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What are REITs? Should you invest in them?

In her Budget speech, the finance minister announced two key proposals for real estate investment trusts. Here's all you need to know about REITs.

What are REITs? Should you invest in them?

Most people who have actually gone through the process of buying real estate can readily vouch for the fact that it can be extremely tedious. Right from identifying a suitable property within one's budget, to negotiating with the builder/vendor, conducting due diligence on the property documents, followed by a lot more, the process can get really tiring. And in case you are getting a loan to finance the purchase of the property (which most people need to take given their high unit cost), then one can expect it to be even more exhausting. Moreover, if the property is bought for the purpose of investment, one has to put continuous effort throughout the investment's lifetime in finding tenants, dealing with errant tenants, and periodic maintenance/refurbishing.

Thankfully, there is a modern way of purchasing real estate for investment purposes. It's through an instrument known as REIT. In her Budget speech, the finance minister announced two key proposals for REITs. One, to allow foreign investors to purchase debt securities of REITs, and second, to exempt REIT dividends from TDS. This has put spotlight on REITs, Let's understand them.

What are REITs?
Investors can think of REITs in a similar manner to a mutual fund. In effect, you give your money to a manager who not only invests it on your behalf, but also takes care of any associated problems such as finding tenants, collecting rent, paying any taxes, taking care of maintenance, etc. Of course she charges a management fee, but in return she ensures that all the rent collected is returned to you (after deducting certain expenses) every quarter.

What kind of assets do REITs purchase?
Theoretically, REITS can invest in residential, office or commercial properties but current SEBI regulations restrict them from purchasing vacant plots or agricultural land. Also, since they are mandated to have a minimum of 80 per cent of their corpus invested in rent-yielding/completed properties and a maximum of 20 per cent on under-construction property/other real estate related securities, REITS are effectively instruments which allow the public at large to invest in rent-yielding properties.

What are my investment options? How do I do it?
In India, there are presently two listed REITs: Embassy Office Park and Mindspace Business Parks. A third REIT, Brookfield India, is soon going to be listed. Investors can directly purchase units of these REITs on the stock exchanges (BSE and NSE). Another option for investors is the indirect route, i.e., purchasing the Kotak International REIT Fund of Funds, which invests in not only Indian REITs but also international REITs.

Should I invest?
There are many advantages to the idea of investing in real estate through REITs. For starters, it can be done from the ease of your house without any hassles. Also, the investment can be made with a small amount of money, thereby reducing/eliminating the need to take out big loans. Moreover, these transactions are subjected to a fraction of stamp duty as compared to purchasing actual real estate. Needless to say, selling these investments is a lot easier than selling a house. Since both of the listed REITs have long-term rental agreements, they have become quite popular with even international investors who are looking for yields in an ultra-low-interest scenario.

In spite of the above-mentioned advantages, there is no direct answer to the million dollar question of whether one should invest in them or not. It depends entirely on each individual's asset allocation needs. One also needs to consider the fact that SEBI regulations require a minimum purchase value of Rs 50,000, therefore it won't be possible to invest in small portions at regular intervals.

Investors need to realise that adoption of the REIT route does not mean doing away with the requirement of undertaking careful research. Every investment decision should be evaluated thoroughly in order to understand the risks associated with the underlying properties. For example, Mindspace REIT has around 80 per cent of its properties in Mumbai and Hyderabad while Embassy REIT has more than 64 per cent of its properties in Bangalore. Therefore, any hyper local risk associated with these cities will be borne by the unit holders. And although SEBI has mandated that at least 90 per cent of the cash collected has to be returned to unit holders, the risk of lower demand for office space is always there. COVID has raised serious doubts about the future of office space consumption and any decline in the underlying properties' values will be reflected in the form of falling unit prices.

Conclusion
The basic risk-return tradeoff and investment characteristics of real estate will not change by much just because investors choose a REIT. Most investors can do without these instruments as their unique nature requires a considerable amount of time and effort in order to gain a thorough understanding of it. Those who are interested in them must do their own due diligence.