Real estate is one of the most popular and lucrative asset classes in India, but it also comes with some challenges such as high entry barriers, low liquidity, legal hassles, and maintenance costs. If you want to invest in real estate without owning physical properties, you may consider investing in REITs or Real Estate Investment Trusts.
REITs are entities that own, operate, and finance income-generating real estate assets such as office spaces, malls, hotels, warehouses, etc. REITs offer investors a way to participate in the real estate market by buying units of the REIT, similar to buying shares of a company. REITs distribute most of their income to the unit holders as dividends, and also offer capital appreciation potential.
In this article, we will explain the benefits and risks of investing in REITs in India, the regulatory framework, the performance of the existing REITs, and the factors to consider before investing in REITs.
Benefits of Investing in REITs in India
Investing in REITs in India has several advantages over investing in physical real estate, such as:
- Diversification: REITs allow you to diversify your portfolio across different types of real estate assets, geographies, and tenants. You can also benefit from the professional management and expertise of the REITs in selecting and managing the properties.
- Low Entry Barrier: You can invest in REITs with a minimum amount of Rs. 50,000, whereas buying a physical property may require lakhs or crores of rupees. REITs also have lower transaction costs and taxes compared to physical real estate.
- High Liquidity: REITs are listed and traded on the stock exchanges, which means you can buy and sell them easily and quickly. Physical real estate, on the other hand, may take months or years to sell, depending on the market conditions and demand.
- Regular Income: REITs are required to distribute at least 90% of their net distributable cash flow to the unit holders as dividends, at least twice a year. This provides a steady and predictable source of income for the investors. The dividends are also tax-free in the hands of the investors.
- Capital Appreciation: REITs can also offer capital appreciation potential, as the value of the underlying properties may increase over time due to factors such as inflation, demand-supply dynamics, rental growth, etc. The unit price of the REITs may also reflect the changes in the value of the properties.
Risks of Investing in REITs in India
Investing in REITs in India also involves some risks and challenges, such as:
- Market Risk: REITs are subject to the fluctuations of the real estate market, which may be affected by various factors such as economic conditions, interest rates, supply-demand dynamics, consumer preferences, competition, etc. REITs may also face the risk of vacancy, default, or renegotiation of leases by the tenants, which may reduce the rental income and occupancy rate of the properties.
- Regulatory Risk: REITs are regulated by the Securities and Exchange Board of India (SEBI), which may change the rules and regulations governing the REITs from time to time. For instance, SEBI may impose restrictions on the leverage, diversification, valuation, or distribution policies of the REITs, which may affect their performance and returns.
- Operational Risk: REITs may face operational risks such as fire, theft, damage, or litigation related to the properties they own or manage. REITs may also incur expenses for maintenance, renovation, or development of the properties, which may reduce their net income and cash flow.
- Liquidity Risk: REITs may have lower liquidity than other equity instruments, as the trading volume and demand for the REIT units may vary depending on the market conditions and investor sentiment. REITs may also trade at a discount or premium to their net asset value (NAV), which may not reflect the true value of the underlying properties.
Regulatory Framework for REITs in India
REITs in India are governed by the SEBI (Real Estate Investment Trusts) Regulations, 2014, which lay down the eligibility criteria, structure, listing, valuation, and disclosure requirements for the REITs. Some of the key features of the regulatory framework are:
- Eligibility Criteria: To register as a REIT in India, the entity must have a minimum net worth of Rs. 500 crore, and a minimum of 200 unit holders. The sponsor of the REIT must have a minimum net worth of Rs. 100 crore, and a minimum of 5 years of experience in the real estate industry. The sponsor must also hold at least 25% of the REIT units for at least 3 years after listing, and at least 15% thereafter.
- Structure: A REIT in India must have a two-tier structure, consisting of the REIT at the top level, and the special purpose vehicles (SPVs) at the lower level. The REIT must hold at least 50% of the equity share capital or interest in the SPVs, which in turn must hold the real estate assets. The REIT may also invest directly in real estate assets, subject to certain conditions.
- Listing: A REIT in India must be listed on a recognized stock exchange, and must raise funds through an initial public offering (IPO). The minimum subscription amount for the IPO must be Rs. 50,000, and the minimum trading lot must be Rs. 1 lakh. The REIT must also comply with the listing and disclosure norms prescribed by SEBI and the stock exchanges.
- Investment: A REIT in India must invest at least 80% of its assets in completed and income-generating real estate assets, and up to 20% in under-construction or non-income-generating assets, securities of other REITs, mortgage-backed securities, equity shares of companies deriving at least 75% of their income from real estate, etc. A REIT must also invest in at least two projects, with not more than 60% of its assets in one project.
- Valuation: A REIT in India must appoint at least two independent valuers to value its assets at least once a year, and disclose the NAV of the REIT at least twice a year. The valuation of the assets must be done as per the International Valuation Standards or any other standards as specified by SEBI.
- Distribution: A REIT in India must distribute at least 90% of its net distributable cash flow to the unit holders as dividends, at least twice a year. The dividends are tax-free in the hands of the unit holders, but the REIT must pay a dividend distribution tax (DDT) of 15% on the dividends.
Performance of REITs in India
Currently, there are three REITs listed in India, namely Embassy Office Parks REIT, Mindspace Business Parks REIT, and Brookfield India REIT. These REITs primarily invest in office spaces across various cities in India, and cater to tenants from sectors such as IT, BFSI, FMCG, pharma, hospitality, etc. The table below shows the performance of these REITs as of December 31, 2021.
REITs have delivered mixed returns since their listing, with Embassy being the best performer and Brookfield being the worst. However, all the REITs have offered attractive dividend yields, which are higher than the average yield of the Nifty 50 index (1.3%). The REITs also have long-term lease contracts with their tenants, as indicated by their high WALEs, which provide stability and visibility of income. The REITs have also maintained high occupancy rates, despite the impact of the Covid-19 pandemic on the office space demand. The REITs have also kept their leverage levels within the regulatory limit of 70%, which gives them headroom to raise more debt for future acquisitions or expansions.
Factor to Consider Before Investing in REITs in India
Before investing in REITs in India, you should consider the following factors:
- Your Investment Objective and Risk Profile: You should invest in REITs only if your investment objective is to generate regular income and capital appreciation from the real estate sector, and you are willing to take the risks associated with the market, regulatory, operational, and liquidity aspects of REITs