Real estate is an investment that is part of most portfolios. It is mostly in the form of residential properties and land.
In some rare portfolios, one may find commercial properties, such as shops, offices, and showrooms. However, the commercial properties generally owned by individuals are small in size, and they rarely attract big business establishments.
The potential rentals in such commercial properties are usually better than residential properties but way lower than the top-notch commercial properties that big businesses lease for their offices and showrooms. Big corporates need office space in tens of thousands or even millions of square feet. Individuals will not have the wherewithal to buy such properties, which may cost tens or even hundreds of crores. Even if they are able to buy, they would need to find corporates that want to lease their property and manage the property. Identifying good property, finding good tenants, and managing the property professionally are difficult tasks for individuals to handle.
This is where Real Estate Investment Trusts (REITs) come in. REITs are entities that invest in high-quality real estate. Properties that REITs invest in include commercial real estate, retail spaces, healthcare units, data centres, apartment complexes, etc. Investors can buy units in these REITs and participate in their growth.
REITs endeavour to distribute regular income to unitholders based on the rentals they generate. In addition, the underlying properties can also appreciate, and hence their holdings could benefit from capital appreciation too.
Investing in REITs
REITs are a fairly new phenomenon in India. There were just three REITs a couple of months ago. These were Embassy Office Parks REIT, Mindspace Business Parks REIT, and Brookfield India Real Estate Trust.
This has now been joined by Nexus Select Trust REIT, which is owned by global private equity (PE) firm Blackstone. Nexus REIT’s investments are in premium retail assets across India. In that sense, Nexus is different from the other REITs, which hold commercial office portfolios for the most part.
Hence, the investment options in the REIT segment are somewhat limited. However, more players are expected to enter the space in the future, as this is a great way for builders to offload their stock, unlock liquidity, and move on.
REIT units are listed on the stock exchange, which provides liquidity to unit holders.
Structure of REITs in India
REITs in India have a three-tiered structure like a mutual fund. There is a Sponsor, who typically will be a property developer; a Trust that will hold the properties directly in a company or through a Special Purpose Vehicle (SPV); and an Asset Manager who makes decisions regarding properties to be bought or sold, tenants, and rental agreements, among others.
The asset manager is also responsible for functioning in line with the extant REIT rules, distributing the surpluses generated, and undertaking reporting as per rules. The Asset Manager may use a property manager for facilities management to ensure that the property is maintained and well looked after.
The sponsor needs to hold 25 percent or more of the REIT in the first three years and 15 percent plus thereafter.
In India, at least 80 percent of the properties that REITs hold need to be completed commercial properties that can be rented out. The remaining can be under-construction properties or other investments. At least 90 percent of the income generated through a REIT has to be distributed to unit holders.
Also read: What do global REITs offer… And, what they certainly do not
Taxation of REITs
REIT taxation is somewhat complicated. Taxation depends on the source from which the income being distributed is coming.
For instance, a dividend distributed by a REIT or through its SPV is not taxable as long as the REIT or the SPV is not claiming any special tax status.
Rental or interest incomes distributed are added to the income and taxed at the investors’ slab rate.
Repayment of the loan is not taxable until the cumulative distribution does not exceed the issue price. If in a particular year, it does exceed the issue price, it will be taxed as income in that year.
The units, when sold, will be subject to capital gains taxation. The short-term capital gains tax is 15 percent until 36 months. After 36 months, it is long-term capital gains, which are taxed at 10 percent, beyond the first Rs 1 lakh.
Also read: ITR Filing: All you need to know about how to account for income from house property
Is it worthwhile to invest in REITs?
REITs are a new investment option that has become available to investors. It is a new way to participate in commercial real estate, which has been out of bounds for the normal investor. Hence, investing in REITs helps retail investors participate in high-quality real estate, which they could otherwise not invest in at all.
This is a product that is somewhere in between an equity and a debt product. REITs offer regular income like a debt product. Most of the distributions are through dividends, which are tax-free. Other distributions can be taxable based on the source of the distribution. REITs have the potential to offer 6-7 percent returns per year.
The underlying property can appreciate over time, which will show up in the NAV. This capital appreciation gives it an equity-like feel, giving it a kicker on returns.
This is a new offering for Indian investors that they could consider investing in to diversify their portfolio and potentially get better returns compared to debt products.
Also read: Understanding the tax implications on sale of property