REITs or Real Estate Investment Trust are the companies that own, manage, and finance income-generating real estate across the property sector. Real Estate Investment Trust companies are the corporation that manages the portfolio of High Net-worth Individuals. SEBI mandates to distribute 90% of income to the investors in the form of dividends. 10% of the income will further reinvest in some projects to increase the purpose of capital gain. In other words, they lease the property and collect rent on it. The rent collects from leasing the property will distribute among shareholders as a dividend.
REITs are a way of capital appreciation and are publicly exchange like stocks, which make them highly liquid. It invests in real estate property like apartments, buildings, hospitals, warehouses, logistics, offices, and malls, etc.
REITs concept evolved in late 50 years ago in United State in 1960. “The Cigar Excise Tax Extension Act” when US president Eisenhower signed the REIT Act for REIT. The US Congress had created the REIT to provide US investors with the opportunity to diversify their portfolios. It allows investors to buy shares in a real estate portfolio. This was previously available only to high net worth individuals and large financial intermediaries. The world’s first REIT was a list on the New York Stock Exchange in 1965. In the upcoming year, a similar instrument was a list on European, Japanese, and Australian stock exchanges also.
REITs in India
In India, Real Estate Investment Trust was came into notice by the Securities and Exchange Board of India (SEBI) in 2007. At that time, SEBI only releases draft regulations, but due to certain reasons, the application do not get approval. In September 2013, SEBI came with revised regulations for REITs, which were later approved on September 26, 2014.
Types of REITs in India
- Embassy Office Parks REIT
- Mind space Business Park REIT
- Brookfield India Real Estate Trust
In the future, some leading names in the real estate sector like DLF and Godrej may expect to introduce REITs. In India, REIT has s 3 tired structure comprising of a Sponsor, Manager, Trustee with different roles and responsibilities such as:
- Sponsor: The sponsor usually owns the assets before the creation of the REIT. The sponsor is responsible for setting up the REIT and appointing the Trustee. There is a minimum requirement of 25% unit holding for the REIT sponsor along with the other sponsor for the first 3 years after the incorporation of REIT. Further, after the completion of 3 years, this minimum requirement will reduce to 15% units.
- Manager: A manager is specialized in facilitates the management of REIT. The manager is responsible for managing the assets of REIT. Other responsibility includes making decisions related to investment, and disclosure of REIT.
- Trustee: The trustee was appointed by the REIT sponsor who specializes in providing the trustee services. The trustee is responsible for holding the asset of REIT for the benefit of the unitholder.
In addition to it, SEBI has compulsorily made the criteria for REITs in India to fulfill certain conditions such as:
- At least 80% of the investment made in REIT need to be in commercial properties such as building, mall, offices, etc. The remaining 20% of assets need to do in stocks, bonds, cash, or any under-constructed property.
- At least 90% of income earn by leasing or interest has to distribute among the shareholders as a dividend or interest.
- Stock marketing listing of the REITs is mandatory.
Types of REITs
There are few types of REITs with their uniqueness. These areas:-
- Equity REITs: Equity REIT owns and manages income-generating real estate. In this, revenue is generated through leasing the property, and rent will distribute among the shareholder as a dividend.
- Mortgage REITs: Mortgage REIT lends the pooled fund to real estate owners and operators both directly through mortgage and indirectly through the acquisition of mortgage security. Mortgage REIT also generates income in the form of interest accrued on the money lend to the real estate owners.
- Hybrid REITs: Hybrid REIT used the investment strategies of both equity and mortgage REIT. In this, some property is used for lease and some are directly or indirectly given to real estate owners. Here, both the rent and interest are the source of income to the shareholders.
- Private REITs: Private REIT caters to the services only to some selected investors might be HNI. This type of REIT is not traded on stock exchanges and is not registered with the SEBI due to which there is a huge risk.
- Publicly Traded REITs: Publicly Traded REITs are the real estate investment trust shares that are enlisted on the National Securities Exchange and are regulated by the regulatory body of the share market. Individual investors can sell and purchase the shares through NSE.
- Public non-traded REITs: Public non-traded REITs are non-listed REITs that are registered with SEBI. But, they are not traded on the stock exchange and hence, are less liquid as compared to other forms of REIT.
Advantages of REITs:
REITs allow investors to diversify the investment portfolio through an investment in real estate share with involving in owning and managing the property by themselves. It allows the investors to go beyond the traditional shares, bonds, ETFs, etc.
#2 Regular Income:
Through investing in REIT one can generate income in two ways: rental income and interest income (Hybrid REITs). REIT eventually provide regular income in the form of a dividend to the shareholder because 90% of generated income has to be distributed among its member as per the guideline of SEBI.
The greatest advantage of REIT over physical property is its liquidity. As REIT are traded on a stock exchange, can be brought or sold anytime at their market price, unlike physical property.
#4 Professional Management:
Property owned by REIT is managed by the professionals which ensure smooth flow of its operation and thus, gain huge profits to the investors through leasing the property.
As regulated by SEBI, REIT investment is considered to be the most transparent investment among others. It provides an investor with several opportunities such as liquidity, tax benefits, ownership, transfer of shares, etc.
Disadvantages of REIT
#1 Market Risk:
Market-linked fluctuation is one of the major risks compiled in REIT. This is why it is not meant for small investors, who don’t like to bear the risk due to their less diversified investment portfolio.
#2 Low Growth:
The capital growth in REIT is quite low as compared to other investments because 90% of REIT earnings are distributed among the investors in the form of rental income or interest. Also, only 10% of earnings are further reinvested in some other project which is very low.
#3 No-tax Benefit:
There is no tax benefit in the REIT because dividends earned from the REIT companies are subjective to the taxation
How does a Company qualify as a REIT?
The company has to fulfill the below-mentioned criteria to qualify as a REIT:
- The company must be incorporated as a business, trust, or corporation.
- It is to be managed by a team of trustees or a board of directors.
- It must have a minimum of 100 shareholders.
- The shares are fully transferable without any restrictions.
- 50% of shares are not held by less than 5 individuals in each taxable year.
- Company 90% of taxable income is to be distributed among the investors as a dividend.
- A company must accrue a minimum of 75% of gross income from mortgage interest or rents.
- 75% minimum investment assets must be in real estate, cash, or U.S. Treasuries.
Why are REITs created?
REITs allow an investor to invest in any property to generate revenue from commercial Real Estate which is not easily available to the small investors due to the large investment amount. But there are few benefits to Real Estate companies that form a REIT, which areas:
- Interest and dividends received by a REIT from a Special Purpose Vehicle (SPV) got tax benefits. SPV can be defined as a domestic company in which a 50% stake is held by REIT.
- Any income that is earned by renting or leasing Real Estate Assets that are owned by the REIT directly is also exempt from the tax.
These tax exemption benefits attract the Real Estate Companies to invest in the REITs to reduce the tax liability and generate a second source of income. Besides it, a Real Estate Company can also get access to additional funds or loans after listing REIT on the stock market under Initial Public Offer (IPO) project.
Who should invest in REITs?
As REITs own and manage high-value real estate properties that are the very expensive avenue of investment. Subsequently, High Net worth Individuals (HNI) engage their funds in the REIT.
For example, big institutional investors, bank departments, etc. can eventually invest in REIT.
There are several chances of fraud in the REIT also. An investor must verify that anyone who tries to sell REIT must be registered with The Securities and Exchange Commission (SEC) whosoever tries to sells. IT is advisable to verify the registration of both publicly traded and non-traded REIT through the SEC EDGAR system. Through the portal, one can review the quarterly and annual reports as any offering prospectus. To prevent Indians from any fraud or mishappening, SEBI mandates the below-mention criteria to follow up-
- Indian REITs can only own constructed commercial property. They can’t own any vacant land or agricultural land.
- At least 80% of REIT investment can be done in completed and rent generating properties. Whereas, remaining 20% will invest in semi-construct property, listed or unlisted equity shares of real estate.
- 51% of the REIT revenue should be from the leasing of the commercial property.
How do REITs generate returns for investors?
The purpose of any investment is to generate wealth for its investor by maximizing the return. Therefore, REIT provides the benefit to both Real Estate Companies as well as the unitholders. The main benefit that an individual will avail as an investor is a dividend or interest that provides a regular source of income. On the other hand, Real Estate Companies get the tax benefit for the REIT investment.
- Dividend and Interest: The primary source for an investor through REIT is the dividend or interest payable to him/her. This revenue will generate by the companies after renting or leasing the commercial property. Hence, some charges will deduct from this earned income such as commission, maintenance, operating expenses, etc. Currently, SEBI mandate the minimum requirement of 90% to distribute among the shareholders and the rest of 10% will reinvest in any other projects for future growth of the both investor as well as the company.
- Capital Gains: REIT is further list and trade on the stock exchange to maintain the liquidity for the investor. Just like the mutual fund, stocks and bond, good performance leads to increase their price, the same thing happens with the REIT also which increase the profit of the investor and also provide the capital gain in a long-run.
Tax rules for REIT
As an investor obtain a different type of profit from the REIT, two different types of tax rules are applicable- one is for dividend and the second is for capital gain. The applicable taxation rule is as:
- Taxation for dividend: The dividend obtained from REIT are completely applicable in the hands of the investors. The dividend receives by an individual will further include in the annual income and taxed according to the tax slab of an individual for a particular year. The tax slab may vary from individual to individual based on their earnings for a specific time.
- Taxation for capital Gains: Capital Gain from the sale of a REIT investment is cover by both Short Term Capital Gain (STCG) and Long Term Capital Gain (LTCG). Usually, STGC is applicable for less than one year from the date of allocation for the units with a 15% of the tax rate on the capital gain. On the other hand, LTCG is applicable for more than one year with a 10% of tax rate on the capital gain.
- Taxation of Capital Gain for the International REIT fund of funds: If the capital gain occurs from the sale of a unit of international REIT fund of funds, then non-equity capital gain taxation rules are applicable. In the case of STCG, the holding period applicable is less than 3 years and the individual tax slab is applicable based on the individual earning. On the other hand, LTGC is applicable if the unit is hold for more than 3 years and a 20% tax rate is applicable.
Should you invest in REITs?
The main objective to invest in REITs is to diversify the individual’s investment portfolio through exposure to the commercial property in the form of shares without holding any physical property and hassles related to purchasing and maintaining that property. Besides it, it includes professional management of assets through the professional who works through proper analyzing a track of record to eventually grew that individual’s portfolio.
On the other hand, it contains dividends, interest, and capital gain benefits with high liquidity. But undoubtedly some limitations too, such as operating expense and tracking error. As a result, it is always advisable that REIT should contain a minor part of your portfolio (ideally not more than 10%). Ideally REITs investment decision will make after, optimizing the asset allocation across debt, equity, mutual funds.
How Indian REITs work?
SEBI made certain rules and regulations for the Indian real estate market. Unitholders can partly make the rules for its working.
- SEBI requires REITs to have a three-tier structure like mutual funds. The sponsor sets up the REIT, the manager manages the portfolio and the trustee overlooks all functions of REIT.
- The sponsor transfers the initial portfolio of assets to the REITs. This transfer is based on an independent valuation. SEBI holds at least 25% of the REIT unit for three years after the IPO and 15% after that.
- Managers usually charge fees i.ie., fund management fees and property management fees. 3.5% of the rent fee was the charge on property management. 0.5 % of the distribution fee was the fund management fee.
- Sponsors need to have a minimum net worth of Rs 100 crore and at least five years of experience in the real estate sector. Whereas, the manager needs Rs 10 crore net worth with a minimum of five years of experience.
- The minimum application size for a REIT in an Initial Public Offer is Rs 50,000 and the minimum trading lot in secondary marker is 100 units.
- REITs are exchange on their expected distribution and Net Asset Value of the portfolio on the stock exchange.
How they distribute the returns?
REITs returns will distribute in the following three ways to its unit holders as:
- Firstly, they receive rent from leasing the commercial property.
- Secondly, investors receive interest from their subsidiaries or SPV which they have funded to develop the property.
- At last, the Capital gain is possible in the long run if the market price of the real estate rise and through the sale of the real estate asset. But the market price of REIT can run ahead or behind their Net Asset Value, based on the market estimates of their income and potential.
REITs can not based on the cash flows, they only earn in the hope of future CAPEX. SEBI mandates 90% of the cash flows is distribute among the unit holder in the form of interest payment or renting from the leasing. These distributions are mandatory for six months. On the other side, some REIT companies committed to distributed quarterly dividends like Embassy. Also, 10% of REIT income will further reinvest in some other property for the future term within a year, failing which 90% will distribute among the unitholders.
For many investors, REITs offer them a unique opportunity to invest in real estate without holding any physical property. As compared to traditional investing, like insurance or fixed deposit, REITs are more convenient, liquid, and accessible to the investor. Also, REIT unitholders got the dividend, interest, and capital gain benefit as an additional income. Whereas, in traditional investment, individuals can only avail interest.
REIT has a superior portfolio of properties and a management team with a proven track record of allocating capital, it is likely to be a good investment, even if the price at which you buy the property is not cheap or deeply discounted at that time.
REIT provides the dividend or interest to the shareholder plus capital gain in long run. So, REIT is considered as a good investment to diversify the portfolio but as a beginner in a career, it is advised to go for some other form of investment.
One can invest in REIT in a publicly-traded REIT, which is listed on the stock exchange, by purchasing shares through a broker. You can also purchase a share of non-publicly traded REIT, through a broker that participates in the non-trading offering.
Generally there are five types of REITs as: equity , mortgage, hybrid, publicly traded and non-traded reits.
Generally, REIT owns and manage a variety of property such as healthcare, shopping complex, office buildings, apartments, big institute, restaurants, etc.
Any individual investor of all ages can invest in REITs worldwide. Also, big institutions, bank departments, trusts can invest in REIT.
REITs were created by U.S. Congress in 1960, to provide individuals an opportunity to diversify portfolios and generate an additional source of income. It facilitates big investors to pool an amount of money together and invest in real estate.
There are several benefits available to REIT unitholders such as dividend, interest, and capital gain in (long-run) by selling the property.
Yes, more than 35 countries have REITs. First, it was introduced in the US by Congress, and later on Australian, Japanese stock exchanges also introduced REIT and so on.