Should you invest in REITs now?

REITs, or Real Estate Investment Trusts, were launched in India with much fanfare. These were touted as less capital-intensive alternatives for investors looking to invest in real estate as an asset class which will give them high return with the least amount of risk. However, REITs have not been able to live up to the hype as they have not been able to deliver the returns that were expected. Many existing investors now want to know if they should stayed invested or exit. Prospective investors, who were considering REITs, are now wondering if they should go ahead with their investment or not? Before we tell you what to do, here is a look at why other routes to invest in real estate have not picked up. Low capital growth in residential properties: Most retail investors have traditionally been investing in residential properties. However, it has been a costly affair and for majority of Indians it has been limited to one self-occupied property. While the number of people investing in second and third properties has risen, the returns have been disappointing both in terms of asset appreciation and rental yield. Long term annual capital growth from residential properties City 3 years 5 years 7 years Bengaluru 6.1% 5.7% 6.0% Chennai 1.0% 3.0% 3.9% Delhi -3.1% 1.6% -2.3% Kolkata 5.1% 3.9% 5.0% Mumbai 3.6% 4.7% 5.3% As on quarter ending September 2020, Source NHB (Residex) 83195636As on quarter ending September 2020, Source NHB (Residex)Low rental yield pulls down total return: The problem of low growth of price gets accentuated with low rental yields. "Residential rental yield (the annual rate of return an investor can earn from his capital invested in a property) has long since stagnated in India and the national average stood at 3% (per annum) for the last few years. As of date, it went down even further to 2.9%, as per the latest ANAROCK research. In comparison, in countries such as the US, the residential rental yield is >7% presently," says Anuj Puri, Chairman, ANAROCK Property Consultants. Residential Rental Yield in Top 5 Cities Cities Rental Yield as on Date (per annum) Hyderabad 3.60% Bengaluru 3.50% Pune 3.25% Mumbai Metropolitan Region (MMR) 3.00% Delhi NCR 2.80% Top 7 cities 2.90% Source: ANAROCK ResearchOn the other hand, savvy investors who own grade A or B commercial properties are likely to continue reaping good rental yields. "As for commercial office space, the rental yield for Grade A office space is presently anywhere between 6-8% while for Grade B office space it is between 4-6%," adds Puri. Such high grade properties have been out of reach for most of retail investors. Many investors have burnt their fingers by investing in low grade commercial properties.Unavailability of less costly alternatives: Physical real estate ownership involves high transaction costs primarily due to brokerage and registration fee. Besides this, lack of liquidity and professional management have also been major pain points. This is where need for professional management of commercial real estate and pooling of resources through fractional ownership was felt by many investors.Real estate MFs did not work: In the early 2000s, many mutual fund houses tried to pool resources and give investors the benefit of real estate return by launching real estate focused mutual funds. However, it could not beat the larger trend in the Indian real estate sector and most of the funds did not work well and ended up shutting their schemes or modifying their objectives. Real estate AIF are mostly out of reach for retail investors: "The minimum investment criteria for regular units in a real estate AIF is Rs 1 crore. However, the minimum ticket size can be higher, say Rs 5 crore, in different class units, where set-up fee and management fee could be lower than regular units," says R.Pallavarajan, Founder and Director, PMS Bazaar, a PMS comparison platform.Let us now take a look at where REITs score, will they survive the pandemic, and what investors should do. REITs came with a promise what many investors were looking for "In India, until the advent of REITs, Commercial Real Estate was inaccessible to retail investors owing to high ticket prices, illiquid long-term investments, and difficulties in administering and managing significant assets. Now, with REITs, retail investors can build wealth through commercial real estate, in a liquid, tradable unit with tax efficiency and high-quality management," says Michael Holland, CEO, Embassy REIT.It works similar to fractional ownership which significantly reduces the entry barrier in terms of high amount of investment for physical ownership as you can start investing even with Rs 50,000 in a REIT. REITs own high grade commercial properties which are rented mostly to multinational and Fortune 500 companies for long term lease often for 6-8 years."REITs provide greater diversification, potentially higher total returns and lower overall risk. The REIT assets are professionally managed with a compulsory minimum allocation of 80 per cent to completed, income-generating assets, and disbursement of regular income to unitholders," says Holland.As the shares of REITs are traded on stock exchanges it gives liquidity to investors. REITs have been mandated to distribute 90% of their rental income as dividend. They can also lend to Special Purpose Vehicles and the earned income is also distributed as interest income to the investors. "REITs also provide the potential for long-term capital appreciation to retail investors. Since REITs are required to distribute at least 90 per cent of earnings to investors, they make a sound choice for those who need an income in addition to capital appreciation" says Holland.Therefore, a major part of return comes in the form of regular income which has typically been in the range of 5-7%. How REITs score on taxationSince the return from REITs largely comprise of distributed income and less of capital gain, taxation of this distributed income becomes critical. "Current rules mandate that dividends obtained from REITs are taxable in the hands of investors. The dividend payouts are included in the annual income of the investor and are taxed as per his/her income slab rate for the said fiscal year," says Puri.When it comes to capital gain the treatment of REITs is comparable to equities. "Capital gains from the sale of REITs units are either considered as Short Term Capital Gains (STCG) and Long Term Capital Gains (LTCG) as applicable to equity investments. STCG is applicable if the holding period of units is 1 year or less from the date of unit allocation. The STCG tax rate is 15% of capital gains obtained from the sale of units. If the holding period exceeds one year from the date of unit allocation, then LTCG taxation rules are applicable. The LTCG tax rate is 10% of gains in excess of INR 1 lakh (across all equity investments for the applicable FY) with no indexation benefit," says Puri.Will REITs survive the second wave? The oldest REIT in India Embassy Office Park got listed on April 1, 2019 and is hardly 2 years old. Just like equities they are not untouched by heightened volatility. All three REITs are currently trading at least 15% below their peak, while the highest fall is 32% for Embassy Office Park. However, except the most recent Brookfield India REIT, which is trading at 9.42% below the issue price, the other two REITs are still trading above their issue price. Also Read: REITs and InvITs help in diversification but watch out for the pitfalls if investing How listed REITs have been performing REITs Embassy Office Parks REIT Mindspace Business Parks REIT Brookfield India REIT IPO Issue Price 300 275 275 Listing date in the exchange 1-Apr-19 7-Aug-20 16-Feb-21 Current price (21 May 2021) 326.5 289.09 249.09 Growth from Issue Price 8.83% 5.12% -9.42% Forward Dividend Yield* 6.50% 6.64% NA Maximum fall from the peak 36.55% 15.27% 18.15% Current fall from the peak(as on 21 May 2021) 31.97% 15.37% 6.85% *It is an estimation of a year's dividend as % of the current stock price"It is still too early to comment on how long it may take for the rental market to revive here in India because of the devastating impact of the second covid wave and further anticipation of the third wave," says Puri.However, it is equally true that there has not been significant reduction in demand for high grade commercial properties. "Now, amid the second wave, there are definitely no move-ins happening across most cities due to lockdown restrictions, but gradually we may see some uptick once the cases begin to recede, and restrictions are eased. This is largely because the previous work-from-anywhere trend is gradually fading. Going forward when things begin to resume to normalcy, most offices will either follow hybrid model or rostered work timings or work-from-office for a day/two in a week. This will push the rental market to see some uptick," says Puri.Most of the REITs have long term leases with multinational and Fortune 500 companies with good track record of honouring long-term rental contracts, therefore shocks are likely to be limited. What should you do? If you are an existing investor, you may continue your investment with caution as the peak of second wave is behind. You need to watch out for any major occupancy and renewal related development with your investment and cut down your exposure or exit if you are not comfortable with any adverse development specific to your stock. Another important aspect is not to go overboard with your overall real estate exposure. "How much exposure strictly depends on the investor's profile. But very broadly speaking, one should not have more than 10-30% in real estate or real estate-oriented investment avenues," says Col. Sanjeev Govila (Retd), a SEBI Registered Investment Advisor (RIA).If you are a new investor, you have to take a call based on your asset diversification need. REITs are not the replacement for your self-occupied property. However, if you are looking to invest beyond that in a second residential or commercial property then you can consider REITs. For this, you need to take a call based on the nature of the return you are expecting. If the need is for capital growth, then REITs may not be suitable. REITs work best when you primarily need regular income with some capital appreciation.If you are senior citizen the return may look enticing as they meet the regular income need however, you need to be cautious as REITs are not an alternative to safe fixed income products. "The risk appetite of senior citizens is typically low and they need fixed income from their investments. REITs can provide regular income in the form of dividends but the same is not a certainty - there could be bad periods when the dividend could be low or may not be there. So, depending on the amount of regular income required, one should invest in fixed income products. Some proportion of total corpus may be invested in REITs to diversify the portfolio, if their own financial circumstances permit so," says Col. Govila.

from Economic Times https://ift.tt/3pgGpgd