Understanding real estate investment trusts

Apart from providing safety and security, having one’s own home is the ultimate dream for most households in India. The flip side, though, is that it requires a huge capital outlay besides other issues like encroachment, defective title deeds, property taxes and maintenance expenses.

Even for those individuals who can afford to buy residential property, investment in commercial property is a daunting task due to the cumbersome legal clearances, finding the right or honest tenants et cetera. This is where Real Estate Investment Trusts or REITs (pronounced as “Reets”) can provide an answer or a route to channelise savings of retail investors.

Let’s try to understand the nuts and bolts of REITs:

What are REITs?

REITs are investment vehicles like mutual funds that pool the money from many investors and invest the funds collected in income-generating commercial real estate assets like offices, hotels, malls, commercial complexes, solar parks et cetera. REITs are run as business trusts that own and operate real estate assets through direct or indirect holding in Special Purpose Vehicles (SPVs). The income they generate includes rental income, interest & dividend income from SPVs and capital gains that are distributed to the investors.

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

What is the eligibility?

Since listed REITs are traded on the exchange an investor needs a Demat account to invest in REITs. To make REITs more affordable & ensure wider retail participation, SEBI, vide its notification issued in July 2021, reduced the minimum investment from Rs 50,000 to Rs 10,000-Rs 15,000 through an Initial Public Offering (IPO). SEBI has also reduced the minimum lot size from hundred units to one unit.

Benefits of investing in REITs

For a retail investor, the biggest benefit of investing in REITs is that he can buy a slice of commercial real estate with a small amount. Unlike physical property where he is exposed to liquidity risk, REITs are more liquid as the investor can sell units of listed REITs on stock exchanges & receive cash just like equity shares immediately.

Also, as per SEBI regulations, REITs must mandatorily distribute at least 90% of the net distributable cash flows to investors on a half-yearly basis. REITs must have a minimum 80% value from completed & income-generating properties. They must also distribute at least 90% of the sale proceeds from the sale of assets to unitholders.

Taxability of REITs

Short-term Capital Gains will arise when the investor sells units of listed REITs before 36 months of allotment, or purchase and the Short-Term Capital Gains (STCG) are taxed at 15%. REITs are superior to a physical property where STCG arises if the holding period is less than 24 months & taxed as per the tax slab of the investor. LTCG in REITS will arise if the holding period is more than 36 months, and tax is 10% on gains above Rs. 1,00,000.

As regards the taxation of income that the unitholder receives from the REITs it’s a little complicated & depends on the nature of income.

While Interest, Dividend, and Rental income are taxed at normal rates (tax slab) as per section 115UA of the IT Act, any other income received from REIT apart from the above will be exempt u/s 10(23FD).

Though REITs are in existence 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 area) was the first REIT to be listed on the exchanges in April 2019. Embassy REIT having a face value of Rs 300 is currently trading at Rs 373. Raheja sponsored Mindspace REIT has a face value of Rs 275 and is trading at Rs 349, while Brookfield India REIT, which has a face value of Rs 275, is trading at Rs 323.

REITs have done reasonably well during the pandemic having held their own, unlike stocks which have had a roller-coaster ride in the last few years. With economic activity back to the pre-pandemic levels, the commercial real estate space holds a lot of potential with more companies likely to launch their own REITs. All these developments augur well for investors looking to diversify their portfolios.

(The writer is a CFA, former banker and currently teaches at Manipal Academy of BFSI, Bengaluru)

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