex fee structures, including upfront fees and external management fees, which can reduce investor returns. It is important for investors to carefully review all fees and charges associated with a REIT before investing.

Frequently asked questions