Reit Investment: A Guide To India's Real Estate Investment Trusts

Real Estate Investment Trusts (REITs) are companies that own, operate, or finance income-producing commercial real estate. They pool investors' capital to enable them to earn dividends from office property investments without needing to buy, manage, or finance any real estate themselves. REITs are regulated by the Securities and Exchange Board of India (SEBI) and are listed and traded on the stock market. They are an alternative to raise funds in the real estate sector, providing a stable return even in uncertain times.

How REITs work in India

Real Estate Investment Trusts (REITs) are companies that own, operate, or finance income-producing real estate. They allow investors to earn income from real estate without having to buy, manage, or finance properties themselves. REITs work like mutual funds—they manage pools of funds for many investors—but for real estate instead of stocks and bonds.

REITs were introduced in India in 2007 by the Securities and Exchange Board of India (SEBI) and are regulated by them. They have a three-tier structure: the sponsor, who sets up the REIT; the manager, who runs the portfolio; and the trustee, who ensures no foul play.

REITs pool money from investors and use that money to buy income-generating properties. These properties are then leased out to tenants, and the rental income is distributed to investors in the form of dividends. REITs are required to distribute at least 90% of their rental income to investors, and they are exempt from paying income tax on the distributed income.

There are two types of REITs: Equity REITs and Mortgage REITs. Equity REITs hold properties such as offices, hotels, shopping centres, and condominiums and draw most of their revenues through rent from these properties. Mortgage REITs oversee the financing of the properties that may be residential or commercial, thereby drawing income from interest earned on the investment in mortgages or mortgage-backed securities (MBS).

Benefits of investing in REITs

Real Estate Investment Trusts (REITs) are companies that own and operate real estate to generate income. They allow investors to pool their funds and invest in large-scale, income-generating properties without the need to purchase or manage them directly. Here are some benefits of investing in REITs:

Diversification:

REITs enable investors to diversify their portfolios by investing in real estate, which is an asset class that is not closely correlated to stocks or bonds. By including REITs in their portfolio, investors can reduce their exposure to risks associated with traditional stock and bond investments.

Steady Income and Capital Appreciation:

REITs provide investors with a steady and consistent income stream through regular dividend payments. They are required to distribute a significant portion (typically at least 90%) of their taxable income as dividends to shareholders. Additionally, REITs offer the potential for long-term capital appreciation, allowing investors to boost their capital over time.

Liquidity:

REITs are traded on public stock exchanges, making them highly liquid investments. Investors can easily buy and sell REIT shares, providing flexibility and access to funds when needed. This is in contrast to physical real estate, which can be challenging to buy and sell quickly.

Professional Management:

REITs are managed by experienced professionals who handle property acquisition, management, and operational aspects. This can be appealing to investors who prefer a hands-off or passive approach to real estate investing, as they can benefit from the expertise of specialists in the field.

Transparency and Regulation:

In India, REITs are regulated by the Securities and Exchange Board of India (SEBI). They are required to adhere to specific guidelines, provide financial disclosures, and file audited financial reports. This regulation ensures transparency, reducing the risk of fraud or mismanagement. Investors can easily access information about the REIT's operations, taxation, ownership, and zoning.

Accessibility:

REITs allow both large and small investors to participate in the real estate market. Small investors can pool their resources with other investors to invest in large commercial real estate projects. This accessibility opens up opportunities for individuals who may not have the financial means to invest directly in real estate.

Limitations of investing in REITs

While investing in REITs has its advantages, there are some limitations that prospective investors should be aware of. Here are some key limitations and challenges associated with investing in REITs in India:

Limited Options

Currently, there are only a few listed REITs in India, which significantly limits the choices available to investors. As of 2024, there are only three REITs in India: Embassy Office Parks REIT, Mindspace Business Parks REIT, and Brookfield India Real Estate Trust. This limited selection may make it challenging for investors to find a REIT that aligns with their specific investment goals and risk tolerance.

Low Liquidity

The number of market participants investing in REITs in India is relatively low, particularly among retail investors. As a result, investors may face challenges when attempting to sell their REIT investments, especially if they need to do so quickly or in an emergency. This low liquidity can make it difficult to exit an investment in a timely manner.

Tax Implications

Dividends earned from REITs are typically subject to taxation at the applicable slab rate. For investors in the higher tax brackets, this can result in a substantial portion of their dividend income being paid as taxes. Additionally, REIT dividends may not qualify for lower tax rates and may face higher taxes than traditional dividends, impacting the overall returns.

Interest Rate Sensitivity

REIT prices are sensitive to changes in interest rates. When interest rates rise, it often leads to a decline in REIT prices. This interest rate risk is an important consideration for investors, especially in a rising interest rate environment.

Low Growth Prospects

REITs are required to distribute a significant portion of their income (typically 90%) to investors as dividends. While this provides a steady income stream for investors, it also limits the REIT's ability to reinvest capital and drive growth. The low retention of earnings may hinder the potential for capital appreciation and long-term growth.

Property Vacancy Risk

One of the biggest risks faced by REITs is property vacancy, particularly in the current environment with the widespread adoption of remote work. The shift towards remote work, especially in the IT sector, has impacted the occupancy rates of commercial real estate. Investors should carefully consider the occupancy levels and average lease tenure of properties held by REITs before making an investment decision.

Regulatory and Tax Uncertainty

While REITs are regulated by the Securities and Exchange Board of India (SEBI), there is still a degree of uncertainty regarding tax implications. Although REITs have been granted pass-through status, there is a lack of clarity on other aspects of income tax and capital gains tax for these instruments. This uncertainty may deter some investors who seek more predictable tax treatments.

Types of REITs

There are several types of REITs, categorised according to the type of real estate holdings, the methods for selling and purchasing shares, and the business they are involved with. Here is a list of the different types:

• Equity REITs – This is the most common type of REIT. Equity REITs invest in and own income-producing real estate properties, including commercial properties and office spaces. The revenue is generated through rentals and sale transactions, which are distributed to shareholders as dividends.
• Mortgage REITs (mREITs) – Mortgage REITs lend money to real estate companies and acquire mortgage-backed securities. They earn income through interest payments accrued on the money lent, which is then distributed to shareholders.
• Hybrid REITs – Hybrid REITs offer the benefits of both equity and mortgage REITs. They invest in physical properties and real estate debt instruments, providing investors with rent and interest income.
• Publicly Traded REITs – These REITs are listed on the National Stock Exchange (NSE) and registered with the Securities and Exchange Board of India (SEBI). Shares can be bought and sold through the stock exchange, making them highly liquid, but they are also exposed to market volatility.
• Public Non-Traded REITs – Similar to publicly-traded REITs, but not listed on any stock exchange. They are registered with SEBI, but shares cannot be bought or sold online, leading to lower liquidity.
• Private REITs – Private REITs are not listed on stock exchanges or registered with SEBI. They cater to a selective list of investors and have lower liquidity than publicly traded REITs.
• Retail REITs – These REITs invest in the retail sector, such as shopping malls, grocery stores, and supermarkets. They lease out space to retail tenants but are not directly involved in running these outlets.
• Residential REITs – Residential REITs own and operate residential facilities like apartment buildings and gated communities.
• Healthcare REITs – Healthcare REITs invest in and operate healthcare-focused real estate, including hospitals, nursing facilities, retirement homes, and medical centres.

Taxation on REITs

In India, REITs (Real Estate Investment Trusts) are regulated by SEBI and must follow certain rules to qualify as a REIT. One such rule is that REITs are required to pay at least 90% of their taxable income as a dividend. While REITs offer investors the opportunity to earn dividend income and appreciate their capital, it is important to note that they do not provide tax benefits. Dividends earned from REIT companies are subject to taxation.

In the past, the Indian government has proposed amendments to soften the tax impact on REITs and Infrastructure investment trusts (InVITs). For instance, in the 2023 Finance Bill, the government proposed to treat distributions from business trusts as a return of capital, rather than taxing them as income from other sources at the applicable rate. This change was intended to benefit unitholders by reducing the tax burden.

However, it is important to note that any amount distributed by REITs that exceeds the issue price would be taxable as income. Additionally, the tax rules for REITs can be complex and may vary depending on the specific circumstances. For example, the capital gains tax treatment for the 'loan repayment' component of REIT distributions is only applicable until the total amount distributed does not exceed the issue price. If the distributions exceed the issue price, the additional amount will be considered income and taxed at the slab rate.

Overall, while REITs can provide investors with steady income and capital appreciation, it is important to carefully consider the tax implications and seek professional advice to make informed investment decisions.

Frequently asked questions