REITs: A New animal In the Investing World

  

What is REIT

Real Estate Investment Trusts (REITs) are similar to a mutual fund wherein investors pool funds which are invested by the sponsor of the scheme into the real estate asset class which acts as the underlying securities. However, the working of a REIT differs a lot. During the launch offer, an investor may buy REIT units which can then be traded on the stock exchanges and thus ensure liquidity. As per the rules, the minimum allotment will be in multiple of one lot each consisting of 100 units and after listing trading will be in multiple of one lot. The REIT shall issue units only in dematerialized form to all the investors.

The minimum subscription amount in REIT has now been reduced from the earlier limit of Rs 2 lakh to Rs 50,000.

India’s first REIT

The first REIT IPO by Embassy Office Parks, a Bangalore-based real estate developer backed by Blackstone Group LP, a global private equity firm, was open for investment between March 18 and 20, 2019. The Embassy Office Parks REIT raised ₹4,570 crore through the IPO. The per unit price of the REIT has been kept in the range of ₹299-300, with the minimum application bid of 800 units. This means that an investor will have to invest at least ₹2.4 lakh in this product. Thereafter, one can increase the lot size in multiples of 400 units. As on 26th April'19 closing price of it was Rs. 327 per unit.

Where it invests

As per SEBI guidelines,  REIT shall hold at least two projects, directly or through SPV, with not more than sixty per cent of the value of the assets, proportionately on a consolidated basis, in one project. Further not less than 75 per cent of the revenues of the REIT and the SPV, other than gains arising from sale of properties, shall be, at all times, from rental, leasing and letting real estate assets or any other income incidental to the leasing of such assets.

The investment can be made in under-construction properties, ‘completed and not rent generating’ properties subject to caps and conditions. REIT is also allowed to invest in listed or unlisted debt of companies or body corporate in real estate sector, mortgage backed securities, equity shares of listed companies, money market instruments and government securities amongst others.

Expected Returns from REITs

As per guidelines minimum 90% of net distributable cash flows of the SPV shall be distributed to the REIT. Further, not less than 90% of net distributable cash flows of the REIT shall be distributed to the unit holders; and any such distributions shall be declared and made at least once every six months in every financial year.

As a REIT investor, the earnings may be in the form of regular income and capital appreciation, if any. In Indian scenario, most industry experts expect return of about 8-12% percent from the REITs.

How REITs are taxed

How the income gets taxed in your hands depends on whether your REIT is passing it off as a dividend income or rental income.

Scenario 1:  If it’s the rental income that it is passing on- which would mostly be the case since REITs are meant to pass on at least 90% of its rental income, then it will be added to your overall income and get taxed at your income-tax rates. In this case REIT will deduct a tax at 10% (TDS) for resident investors and at rates in force (40%, at present) for non-resident investors

Scenario 2: If the income distribution is in the nature of a dividend, then there won’t be any dividend distribution tax or any tax in the hands of unitholders.

Capital Gain Tax:

If you sell your REIT units on the stock exchange after three years, you will need to pay a capital gains tax at 10% (plus applicable surcharge and cess). If you sell your REIT units within three years, a short-term capital gains tax of 15% (plus applicable surcharge and cess) will be imposed.

Things to look beyond

·     Returns can’t be very high as dividend yield might be between 6.5 and 8 percent. Even the capital appreciation can also be limited to single-digit.

·     Another concern is over the liquidity of these instruments. As REIT is a new product and it takes time to catch up. Hence there may be low liquidity in the secondary markets.

·       REITs are best considered as a means to diversify your portfolio across asset classes than for earning higher returns.

And Finally:

Real estate has always been considered an illiquid and a big-ticket investment. REITs provide an opportunity to diversify across real estate as an asset class. REITs are primarily a hybrid investment seeking capital appreciation and even income (rent) from the underlying securities of the sponsor. With twin benefits of REIT and the rules in place, one should expect the REIT to provide a new investment option to the Indian investors.

Elections and The Market

Every time when the elections are nearby, most of the people get worried about who will come to power, what will happen to the market and economies and my investment? This is a very common worry, as everyone wants certainty and clarity whereas elections are most of the time un-predictable.

Market do have impact by the Election results which can been seen by the previous occasions. In 2004 when the BJP-led NDA coalition lost the elections in a shock result, the BSE-30 Index collapsed from 5,358 on May 12, 2004 to 4,961 on May 21, 2004, a loss of -7.4 % in 7 days. When the UPA-2 was re-elected by a wider-than-expected majority in the May, 2009 elections the stock markets surged by +17.2% in one day on May 18, 2009. Trading was halted three times that day as the market hit 3 upper-limit circuit breakers during that truncated trading day. There was less than 90 seconds of actual trading on that day!

But do the Elections results have deeper, long term impact?  History shows that discussion on election results is a great conversation starter but it does not have long lasting impact on our investments! As the heat and dust on election campaign settles down and a new government comes into a picture and slowly starts working for long term policies, the market also settles down.

If we analyse economic growth since 1980, i.e. last 39 years the average real GDP growth was above 6%. In single party rules (all of Congress), for 1980-84 it was 5.9%, 1984-89 it was 5.4% and for 1991-96 it was 5.2%. On the other hand in co-coalition government of 1996-98 (Devegowda & I K Gujaral) & 1998-99 (Bajpayee Govt) actually it was higher at 6.1% & 6.7% respectively. Further in UPA-I the growth was 8.5% while in UPA-II it went down to 6.6%. For current NDA govt. the growth is 7.4% (based on new data series.

What it shows is that the coalition government has actually given better growth compared to single party government. Although it is not necessary, but what it means is that GDP growth depends on various factors and even a coalition govt can also deliver better results.

To summarise:

·        Elections don’t really matter over a longer period, India’s economy will grow.

·        Having a coalition government  can be even better sometimes than having a single-party government!

·       The rate of growth depends on various factors.

·     India growth story may remain intact as India is the domestic consumption based economy with 1.3 billion people who are going to add to the economy.  

So what should we do in this scenario?

Scenario 1 – If we believe that a BJP-led coalition will come to power;

Then we should increase allocation to equities to 60-70% and remaining amount can be split in gold and liquid funds.

Scenario 2 – If we believe that a Congress-led coalition will come to power;

Then we may continue with equities to 50-60% and remaining amount can be split in gold 20-25% and liquid funds 10-20%.

Scenario 3 – If we believe that some third party-led coalition will come to power;

Keep the equity exposure below 50% and remaining amount can be split in gold 25% and liquid funds 10-20%.

Please note that above mentioned portfolio allocation is a general advice and should not be considered as investment advice/recommendation, reader should consult their own financial advisor before taking any decisions.