Real Estate Investment Trust (REIT): Types, Benefits & Risks

Although relatively new in India, Real Estate Investment Trusts (REITs) have been a popular investment vehicle worldwide for years. This $2 trillion asset class consistently ranks among the top-performing investments, allowing investors to benefit from real estate growth across various sectors and geographies. Since the 2019 listing of Embassy REIT, the REIT structure has transformed India’s office market. In the past two years, three REITs have been listed in India, with a combined market value of $7.6 billion (₹55,267 crores), reflecting growing investor interest in the office sector’s development.

Unlike traditional real estate investments, REITs are traded on public stock exchanges, allowing you to buy and sell them like stocks. Let’s dive deeper into understanding how REITs work.

What is a Real Estate Investment Trusts (REITs)?

REITs allow investors to participate in large-scale, income-generating real estate assets such as office buildings, shopping malls, apartments, warehouses, and hotels. This provides a way for people to invest in real estate without having to buy, manage, or finance properties themselves.

Evolution of REITs in India

India’s Real Estate Investment Trust journey began in 2007 when SEBI introduced its first REIT regulations. After several revisions, the regulations were finalised in 2014. Embassy Office Park REIT was the first REIT listed in 2019, raising over ₹4,750 crores. This provided an organised route for real estate developers and investors to raise capital. The 2016 tax reforms exempting REITs from the Dividend Distribution Tax (DDT) further made them more attractive, allowing a greater portion of rental income to be passed directly to investors.

Performance of REITs in India

India currently has three listed REITs: Embassy REIT, Brookfield REIT, and Mindspace REIT, all of which focus heavily on office spaces. These Real Estate Investment Trusts have collectively managed to withstand market fluctuations, including the impact of the COVID-19 pandemic, and have outperformed benchmarks such as the BSE Sensex and Realty Index in terms of returns.

SEBI has introduced several regulatory adjustments to enhance investor participation in REITs. In 2021, the minimum investment in Real Estate Investment Trusts was reduced to ₹10,000-15,000,aiming at boosting liquidity and attracting more listings, along with adjusting the trading lot size to a single unit. Previously, the minimum investment amount required was ₹50,000, and the trading lot consisted of 200 units in the secondary market. This move by the regulator is a positive step towards making REITs more accessible to a wider range of investors.

How REITs Work?

REITs are structured as trusts, allowing developers to raise funds by transferring assets to the trust. Key stakeholders include:

Sponsor: This person creates the Real Estate Investment Trust and transfers their real estate assets to the trust. Typically, a builder or developer will take on this role when they want to raise funds through REIT
Trustee: The sponsor appoints the trustee and holds the assets in trust for the unitholders
Manager: The manager makes investment decisions and manages the REIT’s assets. They are appointed by the trustee and are often a private company closely held by the sponsor
Unitholders: The trust’s beneficiaries indirectly own the REIT’s assets by subscribing to its units. They can be Indian residents or foreign investors
Independent Valuer: The Real Estate Investment Trust appoints an independent valuer to regularly value its assets. This valuer is a credible, unbiased party who accurately assesses the fund’s assets

After registration, REITs can list units on the stock exchange, providing developers access to capital while offering liquidity to investors.

Types of RIETs

The three main types of RIETs are as follows:

1. Equity RIETs

The majority of Real Estate Investment Trusts function as equity REITs, which are real estate companies that acquire and manage properties, leasing space to tenants. After covering operational expenses, equity REITs distribute a significant portion of their income to shareholders in the form of dividends. Additionally, proceeds from the sale of properties also contribute to the income generated by equity REITs

2. Mortgage REITs

Mortgage REITs (mREITs) are investment vehicles that focus on acquiring and managing mortgage-backed securities (MBS) and related financial assets. By purchasing mortgages or mortgage-backed securities, mREITs provide financing for real estate, allowing them to earn interest income from the loans. These REITs play a crucial role in the real estate market by offering liquidity to the mortgage sector

3. Hybrid REITs

Hybrid Real Estate Investment Trusts are investment vehicles that combine the characteristics of both equity REITs and mortgage REITs. This means they invest in both physical properties, such as commercial buildings, residential complexes, as well as mortgage-backed securities or loans

How Does a Company Qualify as a REIT?

A company must adhere to certain conditions to be recognised as a REIT.

Must have at least 75% asset investment in real estate and derive a minimum of 75% of its gross income from interest on mortgages, rental income, or sales of properties
Must be taxed as a corporation and managed by trustees or a board of directors
Must have a minimum of 100 shareholders, with no more than 50% of its shares owned by five or fewer investors
The company is required to pay 90% of its earnings to shareholders in the form of dividends
A REIT must have a minimum asset base of at least ₹500 crore

How REITs Make Money?

Real Estate Investment Trusts (REITs) generate returns through:

Dividend Income: Distributing net rental income after covering operational expenses

Capital Gains: REITs are traded on stock exchanges, and their prices fluctuate based on performance and demand. Investors can make capital gains by selling units at higher prices

How to Invest in REITs in India?

There are three ways to invest in REITs:

Publicly Traded REITs: To invest in publicly traded REITs in India, you can buy shares listed on stock exchanges like the National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) through a brokerage account. This type of Real Estate Investment Trust allows you to trade shares just like stocks, offering the flexibility to buy and sell during market hours. Investors benefit from high liquidity, making it easy to enter or exit investments as needed. Publicly traded REITs also provide regular dividends, typically distributed quarterly, sourced from the rental income of the underlying properties.
Public Non-traded REITs: Public non-traded REITs are not available on stock exchanges, so investors need to acquire shares through direct offerings or private placements, often facilitated by financial advisors or investment firms who participates in the non-traded REITs. These investments are made at set intervals and usually require a longer-term commitment of 5 to 10 years.
Private REITs: Private REITs are generally available to accredited investors, who meet certain income or net worth criteria. To invest, you’ll need to connect with the REIT’s sponsor or investment firm. The investment process typically involves due diligence, reviewing the REIT’s private placement memorandum (PPM), and meeting minimum investment thresholds. Private Real Estate Investment Trusts are not listed on exchanges or registered with SEBI, so they offer less transparency and liquidity but may offer higher returns.

Benefits of Investing in REITs

Lower Correlation with Other Assets

REITs also correlate less with other assets, reducing the portfolio’s volatility. When stocks are down, Real Estate Investment Trusts may not be affected as much or perform better, reducing overall investment risk and providing a more stable ROI

No Self-management

REITs save you from the hassles of engaging in periodic renovations and upkeep that come with owning real estate This can be time- and cost-effective.

No Commissions

Investors can easily buy or sell REITs without incurring additional costs, which might go up to 6% for every sale. Hence, Real Estate Investment Trusts are a cost-effective investment option

Steady Income

Real Estate Investment Trusts (REITS) are required to distribute at least 90% of their taxable income to shareholders as dividends. This makes them an attractive option for investors seeking a reliable income stream, often providing higher yields compared to traditional stocks or bonds

Risks and Challenges Associated with REIT Investments

Vacancy Rates and Defaults

The income generated by a REIT depends on its tenants. High vacancy rates or tenant defaults can significantly reduce revenue and profitability.

Liquidity Issues

While REITs provide a more accessible way to invest in real estate compared to directly buying or selling physical properties, they can still encounter liquidity problems. This means that, at times, there may not be enough buyers or sellers for Real Estate Investment Trust shares in the market, which can make it challenging or costly to sell your shares when you need to. This situation primarily pertains to publicly traded REITs, which are bought and sold on stock exchanges.

Additionally, some non-traded REITs may impose lock-in periods, during which investors cannot access money, limiting the ability to sell their shares.

Management Quality

The success and growth of a REIT largely depend on the quality of management team. A strong management team can effectively identify profitable investment opportunities and manage properties efficiently. However, some firms may charge higher fees for their services, which can reduce the returns for investors.

Additionally, certain management teams might pursue riskier investment strategies to achieve higher profits, which can increase the potential for losses. It’s essential for investors to evaluate the management team’s experience, fee structure, and investment approach before deciding to invest in a REIT.

How to Choose the Right REIT for your Portfolio

Selecting the right REIT for your portfolio involves considering several important factors that align with your financial goals and risk tolerance. Here’s a guide to help you make an informed decision:

Investment Goals: Decide whether you’re aiming for regular income from dividends or long-term capital appreciation. Equity REITs, which invest in properties, are ideal for income-focused investors, while mortgage REITs can offer higher yields meeting capital appreciation goals, however often carry more risk
Sector Focus: Choose a sector based on your view of the future market trends or areas you’re most comfortable with, like logistics or commercial real estate
Performance History: Look at the past performance of the REIT, particularly its dividend payout history, growth in value, and stability during economic downturns. A strong track record can indicate effective management and asset stability
Liquidity Needs: If you need flexibility in your investment, publicly traded REITs are a better option as they are easy to buy and sell. Non-traded REITs or private REITs offer less liquidity and may lock in your funds for longer periods
Risk Tolerance: Consider how much risk you’re willing to take. Mortgage REITs are more sensitive to interest rate changes, while equity REITs tend to be less volatile but still exposed to real estate market fluctuations
Fees and Costs: Assess the management fees, transaction costs, and potential hidden fees associated with different REITs. Higher fees can reduce overall returns, so look for transparent fee structures that align with your expected profits

Who Can Invest in a REIT?

Investors from all groups (foreign/domestic/retail/institutional) can invest in REIT units
Investors can purchase and trade units via Demat account like any other listed securities on the exchanges

Final Thoughts on REITs

REITs are reshaping the investment landscape in India by democratising access to quality commercial real estate. With the backing of regulatory reforms, such as reduced minimum investments and more flexible trading options, REITs are becoming increasingly accessible to retail investors. These changes not only enhance liquidity but also open the door for a broader investor base to benefit from consistent dividend income and long-term capital appreciation. As awareness of Real Estate Investment Trusts continues to grow, they have the potential to evolve into a key asset class, offering a balanced and attractive investment option for both seasoned and new investors alike.

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