Real Estate Investment Trusts in India (REITs): An Introduction

Last Updated on Apr 21, 2023 by Gayathri Ravi

Real Estate, as an investment asset class, makes up more than 50% of household savings in  India. Many Indian families see property as a stable investment that can appreciate in value  over time. Real estate is also a tangible asset with true intrinsic value derived from its usage,  unlike other financial assets such as equity and debt, which cannot be used for any other  purpose than to be held in a portfolio. 

However, investing in physical real estate is limited to a few  who can afford to put up the high upfront capital, take time out to manage it and bear the  location and concentration risk. Investing in physical real estate is difficult and comes with many hurdles, such as: 

1. High capital requirements: Requires a significant amount of capital to acquire and thus a  barrier to entry for many investors. Additionally, it requires ongoing capital  expenditures for repairs, maintenance, and upgrades. 
2. Illiquid: Difficult to sell quickly, and investors may need to wait months or even years to  find a buyer and complete a transaction. This can limit investors’ ability to access  their capital or quickly adjust their investment portfolio. 
3. Management and maintenance: Ongoing management and maintenance, including  finding tenants, collecting rent, dealing with repairs and maintenance, and complying  with local regulations. This can be time-consuming and expensive, particularly for  investors who own multiple properties. 
4. Location risk: The value of the real estate is often closely tied to its location, and investors may experience significant losses if the area experiences economic or demographic  shifts, such as population declines, changes in local zoning laws, or shifts in industry or job opportunities. 

Real Estate Investment Trusts (REITs) overcome most of these drawbacks and provide investors  with the ability to invest in Real Estate with limited capital, diversify, get professional management,  and be able to liquidate their investments with a click of a button. Further, REITs are financial  instruments that allow investors to invest in income-generating real estate assets such as office spaces, shopping malls, residential buildings, hotels, and warehouses. In this article, we will cover the basics of REITs in India, how they work, and their benefits for investors. 

What are REITs? 

A Real Estate Investment Trust (REIT) is a company/trust that owns and manages income-generating real estate properties. Investors can buy shares in the REIT, and in return, they receive a portion of the rental income generated from the underlying assets. Simply put, REITs are like mutual funds for physical real estate investments. REITs in India are regulated by the Securities and Exchange Board of India (SEBI) and were introduced in 2014.

How do REITs work? 

REITs pool money from investors and use that money to buy income-generating properties.  These properties are then leased out to tenants, and the rental income is distributed to  investors in the form of dividends. REITs are required to distribute at least 90% of their rental  income to investors, and they are exempt from paying income tax on the distributed income. 

REITs provide regular income with a steady capital appreciation via the properties they own.  Thus it works like a hybrid product between Equity and Fixed Income. 

What assets can an Indian REIT own? 

1. Real estate projects earning rental income, including commercial projects such as offices,  hotels, retail, industrial, and healthcare. 
2. REITs are not permitted to invest in residential (houses, apartments) or speculative land banks. 
3. Minimum of 80% of the REIT’s assets must be invested in completed and revenue-generating properties. The remaining 20% can be invested in under-construction  properties or other permissible assets. 
4. Leverage restrictions: Unit holder approvals are needed for debt to capitalisation above  25%, and debt to capitalisation is capped at a maximum of 49%. 

What are the benefits of investing in REITs? 

1. Diversification: REITs provide an opportunity for investors to diversify their portfolios by  investing in real estate assets without owning the physical property. 
2. Liquidity: REITs are listed on stock exchanges, making it easy for investors to buy and sell  their shares. 
3. Regular income: REITs provide regular income in the form of dividends from the rental  income generated by the underlying assets.
4. Professional management: REITs are managed by professionals with expertise in  real estate management and investment, which helps in the better management of assets. 
5. Asset quality: REITs invest in professionally managed Grade A commercial assets.  
6. Potential for capital appreciation: REITs can provide capital appreciation over the long  term if the underlying assets appreciate in value. 
7. Transparency: REITs have a strong governance framework and disclosure requirements  from SEBI. 

Who can invest in Indian REITs? 

1. Any investor (domestic/foreign/retail/institutional) can buy REIT units in India. 
2. No minimum trading lot size; previous minimum trading lot size of Rs. 50,000 and 200  units done away with now. 
3. Investors can purchase REIT units through a Demat account, similar to how they would  purchase shares in a company. 
4. Indian REIT units can be bought/sold freely on either NSE or BSE – online or through a broker. 

Listed REIT landscape in India 

How do you analyse which REITs are good?  

An investor considering REITs must assess them based on the following factors:

1. Reputation and quality of the developer: REITs are managed by professional teams, and  investors should evaluate the quality and experience of the management team. Factors  to consider include the team’s track record, investment philosophy, and aligning  interests with shareholders. 
2. Property types: The type of properties held by the REIT, which may include offices, malls, hotels,  warehouses, and residential properties. This would determine the yield of the properties,  the term of the contracts, and the risks involved in managing them.  
3. Quality of the tenants: A significant and stable component of return from REITs is rental  income earned from the tenants. Thus the health and financial strength of the tenants is  of critical importance.  
4. Diversity of the tenant base: High percentage of total revenue from a single tenant or  a high percentage of tenants in the same sector would present a concentration risk for the  REIT.  
5. Yield offered: A 3-4% yield would be too low, while 10%+ may be too good to be true. 
6. Weighted Average Lease Expiry (WALE): This refers to the number of years left for the  lease to expire. Generally, a longer WALE implies that the future income is more  forecastable and stable. However, sometimes a smaller WALE may be good if the in-place rents are low, and new leases can be negotiated with an aggressive escalation. 
7. Occupancy percentage: Vacant properties do not earn rent. Thus higher the occupancy,  the better it is.  
8. Tenant retention percentage: This refers to the percentage of tenants who decide to  renew their leases once their lease expires. Higher retention is generally good as it leads to lesser downtime and lower re-leasing charges.  
9. Leased area vs development area: Future plans of the REIT in terms of expansion and  new properties. 
10. Geographic diversification: It may help to eliminate a city-specific risk. 
11. Leverage: This refers to the level of debt raised by a REIT to fund its investments. Lesser is generally better. 

What are the risks of investing in REITs? 

1. Market risk: The value of REITs can fluctuate due to market conditions and economic  factors. 
2. Interest rate risk: REITs are sensitive to interest rate changes, and an increase in interest  rates can affect the value of the assets. 
3. Tenant risk: The rental income generated by REITs depends on the tenants  occupying the underlying properties, and any vacancies or non-payment of rent can affect the income generated.
4. Regulatory risk: Changes in regulations or policies can affect the operations and profitability of REITs. 

Conclusion 

REITs provide an opportunity for investors to invest in real estate assets without owning  physical property. They offer diversification, liquidity, regular income, professional management, and potential for capital appreciation. However, investors must also be aware of  the risks associated with REITs, such as market risk, interest rate risk, tenant risk, and regulatory  risk. As with any investment, investors should conduct thorough research and seek professional advice before investing in REITs.

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Sushant Suri

Director & Lead Trainer at FinGuru

Sushant Suri, CFA, FRM, CFP, runs a financial training company, FinGuru, in New Delhi. Over the past 15 yrs, he has trained over 7,500+ candidates in the field of Investment Management, Equity Research, and Valuation. Previously he worked as an Investment Banker and Equity Research analyst and has over 7+ yrs of experience in the finance industry. Sushant enjoys teaching finance and training candidates preparing for the CFA Program.

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