Real estate investment trusts (REITs) are essentially a group of income-producing real estate assets held similar to a mutual fund. Just the way in mutual funds, with REITs, the investor’s money is spread into commercial real estate spaces/assets. Through REITs, retail investors get the opportunity to invest in commercial real estate that would otherwise be just a distant dream.
Units included in this portfolio are sold to investors through a public offering. Once this listing is listed on the exchanges, unit holders can trade units on the secondary market
Types of real estate investment funds.
REITs – REITs make money primarily by the owner and provide spaces such as shopping malls, large office spaces, and mega-residential towns to tenants on lease. The income earned is then divided among REIT investors in the form of dividends.
Mortgage Funds – Here, there is no owner concept. There is only money that is taken for debt that is taken for the development of real estate projects. Basically, mortgage trusts earn income in the form of equal installments that are then distributed among REIT investors as dividends.
SEBI requires that REITs in India have a three-tier structure like mutual funds. The sponsor sets up the REIT, the manager manages the portfolio, and the trustee is supposed to monitor both.
Sponsor – They own at least 25% in REITs for 3 years and 15% thereafter. Their main responsibility is to create a REIT and appoint a trustee. To ensure that doubtful entities do not promote REITs, sponsors must have a minimum net worth of Rs 100 crore and at least 5 years experience in the real estate industry.
Manager – A company, LLP, or corporate body that manages and operates a REIT. The Director must have at least 5 years of relevant experience along with other requirements as advised.
Trustee – who generally oversees the activities of REITs that are appointed by the sponsor.
What is the minimum investment required?
In two separate notifications dated July 30, 2021, Sebi said the minimum application value has been reduced to a range of Rs 10,000 to 15,000 for REITs and InvITs, compared to the previous requirement of Rs 50,000 for REITs and Rs 1 lakh for InvITs. Allocation to unit holders will be in multiples of lot size.
However, once listed they can be traded in individual units.
Where do you invest the money?
The REIT is mainly allowed to invest in completed income-producing assets and other approved investments. Also, the REIT must distribute the majority of the income it produces among the unit holders.
REITs can invest primarily in commercial real estate through two methods – (i) directly and (ii) through a Special Purpose Company (“SPV”) which is required to invest more than 80% of its assets in real estate.
The remaining 20% could be in real estate under construction, listed or unlisted debt to real estate companies, listed or unlisted equity shares of real estate companies, mortgage-backed securities, securities, or money market instruments. If the REIT is carried out through an SPV, their final stake in the SPV must be at least 26%.
In terms of leverage, REITs are not allowed to draw more than 49% of their total assets while making sure that they are nothing more than borrowing.
How are the returns distributed?
Unit owners earn income through rents received from real estate owned by REITs which can be through dividend income, interest income or capital gains through the sale of units in the secondary market.
REITs make money through 3 sources:
They get rent from commercial real estate that has been rented out.
Interest payments from subsidiaries or special purpose companies that they financed to develop the property.
Capital appreciation for their property.
They are required to distribute 90% of the income they receive to the unit owners. These distributions are levied once every six months.
WHAT YOU SHOULD CONSIDER BEFORE INVESTING IN REIT
The biggest risk of operating a commercial property is vacancy, which is measured in years by weighted average lease end (WALE). The more time the drug is free, the better.
By law, REITs are required to pay 90% of their distributable cash flows to investors. The metric for measuring this is the yield of the distribution. Also, this is not a guaranteed return and depends on the performance of the trust.
A property located in a prime location will have a high occupancy rate. If the occupancy rate is high, the cash flows are stable.
NAV: Calculated as the estimated market value of all properties minus the liabilities divided by the number of shares outstanding. The net asset value provides a fair estimate of a REIT’s performance and its capital value.
The total income of a business fund consists of interest and dividends from special purpose corporations, rental income if it holds rental-earning assets, investment income from money-deposit trusts/contracts where surplus funds are available, and capital gains under Section 111A and 112.
In the hands of the unit owner:
Transfer of units by unit holders is subject to capital gains tax at the applicable rates.
Any short-term capital gains arising from unit conversion are taxed at 15%. Long-term capital gains are taxable at 10% if the amount exceeds INR 1 lakh.
Unitholders who receive any income distributed through trusts such as interest or dividends must be treated as unit owner income for that prior year.
Similar to REITs, Infrastructure Investment Trusts (InvITs) collect money which is then invested in cash flow generating infrastructure projects such as highways, roads, pipelines, etc.
They usually have a 4-level structure
Trustee: These are the trustees of the bonds who are required to be registered with SEBI.
Sponsor: Promoter, LLP or body with a net worth of at least Rs 100 crore that establishes the trust and must hold at least 15% of the total calls for at least 3 years or as per any regulatory requirement.
Investment Manager – A corporation, LLP, or corporate body that manages essentially all of the business activities surrounding InvITs.
Project Manager – He is responsible for the implementation of the project and in the case of a public-private partnership, the entity formed should take over the responsibilities surrounding the implementation of the project.
Since REITs and InvITs are listed on the stock exchange, one can easily buy/sell them in the secondary market.