Explainer On REITs: Should You Invest?

Have you ever dreamed of possessing a portion of that luxurious house? Buying real estate can be a good investment in the long run, but it usually requires a lot of money. And don’t forget about the illiquidity that comes with real estate.

What if there existed a means of investing in real estate with a reduced amount of capital, allowing one to reap the associated advantages without encountering the additional inconvenience?

In this blog, we will explore REITs, their types, how they operate, and the features they have.

Overview

REITs stand for Real Estate Investment Trust. REITs own, operate, or finance income-producing real estate. Think of REITs as a mutual fund for real estate. REITs pool money from many investors to buy and manage several properties. Investors can participate in the growth of real estate market without buying or managing any property themselves.

Features of REITs

REITs come with some distinct features that make them attractive investment options. Some of their key characteristics are listed below:

• They are generally listed on the stock exchanges, i.e., NSE and BSE for public trading. Also, they may operate as privately owned, known as non-traded real estate investment trusts.
• REITs are allocated to various revenue-generating properties, such as apartments, offices, buildings, shopping centres, warehouses, and healthcare facilities.
• These trusts are generally required by law to distribute a minimum of 90% of their taxable income in form of dividends, which translates into a consistent and regular source of income for prospective investors.

Did you know?

Real Estate Investment Trusts (REITs) in the USA have outperformed equities for over 50 years-time frame.

Types of REITs

REITs offer various options based on the investor’s inclination toward property type and preferred risk-return profile.

Equity REITs

These are the most common types of REITs. They directly own and operate income-producing real estate properties. They invest in properties like apartments, office buildings, shopping malls, and hotels and generate income primarily through rent collected from tenants and appreciation of their property value.

Mortgage REITs

Unlike Equity REITs, mREITs do not own physical properties. Instead, they invest in mortgages or mortgage-backed securities. They earn income from the interest paid on the mortgages and securities they hold and are considered less volatile than equity REITs. However, their returns can be more sensitive to interest rate fluctuations.

Hybrid REITs

These REITs combine the characteristics of both equity and mREITs. They invest in a mix of real estate properties and mortgages and generate income from rent and interest payments. The risk-return profile of a Hybrid REIT depends on its specific mix of investments.

Public & Private REITs

Public REITs are the most common and trade on major stock exchanges like any other stock. On the contrary, private REITs are not publicly traded and are generally offered by investment firms to accredited investors with a higher net worth.

Who should Invest in REITs?

REITs can be a good fit for a variety of investors. The following is an analysis of who may find them attractive.

• Income-Oriented Investors – REITs are known for their steady stream of dividend income, making them ideal for retirees or investors seeking additional income generation within their portfolios.
• Long-term Investors – REITs are designed for investors with long-term investment horizons. While short-term fluctuations may occur, they provide stable returns and capital appreciation over time.
• Diversification Seekers—REITs introduce a new asset class to your investment portfolio, mitigating overall risk by not relying solely on equities or bonds. REITs’ performance exhibits a limited correlation with conventional investment options.
• Investors with limited capital – Investing in REITs offers the opportunity to access the real estate market with a reduced initial capital outlay compared to buying real estate directly. This creates opportunities for individuals who may not have the funds for a conventional real estate acquisition.
• Passive Investing—REIT ownership entails a lower need for management than direct real estate ownership. Investors benefit from collecting dividends without the burden of property maintenance or tenant management.

How REITs operate

REITs function similarly to companies that pool money from investors. This can be done through an IPO or subsequent share offerings. These companies use this pooled fund to acquire and manage income-producing real estate properties. Real Estate Investment Trusts generate income primarily through two ways, i.e., rent and property appreciation.

Furthermore, comprehending how REITs function can help determine whether they are compatible with your investment objectives and risk tolerance.

REITs in India

The concept of REITs is relatively new in India compared to other developed countries such as the USA, UK, etc. The Securities and Exchange Board of India (SEBI) introduced REIT guidelines in 2007, which were later updated in 2014. As of now, there are only five REITs registered with SEBI in India, which are as follows

• Embassy Office Parks REITs
• Mindspace Business Parks REITs
• Brookfield India Real Estate Trust
• Nexus Select Trust
• 360 ONE Real Estate Investment Trust

These REITs primarily focus on income-generating commercial properties like office buildings and business parks.

Points to consider before investing in REITs

1. Vacancy Rate: This refers to how many floors, offices or houses are vacant. Always look for REITs that have lower vacancy rates.
2. Portfolio Mix: Watch the properties owned by REITs and analyse them properly. What kind of properties does each REIT own, and in which location. There should not be any concentration.
   
   Further, also look for a concentration of top tenants. There can be a case that most of the properties in a REIT are owned by a select few tenants.
   
3. Dividend History: Have a look at the track record of dividend and analyse the dividend yield before investing in REITs.

Conclusion

The realm of REITs is continuously developing. As the market matures and new players emerge, thrilling opportunities will unfold. Conduct additional research on specific Real Estate Investment Trusts that align with your investment objectives, and seek guidance from a financial expert to explore your investment options further.

Frequently Asked Questions (FAQs)