What is a Real Estate Investment Trust (REIT)?
- A Real Estate Investment Trust or REIT is an investment vehicle that provides an opportunity to invest in various projects by only investing in the units of a sponsor entity that will manage the paperwork and may be, even the hindrances of investing in the real estate market.
- Look at it like a mutual fund through which you can invest small amounts and own units representing shares of various large companies.
- REIT will offer you an opportunity to own units of commerical real estate. The sponsor entity launches an REIT that owns the properties and then leases them to earn rental income, which is then distributed among the unit holders.
What are the benefits?
- The biggest benefit is the ease of investment as investing in REIT is just like investing in direct equity that can be done through a demat account.
- The other big advantage is getting an opportunity to invest in commercial properties that will earn rental income.
- This is a significant advantage as commercial properties typically earn more rent than residential properties with built-in clauses of rent hikes at fixed intervals. Moreover, REIT regulations mandate the distribution of 90% of the rental income to unit holders.
- The remaining 10% can be used for business purposes. Also, since REIT is a publicly listed and traded instrument, liquidity should ideally not be a concern. Apart from the rental income, any increase in the value of units will also add to overall capital appreciation. Retail investors can diversify their portfolio by investing in high-end commercial properties and earn rental and dividend income.
- From a sector perspective, REIT is expected to bring transparency and liquidity in the real estate segment while allowing domestic and global investors invest in the sector through a well regulated investment vehicle.
Are investors ready to accept REIT as an option?
- If the response to the first-ever public issue of a REIT is anything to go by, then there surely is a demand for such a product. The initial public offering of Embassy Office Parks REIT, which closed on Wednesday, was subscribed nearly 2.6 times with bids received for 18.35 crore units as against 7.11 crore units on offer in the price band of ₹299 to ₹300.
- Though the minimum application size was 800 units or ₹2.40 lakh, the non-institutional portion was subscribed more than three times that shows that there is indeed investor interest in REIT though there is no guarantee that forthcoming REIT offerings would see similar or better response from investors.
What are the risks involved in investing in REIT?
- Every investment has an element of risk and REIT is no exception. A downturn in the real estate sector would impact rental income and also, capital appreciation. Rentals would also be under pressure if the real estate inventory is huge due to lack of demand.
- Also, real estate has been a preferred personal investment avenue for Indian investors for many years so most people would already have an exposure to the sector and increasing the exposure through REIT might not serve any purpose.
- Also, REIT in India is at a nascent stage and as the segment evolves, the regulatory environment could be tightened.Real estate sector also suffers from a host of litigation and compliance issues like title dispute, settlement of project affected people, environment clearance, state & central laws and political interference among others that can enhance the investment risks.
How are REITs taxed?
- It is mandatory for a REIT to distribute 90% of its rental income among its unit holders.
- This income will be added to the overall income of the investor and will be taxed at the applicable rates.
- REIT also involves a tax deducted at source component that is 10% for resident investors and 40% for non-resident investors. Further, if a unit holder sells his/her REIT units on the stock exchange platform then capital gains tax would also be applicable based on the period of holding. If the units are sold after three years, then a capital gains tax of 10% along with applicable surcharge and fees would be levied.
- Selling REIT units within three years would entail short term capital gains tax of 15% plus surcharge and cess.The post-tax returns and capital appreciation will be the big factors in ascertaining whether REITs are here to stay.