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Reits can offer regular yield, capital increase

Regulatory stipulations also make Reits a transparent and stable investment option for retail investors

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Reits (Real Estate Investment Trusts) are investment vehicles wherein money collected from investors is invested in income-generating properties for stable and regular returns which are distributed among investors (also referred to as Reit unit holders).

Reits are governed by the Securities and Exchange Board of India (Sebi) Regulations, 2014 which require them to be listed on the exchange and make an initial public offer to raise money.

Underlying assets

As per Sebi regulations, at least 80% of the value of the Reit assets should be in completed and rent-generating properties and the balance can be in under-construction properties, corporate debt of the real estate sector, mortgage-backed securities, equity shares of companies deriving not less than 75% of their operating income from real estate activity, government securities, unutilised FSI of a project in which it had made an investment and money market instruments or cash equivalents.

Attractiveness and advantages of investment in Reits vis-à-vis physical real estate:

Ticket size

Real estate has always been one of the preferred asset classes in India. But given its high-ticket size and illiquid nature, it has been traditionally preferred mainly by the wealthy/affluent. Reits provide an additional avenue to retail investors to participate in this segment, the minimum subscription amount being as low as Rs 2,00,000.

Diversification and liquidity

Instead of being tied up with one property, investors can diversify their risk as Reits invest in multiple properties across geographies. Being listed, Reits provide liquidity and exit option to investors. Moreover, there is no entry/exit load unlike in physical real estate which entails brokerage costs, stamp duty, etc. Regulatory stipulations also make Reits a transparent and stable investment option for retail investors.

Stable returns

Reits provide a regular yield with steady capital appreciation. Sebi regulations specify a distribution of at least 90% of the distributable cash flows on a semi-annual basis. Currently, commercial real estate in India provides a yield of 7%-9% per annum with an escalation clause of 10-15% every three years. Similarly, with a compression in interest rates over the next three to five years, returns from Reits can be higher due to capital appreciation.

One needs to evaluate various parameters before investing in Reits:

Underlying assets - Since Reits invest in income generating assets, it is critical to understand the supply-demand dynamics of the underlying assets. For instance, in case of commercial real estate one needs to look at occupancy levels of the assets which are dependent on buoyancy in the job market, quality of construction, developer credentials, location, access to physical infrastructure. Similarly, the quantum and quality of upcoming supply will determine the occupancy levels and rentals going forward.

Quality of tenants needs to be evaluated to understand their scalability and sustainability.

The yields generated by properties in the Reit portfolio vis-à-vis market rentals, potential rental growth with mark-to-market opportunities.

Track record of asset managers/developers is extremely critical as it will determine the sustainability of upkeep of assets and quality of tenants.

Tax implications for retal investors

Tax treatment in the hands of the investor would depend on the type of income distributed by the Reit:

Dividend income will be exempt from tax

Interest income will be taxable @ 35% 
If Reits units are sold, they will be subjected to capital gains tax which prescribe an income tax rate of 15% for short term (if held for less than three years) capital gain and a rate of 10% for long-term capital gains. Reits have the potential to offer periodic returns plus capital appreciation. While rental yields of Reits are generally stable, vacancy risks may arise due to a change in the demand supply dynamics of the underlying assets. Real estate as an asset class is cyclical in nature and hence one must invest with a long-term horizon.

The author is the head of research at ASK Property Investment Advisors. The views and opinions expressed in this article are personal

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