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What You Didn't Know About Indian REITs

Real Estate Investment Trusts could be a great vehicle to get transparent & liquid exposure and bumper returns from real estate

The recent budget proposal to kick-start Real Estate Investment Trusts (REITs) in India (the third time in a decade) has generated much excitement among developers, market experts and investors. After all, what could be better than a vehicle that gives you the bumper returns of real estate and also provides transparency and liquidity?

But before letting your enthusiasm run away with you, there are a few things that you must know about REITs, as they are taking shape in India. Based on SEBI's new regulations for REITs, here's what you should know.

They're more like companies than MFs

When you buy units of a mutual fund, you're buying a piece of the fund's portfolio. Any money that you invest in the scheme is directly re-deployed into stocks, bonds or other instruments. This portfolio is valued daily and when you sell units, you get an NAV-linked price.

But Indian REITs will function more like listed companies than mutual funds. The REIT, which is floated by a sponsor, makes an IPO of units (akin to shares) to investors. Investors buy these units based on an offer document and the REIT is then listed on the stock exchange.

The money so raised is used by the REIT either to buy into Special Purpose Vehicles (SPVs) which invest in property or directly take majority stakes in real estate projects. The REIT receives income from these properties, which is distributed as dividend to the REIT investor. If you want to exit a REIT, you have to sell your units (like you do shares) to another investor, at the stock exchange. Remember, just like shares, REIT units may trade at a discount or premium to the company's intrinsic value, at the market. This is unlike a mutual fund where you can always exit at NAV-linked prices.

They will be less transparent and liquid than MFs

Mutual funds deal only in liquid, exchange traded securities. Therefore they value their portfolios on a daily basis, mark them to the market and arrive at a daily NAV based on the last traded price. They also offer you money back at any time (if the fund is open end) at the prevailing NAV. They disclose their portfolios on a monthly basis, financials on a half yearly basis and have their NAV-based returns ranked by independent agencies.

Now, the real estate market in India is scarcely as transparent as the stock market. Property transactions often involve a grey market component. Even within the same city or locality, different property deals can also take place at vastly different prices. Therefore there is no way of measuring the 'daily value' of a REIT's assets. Therefore, REITs, even if listed, are likely to be far more opaque than mutual funds. SEBI has asked for Indian REITs to get their property portfolios valued by an independent valuer twice a year. Therefore, you will probably get to know your REIT's NAV at half-yearly intervals.

But don't expect this NAV to be as water-tight as that for a mutual fund. Given that property values can fluctuate quite a bit based on the most recent transactions, the NAV can at best be a ballpark number.

They're more about dividends than capital gains

Most Indian investors love real estate because they believe that it gives you manifold capital gains over the long-term. Now, REITs are not structured to make you bumper gains from buying and selling property. They are intended to pay you a regular dividend out of the rent they receive from property.

SEBI's regulations for Indian REITs require them to invest at least 80 per cent of their funds in completed, revenue-generating properties. Only 20 per cent is allowed to be deployed in under-construction property, bonds from developers, listed shares of realty companies and instruments like gilts and money market securities. The regulations also require REITs to pay out 90 per cent of the income they earn each year as dividend to investors.

This structure will ensure that REITs earn much of their returns by way of rental income from their property and not from capital gains. As an investor, you too should expect returns which in keeping with commercial rental yields (at the most, 8-10 per cent) and not the fancy multi-bagger returns that are possible from owning land or apartment blocks.

They invest in commercial, not residential property

Given that earning a regular rental income is the primary purpose of a REIT, the majority of its investments will be in office space, malls, commercial complexes, multiplexes and so on. The bulk of the investment will not be in plots of land, residential townships or luxury villas, which most property buyers fancy so much. Commercial property in fact yields higher rents than residential property. In India, residential rental yields in most cities are not above 2-3 per cent, scarcely an attractive return for the REITs to seek.

They won't match property, on tax breaks

In India, most people buy property because of the sizeable tax breaks they get on the investment itself. The interest you pay on a home loan upto a ₹2 lakh limit, can be deducted from your annual income, before you calculate income tax. But your investments in REITs will not earn any such tax exemptions. Yes, the REIT itself has been granted pass-through status in the recent budget. That is, the REIT will pay no tax if it buys or sells property or earns a rent from its holdings. But as an investor, if a REIT distributes the income back to you as dividend, this could be subject to dividend distribution tax.