Investing in commercial real estate is progressively becoming an alternative for investors who wish to diversify their portfolio with real estate exposure while maintaining flexibility. While investing in prime-location commercial property may not be feasible for everyone, REITs offer easy and affordable participation in the commercial real estate business.
Investment in India’s real estate business has increased recently due to increased demand for commercial and residential space. The epidemic has also resulted in good property prices, encouraging institutional interest. Despite the pandemic-induced dip, institutional investments in this sector get expected to expand by 4% to reach 36,500 crores in 2021, according to a Colliers India analysis.
In India, real estate investment has typically meant acquiring physical property, primarily residential property. However, investing in commercial property such as office buildings, malls, and stores is another option to obtain exposure to the industry. It, however, entails large-ticket loans and the bother of obtaining all necessary permissions, locating eligible tenants and engaging in leases, and then collecting rent.
The REIT path is a lesser-known option. This manner of investing should be monitored in light of the Securities and Exchange Board of India’s (SEBI) recent measures to remove entry barriers and widen the market for small and individual investors. Do not miss Modern Real Estate: Can Indian Investors Safely Invest in REITs?
REITs are like mutual funds in which money from numerous participants gets pooled to invest in real estate or loans guaranteed by real estate. The assets, like mutual funds, are managed by a certified manager.
A REIT, or Real Estate Investment Trust, differs from typical property ownership. Consider it a type of mutual fund plan in which money from numerous participants gets pooled to invest in real estate or loans guaranteed by real estate. The assets, like mutual funds, are managed by a certified manager.
REITs are corporations that own, operate, or finance rental real estate. They were founded with the primary goal of channeling monies that would otherwise be committed to operational functions or real estate ownership into additional income production for the investors, thereby making them an investment vehicle.
Similar to how mutual funds invest your money in assets such as equities, debt, and money market instruments, REITs invest in real estate and get traded on stock exchanges.
Simply put, when you invest in and purchase a unit of a REIT, you are acquiring a portion of the trust’s real estate asset, entitling you, the unitholder, to a portion of the REIT’s income. Do not miss Exploring REITs? Here Are The 3 REITs Listed In India & How To Invest.
How Do REITs Earn Profits?
REITs offer unitholders the benefits of both wealth building and regular income. Investors can receive monthly dividends and/or interest distributions that offer consistent income, while the selling of REIT units on stock exchanges can bring financial gains.
While REITs pay out dividends and interest on their Net Rental Income, capital gains get achieved because the REITs are registered and traded on stock exchanges. Therefore the price of individual units varies depending on their performance plus market demand.
As with equities stocks and mutual funds, successful performance by a REIT raises the price of REIT units, which may then be sold at a profit and offer capital gains to the owner.
Returns on commercial real estate in a fast-paced environment can vary between 8% and 10% per year but reach 15% in the case of Grade-A office space. However, REIT rates in India have so far been comparable to safe bond and post office scheme yields. Experts believe that 10% yields may be expected in India only once the REIT market matures.
Based on an ICICI Securities Ltd analysis, the three real estate investment trusts in India are likely to give dividend yields of 6%-9% from the fiscal year 2022 to 2024, combined with capital appreciation of 12%-18%.
As compared to the stock market, mutual funds, and gold, the risk of volatility is also significantly lower in REITs because they are required to retain 80% of their listings from rent-generating properties. Furthermore, SEBI laws require REITs to disperse 90% of their revenue to unitholders via dividends, interest income, or both.
So, how do REITs produce revenue for their shareholders?
REITs generate revenue for their shareholders via dividend and interest payments through leasing or renting out commercial buildings. Investors also receive capital gains since they are traded on the stock market. When the price of REIT units rises, they can be sold in exchange for financial gains for the investor.
- Dividend and interest payments: The money collected by the REIT through leasing or renting out commercial buildings. The net rental revenue distributed to investors gets calculated after deducting important expenditures such as maintenance, and management fees. A REIT needs to pay at least 90% of its net distributable cashflows to unitholders in the form of dividends. Investors often get quarterly dividends or payouts.
- Capital Gains: The value of REITs listed on stock exchanges rises and falls in response to market demand and performance. When the price of REIT units rises, they can be sold in exchange for financial gains for the investor.
REITs can get purchased via IPOs or the secondary market. SEBI changed the minimal subscription amount and trade lot size for such publicly-traded REITs in July 2021. The base subscription value for REITs is now Rs. 10,000-15,000, with a minimum trading lot of one unit. To invest in REITs, you must have a Demat account.
How Else Do REITs Benefit You?
REITs ensure low-entry tickets and pay out their earnings to shareholders as a dividend after each quarter. They are extremely liquid because the units are exchanged on the stock exchange. REITs invest in a portfolio of real estate buildings, and the risk associated with them is fairly minimal.
- Capital required: In general, commercial real estate takes the least investment of Rs 30-35 lakh and can go much higher depending on the location and property. On the other, if you buy through a stock market, the minimum amount necessary to invest in a REIT might be as little as Rs 50,000. If you want to acquire REIT shares in the primary market through an Initial Public Offering (IPO), you must pay a minimum of Rs 2 lakh.
- Returns: Investing in commercial real estate may provide you with guaranteed rentals plus an interest-free security deposit. While the rental yield increases with time, the monthly rent may increase or decrease depending on market conditions. Annual lease rents on commercial premises might range from 6% to 7%. REITs pay out their earnings to shareholders as a dividend after each quarter. The dividend yield is always proportional to the market price of the unit. Therefore if the market price of the unit rises, the yield falls. Embassy Office Parks REIT’s dividend yield is now about 6.81 percent.
- Less Risk: Direct investments in commercial real estate might be hazardous. If the property is kept empty for an extended period, your total profits may suffer significantly. In contrast, because REITs invest in a portfolio of real estate buildings, the risk associated with them is fairly minimal. Furthermore, because the management and leasing are handled by well-trained specialists, the investor is kept stress-free.
- Liquidity: Commercial real estate investment is extremely illiquid. It implies that if you need to sell the property, it could take months or even years. Furthermore, this indicates that your investment may be trapped for a longer period than you anticipated. REITs, on the other hand, are extremely liquid because the units are exchanged on the stock exchange. Furthermore, you have the option of selling a portion of your investment if you so want.
Considerations When Investing in REITs
- Portfolio Occupancy Proportion: Determine what percentage of the finished space gets rented out. The occupancy percentage is a good measure of the portfolio’s stability and performance.
- Tenant Quality and Sectoral Diversification: Having a good tenant in a thriving industry (IT, Pharma, Manufacturing, etc.) is crucial since it decreases vacancy risk as well as the risk of late rent payments.
- Tenant Count: The more renters you have, the more diversified you are as an investment. More renters using less room each is preferable to fewer tenants consuming vast amounts of space individually. If a large number of renters quit, the vacancy level rises dramatically.
- Geographical Portfolio Diversification: REITs with assets in many micro markets or cities are better and more diversified than REITs with holdings in only one or two micro markets.
- Dividend Yield: This metric indicates the overall health of the management company and the portfolio. A greater dividend yield also signifies a bigger return for an investment.
- Prior Stock Performance: Examine past stock performance and price increases over one year, six months, and three months. It’s a positive sign if the stock is gaining traction.
- Increase in REIT Revenue/Profits: There are some significant variances related to the property’s accounting type. Traditional stock indicators such as earnings-per-share (EPS) and price-to-earnings (P/E) ratios are not especially reliable for assessing REITs. The actual indications are increases in rental revenue, portfolio value, and profitability (net operating income).
- Weighted Average Lease Expiry (WALE): This is the median lease duration left for tenants occupying the REIT’s facilities. It demonstrates the portfolio’s stability. A higher WALE indicates a lower likelihood of vacancy.
- Name of the company/developer: High-quality development, portfolio stability, and asset management will get ensured by a reputable real estate developer and fund manager with an established track record.
If you are an aggressive investor looking to add commercial properties to your long-term investment portfolio, a REIT is a great place to start. As the Indian market expands, additional REITs may become available to assist you in diversifying your interests over two or three similar properties.
Assetmonk is a website that offers real estate investment opportunities in major cities such as Bangalore, Chennai, and Hyderabad, with IRRs ranging from 14 to 21%.
Do you want a chunk of commercial real estate at a reasonable price? Invest In REITs FAQs
REITs have historically provided competitive total returns through high, consistent dividend income and long-term capital appreciation. Because of their low correlation with other assets, they are an outstanding portfolio diversifier that can greatly alleviate overall portfolio risk while increasing returns.
The minimum investment criteria have been reduced from INR 50,000 to INR 10,000-15,000 for investment through initial public offerings (IPOs) and follow-on offers (FPOs).