REITs, or real estate investment trust, is a new asset class that allows individuals to invest in real estate without having to purchase or manage the property themselves. Minus the duties of the property owner or the landlord has made Real Estate Investment trusts in India a popular investment choice for individual retail investors.
What are REITs?
Congress in the US first introduced Real estate investment trusts as an amendment to the Cigar Excise Tax Extension in the 1960s. Fast forward to 2022, when this investment segment has catapulted with REITs owning USD 3.5 trillion in assets across the United States.
REITs are companies that own, operate, or finance real estate ventures or income-producing properties. These companies do not own a single property but have a basket of assets. From an investor perspective, investing in real estate involves buying shares of a REIT. It helps them earn a proportionate share of the income all the assets combined generate.
How do REITs Work?
The government of India launched REITs as an instrument to generate more public investment in the real estate sector. This is an incredible opportunity for investors as it enables them to earn profits from the real estate investment without having to bear the additional responsibility of property ownership or management.
Some commercial entities have the license to launch a REIT in India. They either purchase, finance or manage real estate properties. Once the REIT is open to public investments, the investor can choose to buy units of the funds at a predefined price. With investments pouring from several investors, the money is pooled to create a fund. It is then used to either develop, finance, or purchase properties.
REITs generate income from rental yields and capital appreciation. Investors gain when there is capital appreciation of the property and earn dividends from the rental profits from the REIT investment.
What are the REIT types to know?
All REITs are designed to generate income. However, the method of doing so differs depending on the type of REIT.
Let’s look at the three basic types of Real Estate investment open for investment.
1. Equity REITs:
When investors refer to REITs, they generally talk about Equity Real estate investment trusts. This is because most of these investments fall under the purview of Equity REIT. Investing in them allows investors to earn from rents as well as gain from potential capital appreciation in the future. This is possible because the REIT acquires, manages, builds, and sells real estate properties. The income is then distributed to the shareholders in the form of dividends.
2. Mortgage REITs:
Mortgage Real estate investments or m-REITs are those where the parent company does not really own the real estate property. Instead, it is more of an income play by offering to own the mortgage on the said property. In some exceptional cases, the REIT may hold the actual mortgages or, at times, mortgage-backed securities. The revenue is generated from the mortgage payments, and the interest levied on them. Investing in an m-REIT is riskier as they can be leveraged more than equity real estate investments.
3. Hybrid REITs:
Owning a mix of actual properties and mortgages using a combination of investing strategies makes up a hybrid REIT. Such investments find favour with investors who cannot really make up their minds between equity and mortgage real estate investments. The income generated from this will again be a mix of what happens in equity and mortgage REITs.
What are the Benefits of Investing in a REIT?
The benefits of Real estate investments are several. Here’s a snapshot.
1. High Returns with Tax Benefits:
Real estate investments are legally bound to pay 90% of their taxable income to their shareholders. It implies that the average dividend yields are significantly high too. Moreover, investors can also gain when the real estate properties experience capital appreciation over a period. For the investor, it is an excellent prospect to earn dividends exempt from taxation.
2. Portfolio Diversification:
Even though investors purchase units in the REITs, much like buying shares in a company, investments in real estate are a separate asset class. Generally, they are viewed as a part of the real estate sector. It is also an opportunity for investors to diversify their portfolios, which is a great way to offset the potential risk by only investing in stocks and equities. In addition, SEBI tightly regulates such investments, which makes them a safe investment choice.
3. Offers Liquidity:
Real estate investments can be notoriously illiquid. As a result, buying and selling real estate properties that you own can be time-consuming. On the other hand, REITs can be unloaded by calling your broker or with the click of a few buttons. Moreover, REITs are traded publicly, which means you can measure your investment status regularly.
Like stocks and shares, you can invest in REITs for an amount you are comfortable spending. Generally, the starting range is around Rs 300 – Rs 350 per share of a REIT. It makes investing in real estate stocks an affordable investment choice too.
The Bottom Line
REITs offer a great way to explore opportunities in real estate investment without the added drawbacks of property ownership and management. That said, it’s not a risk-free asset class. Minus capital appreciation, the only form of income for prospective investors is dividends.
Choosing an asset class you want to invest in is crucial to your wealth creation journey. In addition, understanding your risk appetite and goals will help you streamline your investments to get the highest returns.