Selecting a REIT: Factor in capital gains and dividend payouts

The Indian REITs Association, a newly formed umbrella body, has meanwhile requested Sebi to classify REITs as equities and petitioned RBI to allow banks to lend to REITs

Real estate investment trusts (REITs) have been garnering much attention recently. Securities and Exchange Board of India (Sebi) chairperson Madhabi Puri Buch has urged investors to look positively at this asset class (along with infrastructure investment trusts or InvITs).

The Indian REITs Association, a newly formed umbrella body, has meanwhile requested Sebi to classify REITs as equities and petitioned the Reserve Bank of India (RBI) to allow banks to lend to REITs.

 Enhanced liquidity

Globally, REITs are treated as equities, the Indian REITs are included in various global indices like FTSE Russell, FTSE-EPRA NAREIT, and S&P Global.

“Classifying REITs as equity instruments will enhance their liquidity through index inclusion and facilitate efficient price discovery,” says Ramesh Nair, chief executive officer (CEO), Mindspace Business Parks REIT.

It will also translate into more favourable tax treatment. “The period required for capital gains to be classified as long-term will reduce from 36 months to 12 months,” says Nair.

At present, REITs can issue bonds and borrow from non-banking financial companies, but not from banks.

“Allowing banks to lend to REITs will increase funding options,” says Vimal Nadar, senior director and head of research, Colliers India.

Nair adds that bank lending will enable REITs to efficiently manage their working capital needs, given the flexibility to draw money in a phased manner that banking instruments offer.

Diversify portfolio

One key benefit REITs offer retail investors is portfolio diversification.

“They allow investors to expand their portfolios beyond conventional stocks and bonds,” says Shobhit Agarwal, managing director and CEO, Anarock Capital.

REITs are also an attractive source of passive income as they must distribute at least 90 per cent of their cashflows semi-annually. “They are particularly appealing for their robust dividend yields,” says Agarwal.

Investors also get the benefit of professional management. Another benefit, according to Agarwal, is liquidity. Physical real estate is illiquid. But, since units of REITs trade on the exchanges, investors can sell and exit easily. There is no entry or exit cost.

REITs also provide retail investors access to commercial and retail real estate, segments that have traditionally been accessible only to institutional investors and high net-worth individuals. “REITs have significantly lowered the entry barrier for retail investors,” says Nadar.

Nair asserts that stringent governance norms and high disclosure standards make REITs a transparent asset.

A nascent asset class

REITs have a short track record: the oldest, Embassy REIT, listed only in April 2019. Currently, investors have limited options as only four REITs have listed so far (Mindspace, Brookfield India, Embassy, and Nexus Select) based on two sub-asset categories (office and retail).

Any event that adversely affects the demand for office space —an economic downturn, a pandemic — has the potential to impact REITs. “They are subject to business cycles and can be volatile,” says Nadar.

Interest-rate movements also affect their attractiveness.

“As rates increase, REITs become less appealing as investors gravitate towards fixed-income instruments. Investors favour REITs more when interest rates are stable or declining,” says Vishal Dhawan, chief financial planner, Plan Ahead Wealth Advisors.

Abhishek Kumar, a Sebi-registered investment advisor (RIA) and founder, SahajMoney, warns that investors should be wary of investing in a REIT that has low liquidity on the exchanges and is concentrated entirely in one geography.

Parameters to consider

On the business front, opt for a REIT that is well diversified geographically. Investors should also be convinced about the prospects of the underlying asset class: office, and retail.

Among operational parameters, Kumar suggests checking out the weighted average lease expiry and underlying portfolio quality (of both buildings and tenants).

He also suggests looking up the REIT’s track record in completing under-construction properties and maintaining a high level of occupancy in the ready ones.

On the financial front, Nadar suggests checking the historical return on the exchange and the dividend distribution track record (as both together determine returns from a REIT). He adds that the reputation of the sponsor and the asset manager should also be critical considerations.

Finally, Dhawan suggests that investors who want regular cash flows (alongside capital appreciation) may allocate 5-10 per cent of their portfolio to REITs with a minimum seven-year horizon.

REITs: UNDERSTAND YOUR TAX OBLIGATIONS

• If Reit units are sold within 36 months of purchase, the capital gain is classified as short-term; if sold after 36 months, it is long-term
   
• Capital gains from listed Reits (where STT has been levied) are taxed as follows: LTCG up to Rs 1 lakh is exempt; LTCG above this amount is taxed at 10%; STCG is taxed at a flat rate of 15%
   
• Applicable surcharge and cess are payable on both LTCG and STCG
   
• Dividend taxation for Reit unitholders depends on tax regime chosen by SPV
   
• If taxed under normal provisions, dividends are exempt under Section 10(23FD) of the I-T Act
   
• If SPV opts for taxation under Section 115BAA, dividends become taxable at individual’s marginal tax rate
   
• Interest income and rental income from Reits are taxed at marginal slab rate

Source: RSM India