What Is a REIT (Real Estate Investment Trust) & How it works?

 What is REIT?

A well-diversified portfolio is important to achieve optimal returns on your investments and also minimize the overall risk of your investments. To create a balanced portfolio, it is important to invest in various asset classes that have a lower correlation to each other. A majority of investors today have a healthy mix of stocks, bonds, and gold in their portfolio for the same reason. Real estate, too, is an important asset class for a well-diversified portfolio as it has a very low correlation to stocks and bonds. However, even though, investing in real estate can be rewarding, not many investors have exposure in real estate primarily because real estate investments, especially, commercial real estate require huge capital that is financially out of reach for retail investors. REIT investments provide the perfect opportunity for such investors to diversify real estate and create an additional avenue of growth and income from their portfolio without actually owning any real estate properties.

What is REIT?

REIT or real estate investment trusts are securities that trade in real estate properties. REITs are companies that own, manage or operate income-generating real estate properties and provide investors with the opportunity to invest in these real estate assets that are otherwise out of their financial reach. REITs invest in commercial spaces like offices, shopping complexes, multiplexes, hotels, etc. and create a steady source of rental income through these investments.  

In a simple definition, REITs can be considered as a mutual fund of real estate, wherein investors buy shares of REIT and contribute money to a pool of funds that are professionally managed and invest the money in income-generating properties. Just like mutual funds REITs have a three-tier structure of having a sponsor- who has the onus to set up the REIT, a fund management company for selecting and operating the properties and a trustee to safeguard the interest of the unitholders. REIT investing provides an opportunity for investors to earn regular returns from the rentals and leasing income of the trust and also long-term gains by way of capital appreciation of the underlying real estate.

How does a company become eligible for REIT?

A company is not eligible as REIT only because it owns some real estate. Here are some specific requirements which it needs to fulfil to become eligible for REIT-:

• REITs must have an asset base of Rs 500 crores
• REITs must distribute 90% of their profits as dividends to the unitholders
• REITs must invest 80% of the funds in real estate that is generating income, and only 20% can be invested in under-construction properties
• REITs must update their NAV twice in a year

How does real estate investment trust work?

The real estate sector has immense potential in India and as the government is continuously working towards creating world-class infrastructure and development of the real estate. As quality properties are high on investment so they are potentially out of reach for the common man. However, investments in REIT funds enable investors of varying financial capacity to invest in the real estate sector and participate in the growth and development of the real estate and earn profits from their investment.  REIT funds are the perfect gateway for investors to invest in high-quality real estate assets by making them affordable and within their reach.

Broadly speaking there are three types of REITs which currently operate in India

1. Equity REITs- These REITs own large real estate properties like shopping malls, business centres, hotels, residential townships and make money by giving properties either on rent or lease agreements. The rental income earned is distributed as dividends to the unitholders
2. Mortgage REITs- These REITs are not owners but provide finance to real estate projects of developers, builders, owners, etc. and earn income in the form of EMI and the Net Interest Margin is distributed as profits among the unitholders
3. Hybrid REITs- These are companies which have both Equity and Mortgage REITs

What are the advantages to investors investing REIT?

• REIT investing is the simplest and least capital intensive way of investing in real estate making it affording for an average investor to invest in them
• REIT, even though, are securities but represent real-estate, that is a separate asset class, thus diversifying your portfolio which has a low correlation to stocks
• As most of the investments in REITs are in steady income-generating properties by way of rentals, they are a reliable source of income for investors looking for a steady income. Moreover, they provide the opportunity of capital appreciation over the long-term as the value of the property goes up
• Strict regulations and norms of SEBI ensure transparency in operations and decrease the chances of fraud

What are the risks of investing in REIT?

Real estate is a great asset class for long-term investment purpose, and REIT provides a great alternative for retail investors to invest in real estate directly, as in investor you should be aware of certain REIT risks associated with your investment-

• The minimum investment amount of REIT is Rs 2 lakh, which is small when compared to directly investing in real estate but still a sizeable chunk of investible surplus for many investors
• Mortgage REITs are debts used to finance debts and subject to interest rate risk and default risk of the debtors
• REITs are required to pay 90% of their income as dividends, thus leaving very little capital for the trust to acquire newer properties
• REITs invest in high investment assets and hence trading in and out of REITs involves high transaction costs

CONCLUSION

The regulatory framework for REIT in India is very stringent, and SEBI guidelines and norms for REITs ensure that the interest of investors is safeguarded at all times when it comes to REIT investments. If you are looking out for exposure in quality real estate, then REITs may be the perfect investment option for you. Reach out to our experts at IndiaNivesh, who can guide you with the ins and outs of REIT investment in India best suited for you.

 

 Disclaimer: Investment in securities market / Mutual Funds are subject to market risks, read all the related documents carefully before investing.