Understanding real estate investment trusts

Safety and security aside, owning a home is the ultimate dream for most households in India. However, the downside is that it requires a huge capital outlay alongside other issues such as encroachments, faulty title deeds, property taxes and maintenance costs.

Even for those who can afford to buy a home, investing in commercial real estate is a daunting task due to the cumbersome legal permits, finding the right or honest tenants, etc. This is where real estate investment trusts, or REITs (pronounced as “reets”), can offer an answer or a way to channel the savings of retail investors.

Let’s try to understand the basics of REITs:

What are REITs?

REITs are investment vehicles like mutual funds that pool the money of many investors and invest the collected funds in income-generating commercial real estate such as offices, hotels, shopping malls, industrial complexes, solar parks, etc. REITs operate as business trusts that own and operate real estate assets through direct or indirect interests in special purpose vehicles (SPVs). The income they generate includes rental income, interest and dividend income from SPVs, and capital gains that are distributed to investors.

REITs follow a three-tier structure – a sponsor who drives the REIT with its own capital, a manager who is responsible for selecting and operating the properties, and a trustee who ensures that investors’ interests are protected. REITs are regulated by SEBI and are governed by the SEBI (Real Estate Investment Trusts) Regulations 2014.

What is the eligibility?

Since listed REITs are traded on the stock exchange, an investor needs a Demat account to invest in REITs. In order to make REITs more affordable and ensure broader retail participation, SEBI has lowered the minimum investment from Rs 50,000 to Rs 10,000-Rs 15,000 through an initial public offering (IPO), according to its notice issued in July 2021. SEBI has also reduced the minimum lot size from 100 units to 1 unit.

Benefits of investing in REITs

For a retail investor, the biggest benefit of investing in REITs is that they can buy a piece of commercial property with a small amount. Unlike physical ownership, where there is liquidity risk, REITs are more liquid because the investor can sell shares in publicly traded REITs on the stock exchange and, like stocks, receive instant cash.

Also, under SEBI regulations, REITs must distribute at least 90% of net distributable cash flows to investors on a semi-annual basis. REITs must have at least 80% value from completed and income generating real estate. They must also distribute at least 90% of the sales proceeds from the sale of assets to shareholders.

Taxation of REITs

Short-term capital gains arise when the investor sells shares in listed REITs less than 36 months after grant or purchase and the short-term capital gains (STCG) are taxed at 15%. REITs are superior to physical property where STCG arises when the holding period is less than 24 months and taxed according to the investor’s tax plate. LTCG in REITs arise when the holding period is more than 36 months and the tax is 10% on gains over Rs. 1,00,000.

Taxation of the income that the shareholder receives from the REITs is somewhat complicated and depends on the type of income.

While interest, dividends and rental income are taxed at ordinary rates (tax plate) under Section 115UA of the IT Act, all other income from the REIT other than those noted above is exempt from US tax 10 (23FD).

Although REITs have existed in the US for decades, they are relatively new to India. Embassy Business Park REIT, sponsored by Embassy and Blackstone Group & Asia’s first and largest REIT (by territory), was the first REIT to list on exchanges in April 2019. Embassy REIT with a face value of Rs 300 is currently trading at Rs 373 The Raheja sponsored Mindspace REIT has a face value of Rs 275 and is trading at Rs 349 while the Brookfield India REIT with a face value of Rs 275 is trading at Rs 323.

REITs have fared reasonably well during the pandemic after holding up, in contrast to stocks, which have experienced a roller coaster ride in recent years. With economic activity returning to pre-pandemic levels, the commercial real estate space holds a lot of potential as more companies are likely to launch their own REITs. All of these developments bode well for investors looking to diversify their portfolios.

(The author is CFA, ex-banker and currently teaches at Manipal Academy of BFSI, Bengaluru)

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