The Blackstone-backed Embassy Group’s first REIT has been in the works for quite some time, but it will finally be listed and offered for investment on March 18, 2019. As REITs become formally available in India, investors wanting to profit from this new source of high-yielding returns want to know what’s in store for them – and for the real estate market.
- About half of India’s total office stock is REITable, up from 30% two years ago.
- Returns on commercial assets are expected to be14 % over the next five years.
- REITs might spread to other asset types such as retail and logistics.
What are REITs?
REITs (real estate investment trusts) are an important component of any equities or fixed-income portfolio. They offer more diversity, higher total returns, and/or reduced overall risk. In summary, their capacity to produce dividend income while also increasing in value makes them a good complement to stocks, bonds, and cash.
Whether it’s the properties themselves or the mortgages on those buildings, real estate investment trusts hold and/or manage income-producing commercial real estate. 1 Individually, through an exchange-traded fund, or via a mutual fund, you can invest in the firms. REITs come in a variety of shapes and sizes.
REITs often provide investors with the option to own high-priced real estate while also allowing them to collect dividend income to grow their wealth over time. Investors can take advantage of the potential to increase their capital while also earning income.
This investment choice is suitable for both large and small investors, who may benefit from it. Small investors may try to pool their resources with those of other investors and participate in major commercial real estate projects as a group. Data centres, infrastructure, healthcare facilities, housing complexes, and other properties are all included in REITs.
Requirements for becoming a REIT:
A corporation must satisfy specified standards to qualify as a REIT, which are outlined below.
- The entity must be set up as a corporation or a business trust.
- Increases the number of fully transferable shares.
- Is governed by a board of directors or a group of trustees.
- A minimum of 100 shareholders is required.
- During any taxable year, no more than 5 people should have held 50% of the company’s stock.
- Is obligated to pay a minimum of 90% of taxable profits in dividends.
- Mortgage interest or rentals must account for at least 75% of gross income.
- Stock held by taxable REIT subsidiaries may account for up to 20% of the corporation’s assets.
- Real estate must account for at least 75% of investment assets.
Real Estate Investment Trusts (REITs) come in a variety of types:
This is one of the most common types of REIT. Typically, it is associated with the operation and management of commercial buildings that generate money. Rents are a common source of income in this area.
It is largely associated with lending money to proprietors and giving mortgage facilities, and it is also known as mREITs. REITs also have a proclivity towards acquiring mortgage-backed securities. Home loan REITs also make money by charging interest on the money they lend to business owners.
Investors may diversify their portfolio by investing in both mortgage REITs and equity REITs using this choice. As a result, both rent and interest are sources of income for this type of REIT.
REITs that are privately held:
These trusts are similar to private placements in that they only accept a limited number of investors. Private REITs are often not listed on stock exchanges and are not registered with the SEBI.
REITs that are publicly traded:
Typically, public real estate investment trusts issue shares that are listed on the National Securities Exchange and regulated by SEBI. The NSE allows individual investors to sell and buy such shares.
REITs that are not listed on the stock exchange. These are REITs that are not publicly traded but are registered with the Securities and Exchange Board of India (SEBI). The National Stock Exchange, however, does not trade them. These options are also less liquid as compared to public non-traded REITs. In addition, because they are not affected by market movements, they are more stable.
Is REIT a good Investment?
REITs, like any assets, have their benefits and drawbacks. High-yield dividends are one of the most appealing features of REITs. REIT dividends are frequently substantially larger than the typical stock on the S&P 500 since REITs are mandated to payout 90% of taxable income to shareholders.
Portfolio diversity is another advantage. Few people have the financial means to own commercial real estate in order to create passive income; nevertheless, REITs provide the general public with the opportunity to do so. Furthermore, although purchasing and selling real estate can take a long time, tying up cash flow, REITs are extremely liquid, with the majority of them being able to be purchased and sold with the click of a mouse.
REITs are obliged to produce financial reports that have been audited by specialists, as they are regulated by the SEBI. It allows investors to obtain information on topics like taxation, ownership, and zoning, making the entire process more open.
Liquidity: Because most REITs trade on public stock markets, they are simple to purchase and sell, enhancing their liquidity.
Obtains risk-adjusted returns: Investing in REITs provides individuals with risk-adjusted returns while also assisting in the generation of consistent cash flow. It allows people to have a consistent stream of income to rely on, even when inflation is strong.
Why REITs are a Bad Investment?
There are several disadvantages to REITs that investors should be aware of, the most significant of which being the possible tax burden that REITs might produce. Because most REIT payouts do not fulfil the IRS’s definition of “qualified dividends,” REIT payouts are taxed at a higher rate than most other dividends. Although REITs qualify for the 20% pass-through deduction, most investors will have to pay a significant amount of taxes on REIT profits if they store them in a traditional brokerage account.
The susceptibility of REITs to interest rates is another possible concern. REIT prices often decrease when the Federal Reserve raises interest rates in a bid to rein on spending. Furthermore, different forms of REITs face property-specific risks. Hotel REITs, for example, frequently perform badly during economic downturns.
No tax advantages: REITs offer nothing in the way of tax advantages. Dividends received from REIT firms, for example, are subject to taxes.
Concerns connected with market fluctuations: One of the most significant risks connected with REITs is that they are sensitive to market-related swings. This is why investors with a low-risk appetite should consider the investment’s ability to generate returns before making a decision.
Poor potential for capital appreciation: REITs have a low potential for capital appreciation. It’s partly because they give back up to 90% of their profits to their investors and only reinvest the remaining 10% in their business.
The major reason to invest in REITs is to diversify your investment portfolio by gaining exposure to commercial real estate without having to deal with the headaches of owning and managing a single or multiple immovable properties. Professional asset management and a relatively small investment ticket size are two more advantages of investing in REITs.
REIT Taxation Regulations in India:
- Dividend Taxation: Dividends received from REITs are totally taxable in the hands of the investor under existing laws. REIT dividend payment is included in the investor’s yearly income and taxed at the investor’s slab rate for the corresponding Financial Year.
- Capital Gains Taxation: Short Term Capital Gains (STCG) and Long Term Capital Gains (LTCG) are both applicable to equity investments and cover capital gains from the sale of REIT units. The STCG is applicable if the units are held for a duration of one year or less from the date of allocation. The capital gains tax rate on capital gains from the selling of units is 15%. LTCG taxation regulations apply if the holding duration exceeds one year from the date of unit allocation. The LTCG tax rate is 10% on profits over Rs. 1 lakh (across all equity investments for the applicable FY) and there is no indexation advantage.
- Capital Gains Taxes for International REIT Fund of Funds: Capital Gains derived from the sale of units of International REIT Fund of Funds are subject to non-equity capital gains taxation. If the holding term is three years or less, Short Term Capital Gains are applicable (calculated from the date of unit allocation). In this situation, the STCG is calculated using the investor’s relevant slab rate for the fiscal year. The LTCG tax is 20% on indexed Capital Gains on units held for more than 3 years, computed from the date of unit allocation. Let’s look at how you might invest in REITs next.
How can you invest in Real Estate Investment Trusts (REIT)?
- Stocks: Individuals searching for a more direct approach to invest in REITs could check at stock options.
- Individuals who use mutual funds will be able to diversify their financial portfolio considerably. Investors would have to invest in such a fund through a mutual fund business because it is an indirect investing strategy.
- Exchange-traded funds (ETFs): With this type of investing, investors get indirect ownership of properties while also benefiting from diversification.
Finally, people should make it a point to learn how their investments will be repaid. For example, they should examine the REIT’s management team and their track record using measures such as fund from operations or financial management rate. To maximise gains, it’s also a good idea to consider a REIT’s EPS growth and existing dividend income before investing.
The market must stay attentive once REITs become a reality on the ground. If the availability of investment-grade office space does not keep up with demand, it might be a huge problem for Indian REITs. If it doesn’t, an asset bubble will arise in the short-to-medium term.