Can REITs replace your investment portfolio with physical property?

 

Immobilien has always remained the most popular and sought after Indian asset class. The favorite investment avenues are plots, houses, apartments or commercial spaces. In the 2017 report — Indian Household Finance — by RBI's Household Finance Committee, the average Indian household holds 84% of its real estate and other property wealth, 11% in gold and 5% in financial assets. qatar property finder

Especially the residential segments have decreased significantly over the last decade, due to negligible capital appreciation. According, for example, to the National Housing Bank (NHB) residential price index RESIDEX, the compound housing prices in 50 cities in India rose by only about 4 percent annually between June 2013 and September 2020. Adjusting the returns to inflation is negative. Investing in residential property does not seem attractive to low rates of 1.5 to 2.5 percent. Commercial properties obtain better rent, but deep pockets are required to invest.

However, Indian investors have taken Real Estate Investment Trusts in the last two years (REITs). More about REITs, alternatives to physical real estate investment.

What are REITs? What are REITs?

A REIT is an investment trust that owns real estate income. A REIT is now only permitted to invest in commercial properties in India. Like mutual funds, REITs combine investors' money and invest it in real estate. The best thing about a REIT is that it allows retail investors to invest in commercial immovables, in particular Grade 'A' office spaces that would otherwise not be accessible to them. So far, three REITs have been listed on Indian trade—Embassy Office Parks REIT, Mindspace Business Parks REIT and Brookfield India Real Estate Trust. It is expected that DLF and Godrej Properties will soon be able to produce REITs.

While REITs are new to the Indian market, they are available to investors worldwide for a long time. REITs, for example, are well established investment options in the US, Singapore and Japan, and attract good investor participation. According to CRISIL's 2019 report – the REIT opportunity in India, "REITs account for almost 50% of market capitalism for the real estate industry in Singapore and Japan almost two decadas ago, while they represent 96% of market capitalization in the US, which pioneered REITs in the 1960s."

Why REIT on physical property?

Investing in physical property requires a large fund, in addition to a tedious job in finding the right property. Sustainability, liquidity, taxes and transaction costs are also disruptive. "Owning one's home is most desired. Furthermore, any real estate investments must be seen from a point of return (growth) and return (income or rental). Rent rates in the residential category are not very high and we know that appreciation/growth needs patience. Disruption like demonetisation, RERA, a pandemic may award your plans, therefore avoid real estate when liquidity is necessary for your portfolio," says Lovaii Navlakhi, Managing Director & CEO, Money Matters International.

Investing in REITs, on the other hand, is "a good way to diversify in real estate; it's like purchasing a fund in place of one stock," Navlakhi added. REITs can also help you earn better income compared to physical property investment. "REIT enables you to engage in high-quality rent yields that a retail investor generally cannot afford. One must evaluate whether this makes sense beyond and beyond the real estate investments they already have, which is true of most people," says Ladder7 Financial Advisories' founder, Suresh Sadagopan.

Appreciation of capital or regular income?

Whether you should invest in REITs to appreciate capital or regular income is an issue. "India has limited choices – we know that REITs internationally fulfill both objectives," says Navlakhi.

"It is more appropriate than appreciation of capital for someone looking for regular income, yet income post expenses and taxes are comparable to debt products. If that is all right, REIT should be good as a diversifier," Sadagopan said.

Experts believe, however, that REIT is not suitable for seniors looking for stable regular income. "We would not propose REITs for senior citizens who want steady income, low volatility and protection of capital. As REITs yield similar returns as debt products, a senior citizen should instead invest in debt products," says Sadagopan.

Tax on REIT income

You make dividends when you invest in REIT and make capital gains/losses when you sell the units during your holding period. Dividends are completely taxable by investors in accordance with the slab rate applicable. Capital gains from the sale of REIT units are deemed to be short term capital gains (STCG) if they are held for less than one year and longer term capital gains (LTCG) if held for more than one year. Capital gains The Tax rate of STCG is 15% of the capital gains from the sale of units, whereas the rate of LTCG tax is 10% of the gains exceeding Rs 1 lakh (all equity investments for the relevant FY) with no indexation benefit.

Risk of REIT investment

Navalakhi believes REITs are new to India, and the risk involved is assessed very early. Nevertheless, Sadagopan states, "REIT investment is concentrated investment and the buildings below can have no occupancy periods, legal encounters, rent/non-occupancy problems or lower offshooting for commercial properties resulting from COVID situations etc. No real benchmark is another downer to compare REIT."

Can REIT return better than other assets?

"Each of these investment options has different goals. Debt instruments include liquidity and income instruments. For long-term growth, the equity asset class is. When the REIT market matures, 10 per cent of the net value in REITs can be taken into account," says Navlakhi.

 

Because fixed-income instruments currently offer low interest rates all the time and equity markets trade at an exceptionally high price-equity ratio, REIT can diversify into an alternative asset class for retail investors. "REIT cannot deliver better returns after expenditure and taxes than any equity-driven product. Their performance can only be compared with debt," says Sadagopan.

Impact of the REIT pandemic

As already mentioned, REITs are only permitted to invest in commercial real estate in India, in particular offices that can generate regular incomes. However, due to the pandemic companies allowed their employees to work at home, demand for office space and, eventually, the future of REIT are highly questionable. Experts believe investors should be careful to invest in REITs. "As we know, the pandemic has had a stronger impact on commercial property and it might be a while before it gets over water," says Navlakhi.

However, most of the real estate stakeholders believe that the demand for better space in the office will increase once the situation becomes normalized. This could therefore be a good time to invest in REIT, because valuations are low. However, only ensure that you invest in a REIT if it matches your asset allocation and risk profile.