REITs – Serving Small Bites of the Large Real Estate Pie

India is waiting with bated breath for the first listings on its home-grown Real Estate Investment Trusts (REITs). In fact, the first listing will happen within a couple months. REITs are good news for investors who have a small appetite – as small as Rs 2 lakh – and yet want to invest in the otherwise highly cost-intensive commercial real estate market. With REITs, they can literally take a small bite of the large Indian commercial real estate pie.

One of the major real estate players in the country (Blackstone-backed Embassy Group) is in the process of launching its first REIT to raise approx. $1 billion as part of its strategy to monetize its rent-yielding commercial properties. Currently, this realty major is in the reshuffling of its property portfolio to include assets across Bengaluru, NCR and Mumbai.

The company has more than 30 million sq. ft of leased office space and about 22 million sq. ft. more in the pipeline across cities. Another player in the fray for listing REITs is IIFL Holdings.

REITs Decoded

Just like mutual funds, REITs are investment vehicles that own, operate and manage a portfolio of income-generating properties for regular returns. As of now, REIT-listed properties are largely commercial assets – primarily office spaces – that can generate steady and lucrative rental income.

REIT-listed office assets are very likely to be followed by other REITable asset classes in India, including retail malls, hotels, etc. Post its registration with SEBI, units of REITs will have to be mandatorily listed on exchanges and traded like securities. Like listed shares, small investors can buy units of REITs from both primary and secondary markets.

Thus, besides low entry levels, REITs will provide investors with a safe and diversified portfolio at minimal risk and under professional management, ensuring decent returns on investment. REITs will not only be characterized by investment in real estate assets – they will also offer limited liability for all unitholders.

To ensure regular income to investors, it has been mandated to distribute at least 90% of the net distributable cash flows to the investors at least twice a year.

That’s not all. As per the guidelines, 80% of the assets must be invested in completed projects, and only 20% will be in under-construction projects, equity shares, money market instruments, cash equivalents, and real estate activities.

Expected ROI

Small investors will raise a pertinent question – will REITs be able to offer the same returns on investment that they can expect from ‘real’ real estate investments? The answer is, probably not. Definitely, investors who are hoping for unrealistic returns (>20-30%) will need to look elsewhere.

Being realistic in one’s returns expectations from REITs is important. A realistic ROI expectation would be in the range of 7-8% annually, post adjustment of the fund management fee.

With REITs, the ROI will be highly structured, realistic and risk-averse. REITs are ideal for investors who want a steady income with minimum risks. Moreover, investors can earn two types of income from REITs – one through capital gains post the sale of REIT units, and the other via dividend income. Moreover, REITs will be a good investment option for investors who are looking to diversify their portfolio beyond gold and equity markets.

The Downside

On the flipside, a plethora of taxes have currently made REITs more than a little unattractive in India. For instance, when a REIT sells shares of assets, the capital gains are taxable. Further, in other countries where REITs have been functional for a long time have been exempted from stamp duty. Such tax benefits, if and when are provided in Indian REITs, will act like a catalyst in making REITs more functional and attractive in the long run.

More importantly, if REITs become attractive to investors via tax sops, channels for foreign funding in Indian real estate market will open up. The potential is considerable, but a proactive decision on the taxation aspect needs to be made.

Global Players Galore

Sensing immense opportunity, large global institutional investors are already eyeing India’s real estate market through REIT-tinted lenses. These include Japan’s NikkoAm StraitsTrading Asia, US’ North Carolina Fund, Malaysia’s Hwang Asia Pacific REITs and Infrastructure Fund, Taiwan’s Eastspring Investments and Canada-based Sentry Global. This ignited interest of global entities is largely due to the uptick in office leasing activity in major Indian cities.

To be fair, the Government and SEBI have incorporated several changes time and again to make the issuance of REITs a success. However, only time and circumstances can reveal the ‘real’ success of REITs in India. The first listing will be more of a test case for the Indian market. If it succeeds, there will certainly be no looking back.