How REITs Can Add Value To Your Portfolio

  • 02 Aug 2023
  • Read 5 mins read

Understanding the Benefits and Risks of Investing in REITs

There are a number of listed REITs in India. Most of the REITs have performed fairly well in the Indian context post-listing. While we shall look at the concept of REITs in much greater detail, you can understand REIT as a real estate mutual fund. In India, residential REITs are not permitted so all the existing REITs are only on commercial property. Unlike the mutual fund that holds shares and bonds in its portfolio, the REIT holds a portfolio of commercial real estate assets. The rentals earnings and the trading profits are distributed to the REIT holders in the form of dividends and capital distribution. They not only diversify the existing portfolio but also allow small investors to indirectly participate in commercial property

 

Understanding REITs as an investment product

A typical listed REIT collects funds through a public issue and then allocates these funds to create a portfolio of real estate portfolio. The difference is that REITs are floated by entities that already have a real estate portfolio and use the IPO to hive it off as REIT units. The REIT typically invests in a portfolio of real estate (property) assets. For an investor, the REIT is like a real estate mutual fund. Instead of investing in commercial properties, which is out of reach for most retail investors, REITs allow investors to indirectly hold a share in commercial property through REITs. REITs convert real estate into a financial asset.

How are REITs structured in the Indian context?

Before we get into the benefits of REITs, here is a quick look at the REIT structure. Like a typical mutual fund, the REIT works like the AMC of a mutual fund. It collects money from investors, aggregates and invests the same in a portfolio of commercial real estate assets. The REIT can only invest in commercial property assets and it is required to mandatorily distribute 90% of any income by way of rentals and capital gains as dividends to REIT unit holders. REITs are treated as pass-through intermediaries and are tax-exempt.

Key benefits of investing in REITs

Apart from the fact that REITs offer one more asset class to invest in, there are some very distinct benefits that investors can have by investing in REITs

  1. REITs diversify your portfolio. You can diversify your equity portfolio into gold through gold ETFs or SGBs. The financial asset equivalent in real estate is REIT. You can get a good diversification of risk through REITs.
  2. REITs offer a simple, yet sophisticated method of holding commercial property. Property can be held as securities in an existing Demat account. No hassles about stamp duty, maintenance, transfer charges etc. REITs are more suited to investing in real estate.
  3. Most of the small and medium-sized investors cannot afford to buy a share in commercial property, REITs fill that gap. Yields on commercial property are much higher in India compared to residential properties.
  4. With SEBI reducing the minimum investment in REITs from Rs2 lakhs to Rs50,000, REITs are now more accessible to small and medium investors. They can now participate in commercial property investments indirectly.
  5. REITs are tax efficient for an investor, being a pass-through structure. This tax advantage enhances the post-tax yield on REIT investments.

Risks of investing in REITs

What is the downside risk of investing in REITs? Firstly, since REITs offer a stake in commercial property, the value of your REIT will depend on market prices. Property prices have the propensity to be volatile and also opaque in their pricing methodology. This gets transmitted to REITs too. Above all, there are few benchmarks to evaluate performance and the history of REITs is also very limited. Also, the varied state-level rules can also make these REITs cumbersome.

However, it cannot be denied that REITs do offer a unique and intelligent avenue for investors to diversify risk and take exposure to commercial real estate.