- August 25, 2023
- Posted by: Advince
- Categories: Blogs, India F&A
A Real Estate Investment Trust (REIT) is a specialized financial vehicle that allows individuals and institutions to invest in income-generating real estate properties without directly owning or managing them. REITs pool funds from multiple investors to purchase and operate a diversified portfolio of real estate assets, such as commercial buildings, apartments, hotels, or industrial properties. “Since their introduction in the Indian market in 2019, REITs have gained popularity as publicly listed investments regulated by the Securities and Exchange Board of India (SEBI). Investing in REITs provides several advantages, including instant liquidity, affordability, safety through regulatory oversight, tax benefits etc. They are mandated to distribute at least 90% of their taxable income to shareholders in the form of dividends, offering investors the potential for regular income and other benefit.
Criteria that a company must meet to qualify as a REITs-
For a company to qualify as a REIT, it is vital that the following criteria are satisfied:-
- A minimum of 90% of the earnings should be disbursed to investors through dividend payments.
- At least 80% of the investments must be directed toward revenue-generating properties.
- Only a maximum of 10% of the total investment can be allocated to properties under construction.
- The company needs to maintain assets valued at no less than INR 500 crores.
- The Net Asset Value (NAV) must undergo semi-annual updates during each financial year.
Types of REITs
The three main types of REITs are-
These REITs primarily invest in income-producing real estate properties and generate revenue from rental income. Investors in equity REITs receive dividends based on the rental income generated by the properties in the portfolio.
Mortgage REITs (mREITs):-
Unlike equity REITs, mREITs invest in real estate mortgages and securities tied to real estate loans. They make money from the interest on the mortgages and may be more sensitive to changes in interest rates.
These REITs combine characteristics of both equity and mortgage REITs. They invest in both physical properties and real estate loans, offering a mix of rental income and interest income.
Structure of REITs-
In India, the structure of Real Estate Investment Trusts (REITs) is regulated by the Securities and Exchange Board of India (SEBI). The structure of REITs in India follows a specific framework:
• Sponsor: The sponsor is typically a real estate developer or a financial institution that initiates the formation of the REIT. The sponsor must hold a minimum of 15% of the total units of the REIT for a specified lock-in period.
• REIT Manager: The REIT is managed by a manager, which is often an entity related to the sponsor. The manager is responsible for the day-to-day operations of the REIT, including property management, leasing, and administration.
• Trustee: A trustee is appointed to safeguard the interests of the REIT’s investors. The trustee ensures that the REIT complies with SEBI regulations and the terms of the trust deed.
• Investors: Investors purchase units of the REIT, which represent their ownership in the trust. These units are listed and traded on stock exchanges, providing liquidity to investors.
• Asset Portfolio: The core of the REIT’s structure is its real estate asset portfolio. Indian REITs primarily invest in income-generating commercial real estate, including office buildings, IT parks, shopping centers, and similar properties.
• Income Generation: The primary source of income for Indian REITs is the rent collected from tenants of the properties in their portfolio. This rental income is distributed to investors in the form of dividends.
• Dividend Distribution: Indian REITs are required to distribute at least 90% of their net distributable income to investors, primarily through dividends.
• Minimum Investment: To invest in an Indian REIT, an individual investor must purchase a minimum number of units as per SEBI regulations.
• Taxation: Indian REITs enjoy certain tax benefits, such as exemption from taxation at the trust level, provided they meet SEBI and Income Tax Department requirements.
• Valuation: The Net Asset Value (NAV) of the REIT’s units is calculated regularly, allowing investors to monitor the performance of their investment.
• Listing: Indian REITs are listed on stock exchanges, providing liquidity and ease of trading for investors.
• Regulatory Compliance: REITs in India must adhere to SEBI regulations, including guidelines related to minimum asset size, leverage, and distribution of income.
Taxation of REITs-
- One of the key benefits of REITs in India is that they are not subject to income tax at the trust level. This means that the income earned by the REIT from its real estate assets, including rental income and capital gains, is not taxed at the trust level. Instead, the income is passed on to the unit holders (investors).
- Dividend income from REIT units is tax-exempt if the REIT’s Special Purpose Vehicle (SPV) has not opted for the lower tax regime under section 115BAA of the Income-tax Act, 1961.
- If the REIT’s SPV has opted for the lower tax regime under section 115BAA, dividend income from REIT units is taxable at the individual’s applicable income tax rate.
- When selling REIT units held for more than 36 months, long-term capital gains are taxed at a rate of 10%, plus surcharge and cess.
- Short-term capital gains from the sale of REIT units held for up to 36 months are subject to a tax rate of 15%, plus surcharge and cess.
- According to the Finance Act 2023, investors can reduce ‘loan repayment’ from the cost of acquisition when selling REIT units. This deduction helps in determining the taxable capital gains.
Benefits of REITs
• REITs are mandated to distribute 90% of their taxable income as dividends, ensuring a consistent and potentially substantial income for investors. This feature is especially attractive to those seeking reliable income, such as income-focused investors.
• REITs typically manage a mix of real estate assets, spanning various sectors like residential, commercial, industrial, and healthcare. This diversification minimizes risk by spreading exposure across different types of properties and locations, reducing vulnerability to sector-specific or regional fluctuations.
• REIT shares are publicly traded on stock exchanges, providing investors with liquidity. Unlike direct real estate investments, which can be illiquid and time-consuming to buy or sell, you can easily buy or sell REIT shares at market prices.
• REITs are managed by experienced professionals who handle property acquisition, leasing, maintenance, and other operational aspects. This allows investors to benefit from the expertise of real estate professionals without the need for direct involvement.
• REITs are obligated to adhere to rigorous regulations that mandate regular financial reporting and disclosure. This commitment to transparency ensures that investors have a transparent view of the REIT’s financial well-being and performance.
• REITs are exempt from paying federal income tax at the corporate level if they meet specific criteria. This tax-efficient structure allows more of the income to be passed on to investors.
• Investors can typically start investing in REITs with a relatively small amount of capital, making them accessible to a broader audience.
Quarterly REIT Performance
In the second quarter of 2022, the REIT industry experienced a challenging period, as reflected in negative market returns. Equity REITs saw a decline of 14.7%, while mortgage REITs experienced a drop of 15.8%. The broader market, as measured by the S&P 500, also faced a decrease of 16.1%. However, it’s worth noting that despite the tough stock market performance, REITs demonstrated resilience in their operating performance during this period. Total REIT Funds From Operations (FFO) showed a notable increase, rising by 9.8% from the previous quarter and 15.4% over the past four quarters. Some sectors, such as lodging/resorts, self storage, and residential, exhibited particularly strong FFO growth over the year. REITs also maintained strong balance sheets, with an average debt maturity of over 7 years, and the unemployment rate held steady at 3.6%.
• Market Risk: REITs are subject to market fluctuations, and their share prices can be influenced by broader market movements. Economic downturns, bear markets, or adverse events affecting the financial markets can lead to declines in REIT stock prices. The extent of these market risks varies depending on the overall economic and investment climate.
• Dividend Risk: While REITs are known for their dividends, there is a risk that economic downturns or financial difficulties within the REIT may lead to reduced or suspended dividend payments. Investors relying on consistent income from REITs should be mindful of this risk.
• Regulatory Changes: Changes in tax laws or regulations affecting REITs can have a significant impact on their income, expenses, and overall profitability. Investors should stay informed about regulatory developments that could affect the REIT market.
• Low growth prospects: The prospect of capital appreciation is quite low in the case of REITs. It is mainly because they return as much as 90% of their earnings to the investors and reinvest just the remainder 10% into their venture.