What Is a REIT? Exploring the Basics of Real Estate Investment Trusts

In 2017, an RBI report titled The Indian Household Finance Landscape said almost 77% of household wealth in India is invested in real estate. For us Indians, real estate investment is put ahead of even that in gold, the report indicated. In fact, it said, Indians invested 11% of their wealth in gold, which though high by global standards, fell far short of what we spend on real estate.At the same time, let us face it: investing in real estate comes with its own problems, such as high investment amount, liquidity issues, operational difficulties, etc.But what if we told you that you could invest in real estate and earn rental income from it without actually owning the property? What if we say you can actually invest in them, and that too starting with a really low amount? Plus, what if we told you that you don’t need to take care of the operational work like collecting rent, maintaining the properties, etc.?You may think we are joking, but we are not. All this is possible with REIT – a specialized company that owns real estate properties. While REIT as a concept found itself in SEBI’s discussions since 2008, it became a reality as an investment avenue only in 2019 when India’s first REIT IPO , Embassy Office Parks REIT was launched.What is this new investment avenue and how exactly does it work? This is what we will discuss in detail in this blog.

REIT or Real Estate Investment Trust is a company that invests in real estate. It pools investors’ funds to buy, finance, and operate real estate properties. The rental income or any other income that the properties generate is then distributed to the investors as dividends.Usually, REITs own commercial real estate properties like commercial complexes, data centres, office spaces, healthcare facilities, etc. They are let out on long-term leases to big corporations with creditability, which lowers the risk of rent defaults and ensures stable cash inflows as rental income.Rent is a major component of a REIT’s income and a major source of dividends for investors. REITs can also earn profits from the sale of these properties. As per SEBI rules, REITs are required to allot at least 90% of their net income – i.e., the income after deduction of management fees, depreciation and maintenance fees – on dividends and interest payment to investors.

What is a Sponsor of an REIT?

Usually, when a REIT is launched there is an entity that already owns the real estate properties that become part of that REIT’s portfolio. This entity is classified as sponsor of the REIT. The sponsor is responsible for setting it up and appointing a trustee.

What is a Trustee of an REIT?

The Trustee is responsible for holding the assets of the trust for the benefit of its beneficiaries, i.e. the investors in the REIT. Once the REIT is formed, the trustee assumes the ownership of the assets from the sponsor, which relinquishes all ownership claims on the assets. The trustee ensures that a professional team is appointed for the management of the REIT and its smooth operation.The manager of the REIT is responsible for handling the operational activities of the assets as well as making decisions that are beneficial for investors, including investment decisions.

The working of REITs is quite like that of mutual funds. Like mutual funds, REITs also pool investors' money to buy assets that are managed by professionals. But while mutual funds invest in a broad range of assets, REITs are limited to real estate; they pool investors’ money to buy, finance, and operate real estate properties and generate income from rent, capital appreciation, and property sale.REITs are launched via an IPO and investors can apply, just as they would for a stock IPO. The investors get an allotment of units against their investment amount. The pricing of the units is derived from the value of assets in a REIT’s portfolio but is not exactly the same. TheREIT IPO price can be a discount or a premium to the NAV of a REIT.Once the IPO process is completed, the REIT is listed on the stock exchange, enabling investors to buy/sell its units. As a REIT investor, one earns dividends as and when declared and via capital appreciation as the price of units of REIT grows.There is more to learn about how an REIT works.

Globally, there are many types of REITs that are available for investors, the three broad types of which being Equity REITs, Mortgage REITs (mREITs) and Hybrid REITs.

Equity REITs

These REITs operate by owning commercial properties and generating rental income from them. The properties could include office spaces, data centres, healthcare facilities, etc. The equity REITs can be further divided into a few types, each focusing on a particular category of real estate:

1. Retail REITs: This type of REITs invests in commercial retail properties such as shopping malls and retail stores, their major source of income being the rents from such properties.
2. Healthcare REITs: These REITs focus on healthcare properties, their portfolio consisting of assets like hospital buildings, medical centres, nursing homes, etc.
3. Residential REITs: These own and manage residential apartments and buildings in a particular city or across various cities.
4. Office REITs: This group primarily invests in office spaces and corporate complexes and rents them out to companies on long-term leases. As they are leased out, their primary source of income is rental income, or sale proceeds when they sell the properties.

Mortgage REITs (mREITs)

Mortgage REITs or mREITs as they are popularly known are REITs that also invest in mortgages in addition to real estate. As a result, apart from earning rental income from the owned real estate, they earn interest from the mortgage.

Hybrid REITs

As is indicated by its name, the Hybrid REIT invests in both Equity REIT and Mortage REIT.

Private REITs:

These REITs can only be subscribed to through private placements out of a list of select investors. These are usually not listed in the NSE or registered with SEBI.

Publicly traded REITs

Publicly traded REITs are companies that own, operate, or finance income-generating real estate assets. They are listed and traded on stock exchanges, allowing investors to buy and sell shares.

Publicly non-traded REITs

Non-traded REITs, unlike publicly traded REITs, are not listed on stock exchanges and cannot be easily bought or sold. They are typically sold through broker-dealers or financial advisors. Investors in non-traded REITs may benefit from potential income and long-term appreciation, but they generally have limited liquidity, longer holding periods, and higher fees compared to publicly traded REITs.

There are several types of REITs available globally. However, REITs are a new investment avenue in India, which means currently we only have one type of REIT that can qualify as per SEBI’s mandated criteria.This criterion mandates that a REIT in India should have at least 80% of its investments in commercial properties that actively generate rental income. The remaining 20% can be invested in stocks, bonds, under-construction property, or can be held in cash.Currently, in India, we have 4 REITs that are listed and available for investment namely Brookfield India REIT , Embassy Office Parks REIT , Mindspace Business Parks REIT , and Nexus Select Trust REIT . Of these, the first three are Office REITs while the fourth is a Retail REIT.Another type of indirect real estate investment is InvITs, learn more about what InvIts are, how they work and how InvIts are different from REITs.

Investing in REITs can be done in a few ways in India:

1. Through the stock exchanges: The units of an REIT are basically a security listed and traded on the stock exchanges. So, as long as an investor has a Demat account, they can easily buy units of an REIT off the stock exchanges. It is important to note, though, that the prices of the unit will fluctuate based on the demand for them.
2. Through a mutual fund: In India, there are a few mutual fund houses that invest in REITs along with other investments. Investing through a mutual fund would also help an investor diversify their portfolio.
3. Through IPOs Investors can actively search for upcoming initial public offerings (IPOs) of Real Estate Investment Trusts (REITs) in India and invest in them during their launch. This approach does call for extensive research and a thorough understanding of the risks associated with REITs, though. As the Indian REIT market is still developing and the number of available options is limited, investors may need to wait for the next IPO to become available.

Investors in a REIT can benefit because of the following reasons:

Low-ticket investments

REITs offer investors the opportunity to invest in commercial real estate at significantly low amounts. Currently, if someone wants to invest directly in commercial properties, the investment size would run into lakhs and crores whereas investing through REITs means the investment would be a fraction of that amount.

Diversification

The portfolio of a REIT consists of various properties located across locations within a city or across different cities. Such diversification in direct investment is only possible when an investor has a really high-ticket size. Diversification helps reduce portfolio risk and increase the stability of cash flow from investments.

Professional management

As REITs are operated and managed by a team of professionals under the watch of a Trustee, the investor doesn’t need to worry about the stability of their income, hassles in property management, and the stress of operational activities. Everything gets taken care of while the investor can enjoy the dividends.

Tax exemptions

REITs enjoy two types of tax exemptions not available to real estate companies in general. The first relates to interest payments and dividends it receives from any domestic company in which it holds a stake of at least 50%. The second relates to income via rent and or leasing of property it owns directly.

This brings us to the REIT’s tax exposure. As explained earlier, a major source of income for any REIT investor in India is the dividend that the REIT declares. This dividend is considered a part of the individual’s income and is therefore taxed as per the person’s applicable tax slab.The capital gains that the investor makes by selling the REIT units are taxed just like the gains made on any other listed stock. If the gain is STCG, it is taxed at a flat rate of 15%, and if it is LTCG, it is taxed at 10% over and above the tax-free limit of Rs. 1 lakh.

Fees associated with REITs:

Indian REIT managers typically charge a fee based on a percentage of the assets under management. This fee is usually divided into two components: a fund management fee and a property management fee. The fund management fee covers the cost of managing the REIT portfolio, including investment decisions and overall fund administration. The property management fee is associated with the management and maintenance of the underlying real estate assets owned by the REIT. These fees compensate the REIT managers for their services and ensure the smooth operation of the REIT.

Now that we know what REIT investments are and how they work, it is necessary that we also look at the risks involved with them. REITs are a relatively new investment option in India, and investors have limited options to choose from currently – four listed REITs and one International REIT FoF.All REITs are listed on the stock market and investors can trade their units. However, as it is not a popular product as of now, it is possible that an order placement could take time in the absence of readily available sellers or buyers. This can force an investor to buy at a premium or sell at a discount to ensure the order goes through.REITs offer investors a good option to invest in real estate, but that does not mean that the risks involved with the real estate market don’t exist with REITs; these are just as risky as any other real estate asset. It is advisable for investors, who are new to the concept of REIT, to make the time to learn about them and invest only if their risk appetite allows them to.

Here are the guidelines that qualify a company to be an REIT:

• The organization must have a legal structure as a business trust or a corporation.
• Shares of the entity can be freely transferred between investors.
• The entity is managed by a board of trustees or directors.
• A minimum of 100 shareholders must be involved in the entity.
• No more than 5 individuals can hold 50% of the shares during each taxable year.
• The entity is obligated to distribute at least 90% of its taxable income as dividends.
• At least 75% of the entity's gross income must come from mortgage interest or rents.
• The entity's stock holdings in taxable REIT subsidiaries cannot exceed 20% of its assets.
• A minimum of 75% of the entity's investment assets must be in real estate.
• At least 95% of the entity's total income must be invested.