Can get even single REIT units; retail buyers need to understand this asset class

Real Estate Investment Trusts (REITs) is a relatively new asset class for investment by retail buyers in India. As in anything new, it is not fully understood and therefore can be intimidating.

REITS are funds that own, operate and manage a portfolio of income generating commercial property. They allow consumers to own small shares of high quality income generating commercial real estate assets. Any domestic, foreign, retail or institutional investor can purchase REIT units. They are listed on the stock exchanges and investors can buy shares of REITs like any other shares on the stock exchange, through demat accounts, with no minimum trading requirement. They can be bought and sold on NSE or BSE, either online or through a registered broker or in a REIT IPO, upon listing. REITs are highly regulated and must pay out at least 90% of the Net Distributed Cash Flows semi-annually. They are a hybrid product between yield-oriented fixed income generating assets and capital appreciation oriented equity products.

Today there are 3 REITs in India which manage 86 million sq ft. They have a combined market capitalisation of Rs 580 billion and have raised Rs 167 billion in primary equity proceeds since 2019. They have distributed Rs 53 billion and have a AAA credit rating. By reducing the trading lot sizes, there is enhanced liquidity. All three REITs rank among the top 10 listed real estate players in India: Embassy REIT with Rs 329 billion, Mindspace REIT with Rs 174 billion and Brookfield REIT with Rs 77 billion, as of June 30, 2021. The Blackstone-Embassy REIT has assets in Bengaluru, Mumbai, Pune and Noida. The K Raheja sponsored Mindspace REIT is present in Mumbai, Hyderabad, Pune and Chennai, while the Brookfield India REIT has assets in Mumbai, Gurgaon, Noida and Kolkata. Clearly IT is the driver and mainstay of this investment asset.

There are rules on the kind of assets that REITs can own. These include rental income earning real estate projects in commercial sectors of offices, hotels, retail, industrial and healthcare. At least 80% portfolio must be completed and income earning projects and a maximum of 20% can be under-construction assets.

With this type of portfolio, the REIT earnings are from rental income generated by the underlying assets in the portfolio. The asset quality is high-quality institutional grade commercial properties in key metro cities that attract premium rentals. The tenant quality is diversified and consists of multinational companies that pay rentals on time. Long-term lease contracts ensure steady cash flows.

Both REITs and equity shares can be purchased in single units, are freely transferable listed securities, with entry or exit loads and are professionally managed. Direct investments in real estate, on the other hand, have an entry barrier of at least Rs 25 lakh normally, are locked-in, illiquid and with transaction costs involved. The management standards too are not regulated, and therefore not assured.

REITs, according to present regulations, must necessarily have Grade A assets in prime locations and are primarily office properties with marquee tenants across sectors. Equity stocks are a mix of Grade A and B stocks of office, residential and retail sectors with multiple tenants across sectors. Direct investment is usually in standalone buildings which are exposed to single tenant risks.

REITs returns are through capital appreciation and regular cash distribution (90% mandatory), RE equity shares give returns based on capital appreciation and dividends which are not mandatory, while direct investments give returns only through a timely and profitable exit.

REITs and RE equity dividends are tax exempt, while direct investments are taxable. REITs regulation is stringent. It de-risks the retail investment as at least 80% of value must be in completed and income producing assets, ensuring regular cash flows. There are restrictions on speculative land acquisition. At least 90% of distributable cash flows must be distributed semi-annually.

There is a restriction on debt. Majority unitholder approval is required if debt exceeds 25% of asset value. Debt can also never exceed 49% of asset value.

At least 50% of independent directors on board must have a 50% representation on all committees. The REIT manager can be removed with 60% approval of unrelated unitholders. There is alignment with the unit holder interests due to a distribution-linked management fees structure.

Safeguards include prohibiting sponsors from voting on their related party transactions. Majority unitholder approval is required for acquisition or disposal of assets that exceeds 10% of REIT value. Acquisition value cannot deviate more than 10% from average valuation of two independent valuers. Fairness opinion from an independent valuer is required if a related party leases more than 20% of the underlying asset.

Indian REITs are primarily skewed toward IT-occupied assets. This is backed by the projection that the Indian digital economy grew from $200 billion in 2017-18 to $1 trillion in 2025. Digital services as a percentage of all services is estimated by Nasscom to grow from 29% in 2020 to 58% in 2025. This is reflected in the 82% growth in the number of employees from 2020 to 2022.

As of now buying into IT assets backed REITs is a good idea for the short and medium term as digital businesses and solutions providers are witnessing booming business. GOing forward many more categories of REITs are expected to hit the market as the regulator opens up more categories of rental income earning assets to be aggregated under this umbrella.

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