REITs: Good option for investors seeking regular income, diverse portfolio

But initial investors have to deal with low liquidity on exchanges, lack of choices, and absence of track record

Embassy Office Parks, the joint venture between Bengaluru-based Embassy group and US-based private equity fund Blackstone, plans to file the offer document for its real estate investment trust (REIT) soon. REITs, a long-awaited investment product, will give retail investors access to one more asset class with which to diversify their portfolios. 

REITs offer several advantages to retail investors. First, the underlying asset here is commercial real estate. If the retail investor were to invest directly in commercial real estate, the ticket size required would run into millions. “With REITs, investors will be able to invest in quality commercial real estate with small amounts,” says Rajeev Bairathi, executive director and head–capital markets, Knight Frank India. The minimum amount a retail investor must put in is Rs 200,000. 

This is also a stable asset class. “Leases in commercial real estate tend to be long term, and the rental escalation clauses also tend to be standard, so investors can look forward to steady returns,” says Neeraj Sharma, director, Grant Thornton Advisory.   
 

By investing directly, even high net worth investors may at best able to invest in two or three buildings. A REIT, by holding multiple assets across cities, will offer diversification across geographies and developers. Investors will also get the benefit of professional management. 

REIT is also expected to be a transparent product. While listing, it will have to comply with a large number of regulations of the Securities and Exchange Board of India and also make several disclosures. Such business-related information is not easily available to an investor investing directly in commercial real estate. 

Investors looking for a regular income stream may invest in it. “It will not be suitable for those looking for short-term capital gains. Capital gains will happen, but only over the longer run,” says Bairathi. In India, Bairathi expects gross yields from REITs to be in the range of 14-15 per cent. The net yield will equal the gross yield less the expense ratio (which is not known at present).

REITs will also be subject to a variety of risks. One is vacancy risk. The other is pricing risk (the building could get re-leased at a lower rate). During economic downturns, both rentals and capital appreciation from commercial real estate tend to be affected. 

REITs may also not be very liquid. “The underlying asset class is not very liquid. Investors who want to exit REITs may have to sell their units at a discount on the exchanges,” says Vishal Dhawan, chief financial planner, Plan Ahead Wealth Advisors. Moreover, he adds, this is a new structure, so no performance track record will be available initially. Investors will also not have several options to choose from. He suggests that investors should avoid investing heavily in this asset class initially. And even later, their holdings in REITs should not exceed 10 per cent of their portfolio.

As for taxation, capital gains will be taxed at the same rates as listed securities. If you hold their units for the long term, the tax rate will be 10 per cent, and for the short term it will be 15 per cent. The Rs 100,000 exemption on long-term capital gains will also be available to REITs. “The only difference is in the holding period. For listed shares, the holding period for capital gains to be treated as long term is 12 months, while in the case of REITs it will be 36 months,” says Bhavin Vora, director-tax and regulatory, PwC. 

Dividend from a REIT will be tax-free in the hands of the investor. Interest income will be taxed at 5 per cent for non-resident Indians, while resident Indians will have to pay the maximum marginal tax rate.