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India witnessed the launch of its second REIT IPO on 27th July 2020 by Mindspace Business Parks, only one year after the Embassy Office Parks REIT hit the primary market.

By: Tavaga Research

Ever heard of owning commercial offices, malls, IT parks, hotels, and residential apartments, etc. all at one time? Well, a Real Estate Investment Trust (REIT) provides the chance for investors to own it without spending a lot.

REITs have provided the investors an opportunity to invest in real estate as an asset class without making huge investments or without getting emotionally attached to properties. 

What are the Basic Forms of Real Estate Investment?

Real estate investment can be made in 4 basic forms, namely private debt, private equity, public debt, and public equity. Because of its indivisibility and illiquidity, the size of investment in private real estate is larger than publicly traded real estate investments.

  • Private Debt and Private Equity: Real estate investment in private debt is made via mortgages which are collateralized by the underlying real estate. In simple words, money is lent to the purchaser of the property. In the private equity market (real estate), investments are made directly by purchasing properties
  • Public Debt and Public Equity: Real estate investment in public debt is made via mortgage-backed securities that are secured by a mortgage or a collection of mortgages, and mortgage REITs that invest in mortgage-backed securities and loans collateralized by real estate. Public real estate equity investments are done through REITs and REOCs (Real Estate Operating Companies). If the business is ineligible to form as a REIT, it will be a REOC. Example of a REOC – Instead of generating rental income, a company may prefer to develop and sell the real estate, unlike REITs 

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What is a REIT and what are the types of REITs? 

  • REIT is a company that owns and operates income-producing real estate, thus managing a huge portfolio of real estate properties
  • REITs that are actively managed and seek to generate cash flows by leasing properties are known as equity REITs. The cash flows are later distributed among REIT shareholders as income and dividends
  • When the mortgages and mortgage-backed securities are purchased to provide financing for income-producing real estate, they are known as mortgage REITs or mREITS
  • Hybrid REITs are those where the investor can further diversify the portfolio by investing in equity REITs and mortgage REITs 
  • The concept of REIT is similar to a mutual fund with real estate as an underlying asset

What are the subtypes of Equity REITs?

  • Retail REITs: Retail REITs own shopping arcades and buildings in prime shopping areas. Two important factors that analysts must consider while evaluating a retail REIT are sales per square foot and lease rates
  • Health Care REIT: REITs in this category invest in hospitals, clinics, rehabilitation centers, etc. While the overall economy doesn’t affect health care REITs, government spending on healthcare as a percentage of GDP, insurance costs and demography are important factors that concern the health care REITs
  • Office REITs: An office REIT leases properties to multiple business tenants. The location of properties, logistics support, and the quality of the building affects office REITs. Typically, there are long leases, and the rent increases throughout lease in the case of office REITs. The Embassy Office Parks REIT is an example of office REIT
  • Hotel REITs: The trust in this category leases properties to management companies. Short term lease and the cyclical nature of the sector has led to volatility and variations in revenue collection. Some important factors the analysts must consider while evaluating a hotel REIT are RevPAR (Revenue per Available Room = average occupancy rate * average room rate), sales of refreshments, property maintenance expenses, etc.
  • Residential REITs: The multi-family residential REITs invest in rental apartments where the lease periods are short and the rental apartment demand is usually stable. In analyzing residential REITs, analysts must take into consideration the health of the local economy, demography, and impact of costs as operating costs such as taxes, maintenance are borne by the landlord
  • Industrial REITs: An industrial REIT leases properties to businesses involved in manufacturing and warehousing. Typically, the leases are long and as a result, the value of industrial properties is stable. Location, logistical support and access to ports are some important factors that affect industrial REITs
  • Diversified REITs: Diversified REITs hold more than one category of REIT.

Why investors in India may not prefer to invest in REITs?

  • Taxation: Real estate investment trusts are required by the law to pay at least 90% of their taxable income as dividends to unitholders. Before budget 2020, investors enjoyed a tax-free status on dividends received. However, dividends were made taxable at slab rates in budget 2020, thus discouraging the unitholders of REITs.

Later, as industry players made their reservations against this taxation policy, amendments were announced (with a caveat) in response by the government. The dividends were made taxable in the hands of unitholders only if the REIT opts for a lower corporate tax of 22% (instead of 30%). The exemption status on dividends was only permitted if the REIT doesn’t opt for a concessional tax rate of 22% and instead chooses to pay 30%. 

Globally, there is a different practice altogether when it comes to taxation policies concerning the trusts. The REITs enjoy exemption from corporate taxes as long as certain requirements are met, for example, the income and assets of the REIT must come from rental income-producing real estate and the REITs must distribute almost all of the taxable income to unitholders

  • COVID- 19 Pandemic: Companies resorted to the work from home (WFH) model since March 2020 as the government imposed a strict lockdown due to pandemic caused by coronavirus. Since then, the companies have saved a lot on rental payments, electricity bills and hence, many firms from the IT sector have requested the Information and Technology (IT) Ministry to grant them the use of this model permanently.

A few days back, the department of telecommunications (DoT) extended relaxations in work from home norms up to 31st December 2020 for IT and IT-enabled services firms. It is important to note that the major clients of REITs include companies from the IT sector. The clients of Mindspace Business Parks REIT include Accenture, JP Morgan, Capgemini, Barclays, Amazon, UBS, Facebook, and Qualcomm. 

The price of Embassy Office Parks REIT has failed to recover from its all-time low in April despite the sharp recovery of the broad market from its all-time lows in March.

6-Months Performance of Embassy Office Parks REIT

6-Months Performance of Embassy Office Parks REIT
Source: Google Finance | Data Updated as of 27th July 2020

  • Limited growth: Unlike equities, where there are no regulations of payout of dividends from the income a company generates, REITs are required to pay at least 90% of their income as dividends, as discussed above. As a result of this, there may not be much room left for REITs to grow through the reinvestment income which would eventually affect the share price of REITs

What are the Advantages of REITs?

  • Predictability of earnings: The rental income of REITs is fixed by contract bringing-in consistency in the earnings of REITs across periods
  • High dividend yield: With REITs required to distribute their rental income in the form of dividends, the dividend yield on REITs is greater than the dividend yield on equities   
  • Professional management: To acquire additional properties, maximization of rent, and control expenses, REITs are managed professionally unlike direct investment in real estate where every buyer of the property is needed to have investment expertise
  • Diversification benefits: With properties spread across the country, REITs enable geographical diversification to investors. Along with geographical diversification, an investor can diversify across property types
  • Liquidity: The only listed REIT in India, the Embassy Office Parks, trades on NSE and BSE which makes it easier for an investor to purchase and sell
  • Protection against inflation: With a rise in inflation, the property prices and rental income rises making REITs a hedge against inflation. 

REITs in India

  • Embassy Office Parks REIT backed by Blackstone Group and Embassy Property Developments Pvt. Ltd., launched the IPO in March 2019 and received an overwhelming response as the offering was subscribed 2.58 times. As the name suggests, it is an office REIT spread across seven office parks and four city-center office buildings. The closing price of Embassy Office Parks REIT on 27th July 2020 was Rs. 362
  • On 27th July 2020, the Mindspace Business Parks REIT, jointly owned by the Blackstone group and K Raheja Group launched its IPO. The REIT aims to raise Rs. 4,500 crore where the investor will have to bid for a minimum of 200 units worth Rs. 55,000. It is India’s 2nd REIT with Accenture, Facebook, Barclays, Amazon, etc. being its clients along with hotel rooms from Chalet Hotels and 6 malls and 278 retail shops
  • Brookfield REIT is planning to launch an IPO for its real estate investment trust in India, with Bank of America, Citigroup, and Morgan Stanley being the bankers to its IPO (as per Bloomberg)

Diversification plays an important part in asset allocation and therefore real estate along with equity, debt, and gold plays an important part in the portfolio. While concerns arising out of Covid-19 exist, it is very early to write off the concept of REITs in India. However, one must check the list of tenants, and the quality of underlying real estate before investing in REITs.

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