REITs: A combination of good returns with room for growth, say experts

Payouts can be affected by vacancy and tenants defaulting on payments

While the Nifty 50 index is down 6.2 per cent, all the three real estate investment trusts (REITs) listed on the exchanges are displaying positive year-to-date returns. Embassy Office Parks REIT is up 8.6 per cent, Mindspace Business Parks REIT is up 7.6 per cent, and Brookfield India Real Estate Trust is up 10.1 per cent.

Positive outlook

During the pandemic, with most people working from home, commercial real estate’s outlook had turned negative. Prices of REITs had corrected during that period. “Now, with the economy on the revival path, and companies calling employees back to office, the prospects of commercial real estate have brightened, which is why REITs have gained favour,” says Aditya Shah, chief investment officer, JST Investments.

Experts say the three listed REITs managed to emerge from the pandemic relatively unscathed. “These three REITs have good portfolios with high-quality grade A office spaces boasting state-of-the-art facilities, which help them command good rentals. Most corporates did not give up their rented office spaces even amid work from home. Despite the pandemic, the numbers released by Brookfield and Embassy REITs previously indicated that rental collections were at 98-99 per cent,” says Anuj Puri, chairman, ANAROCK Group.

Regular income, low entry barrier

Retail investors looking for a regular income can turn to REITs. “They can help investors who require a regular cash flow generate a reasonable return, since by regulation REITs are supposed to pay out 90 per cent of their income to unit holders,” says Vishal Dhawan, chief financial planner, Plan Ahead Wealth Advisers.

These dividends tend to be steady under normal circumstances.

According to Puri, currently REITs are offering decent returns of at least 6 per cent post all deductions.

The special purpose vehicles (SPVs) of the listed REITs did not avail of tax benefits when they were set up and assets were transferred to them. “Hence, a large part of the money paid out, which is in the form of dividend, becomes tax-free,” says Dhawan.

The high corporate governance standards that REITs adhere to are also endearing them to investors. “All the REITs involve global players that strictly adhere to global standards and practices in managing assets,” he says.

People who have traditionally depended on rental income from real estate can use REITs. “Retail investors can diversify into commercial real estate even with small amounts,” says Shah.

These investors will be saved of the headache of managing real estate.

While real estate is an illiquid asset class, units of REITs can be bought and sold easily on the exchanges.

With the real estate sector emerging from a 10-year-long slump, experts believe this is a good time to enter REITs. “Most REITs are quoting at a discount to their net asset values (NAVs), which indicates they are attractively priced,” says Dhawan.

Be cognizant of risks

REITs are subject to many of the same risks as commercial real estate. Tenants may not pay on time or a part of the building may remain vacant for months. REITs hold physical assets, such as office buildings and malls, which could get damaged by calamities such as earthquakes. Also, if interest rates continue to rise, bonds could become more attractive, reducing the relative attractiveness of REITs.

Make a judicious choice

REITs are currently a nascent asset class with only three options available on the domestic exchanges. “While selecting one, consider the size and quality of the properties the REIT owns, the localities in which they are situated, and the quality of its management and tenants,” says Shah.

Dhawan suggests examining occupancy levels, NAV versus current price, the percentage of assets likely to get repriced soon, the yields being offered, and the tax efficiency of those yields.   

Both -- investors looking to diversify into real estate, and those looking for regular cash flows -- may invest in REITs. However, enter this asset class with at least a 7-10-year horizon and avoid short-term speculation.

‘REITurns’ How incomes from them are taxed 

CAPITAL GAINS 

• For listed REITs, units held for up to 36 months will be treated as short-term capital gains and taxed at 15 per cent
• Units held for more than 36 months will be treated as long-term capital gains and taxed at 10 per cent (on gains in excess of Rs 1 lakh) without indexation benefit

DIVIDEND

• Taxation of dividend depends upon the system opted for the special purpose vehicle (SPV)
• If the SPV has opted to pay taxes according to normal provisions, the dividends received will be exempt from taxation in the hands of the investor under Section 10(23FD)
• If the SPV has opted to pay tax at 22 per cent under Section 115BAA, dividends will be taxed in the hands of the unitholder at slab rate

INTEREST AND RENTAL INCOME

• Interest income received by a resident Indian from the business trust will be taxed at marginal slab rate; rental income will be taxed similarly

Source: RSM India