Caution is key if investing in Reits, Invits

The government plans to utilise real estate investment trusts (Reits) and infrastructure investment trusts (Invits) in a big way to divert funds towards construction and infrastructure projects. Investor interest in these new generation instruments is high due to the prevailing interest rate structure. “Choices are limited for fixed income investors due to the low interest rate environment and Reits can be a good option now,” says Sharad Agarwal, ED, Capital Markets, Knight Frank India.Reits are schemes that collect money from investors and invest the same in real estate. Since 80% of the Reit’s corpus is supposed to be invested in income generating properties and 90% of the income generated needs to be distributed, it is a good option for regular income. Invits are similar to Reits but its investments are restricted to infrastructure projects such as roads, bridges, power grids, etc. Since these routes were made more investor friendly in the recent Budget, more Reits and Invits are expected to hit the market in coming months.While the majority will be aimed at high net worth individuals (HNIs) and foreign portfolio investors (FPIs), some will be aimed at retail investors. These will be listed on the BSE and NSE through the IPO route. Investors, however, should be cautious about the new Reits and Invits because of the volatility seen in earlier ones. For instance, the IRB Invit is now trading at Rs 54.75, compared to its issue price of Rs 102 in May 2017 (see table). Even the fancied Brookfield Riet IPO, listed last week, is trading at a discount to its issue price. 81240687High volatilityHigh volatility in prices of Reits and Invits are due to several reasons. “Though the return profile of Reits and Invits is largely in line with debt products, their risk profile is much higher and more akin to equity,” says Shubham Jain, Senior VP and Group Head, ICRA. “Compared to pure fixed income instruments, Reits and Invits carry higher risk as their prices are dependent upon variables like lease renewals, rental escalations etc. However, higher perceived risk is compensated by higher expected returns, which is a combination of distributed cashflows and capital gains over time,” says Mahesh Kuppannagari, Head, Products & Advisory, Global Private Client, Ambit Capital. 81240731High volatility in Reits in the past year can be attributed mostly to cash flow disturbances. “Reits have become highly volatile because of the disturbances in rentals triggered by lockdowns and the fear that future rentals may be renegotiated at lower rates,” says Gaurav Dua, Senior VP and Head – Capital Market Strategy, Sharekhan. The emergence of the work from home culture could cut the need for office space and put pressure on rental rates. However, Agarwal feels that worst is over. “Though there was fear of commercial space rentals going down during lockdown, it is not a fear now because offices are opening. Reduction in commercial real estate supply, due to covid induced disturbances, will support the rent rates,” he says.Concerns about quality of assets and valuation can be another reason for volatility, especially when the sponsors of Reits are also the sellers of the property. For example, IRB Invit is still quoting at a deep discount due to these transparency concerns. Going with professional Reit sponsors, like that of Brookfield, is one way to avoid these ‘related party concerns’. The good news for investors is that the negative sentiments about these products now are keeping their valuation at reasonable levels. “All three listed Reits have high quality assets as underlying and expect them to do well once normalcy returns to the rental market,” says Kuppannagari.HNI products“Reits and Invits are aimed at investors like HNIs, insurance companies, provident funds, etc which can hold for the long term and therefore, can ignore short term market volatility. So, it is better if retail investors, who come to the IPO market for listing gains, avoid this space,” says Dua. Their complex nature also makes them suitable only for HNIs. “Since Reits and Invits are complex products, they are suitable only for investors who have the required knowledge,” says Jain. For example, Reits may have income in the form of rent, interest and dividends. Since Reits are ‘pass through’ vehicles and not liable for tax on income received, the tax liability falls on the investor. At the time of distributing surplus, Reits will declare this ratio and investors pay tax accordingly.Consider the priceThough long term investors can avoid the short-term volatility, they should not ignore the price at which they are entering. “Since each Reit and Invit has different asset bases and expected distribution yields, right valuation becomes key,” says Jain.Since 90% of the income is distributed to investors, return from these instruments will come mostly from interest or dividends. Checking distribution yield and comparing it with prevailing interest rates can be the best way to assess valuation. “We are bullish on all three listed Reits. Allow diversification across assets by investing 40% of your Reits allocation in Brookfield, 30% in Mindspace and 30% in Embassy,” says Kuppannagari.

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