Explicit Indian ideology establishes the Roti, Kapda, Makaan as the foundation on which you build a life of your dreams. This notion is so deep-rooted that when it comes to investment, real estate is the first thought which crosses one’s mind. Not only because the real estate is perceived as the safest investment option, but also it is highly lucrative as it maximizes its earning potential in the long-term.
But the other side of the coin is that real estate investment is capital intensive as one requires a pot of gold to invest in real estate. Furthermore, some risk involving restrictive factors such as illiquidity and high maintenance cost makes real estate investment a high net worth individual’s sport. On this account, it holds back a middle-class person having limited monetary supplies, to consider real estate as a viable investment option.
But what if I tell you that you can invest in real estate with as little as 50,000 rupees and earn rental income that too from A-grade properties developed by quality builders at prime locations.
*NOT CLICKBAIT* but for real though, here is how you can invest in real estate with pretty much whatever money you have saved up right now without doing any of the work yourself. There is no buying, no selling; there is no renovating property neither trying to find tenants nor dealing with 2:00 am phone calls for a broken pipeline that you have to fix.
You just have to invest your money and earn money passively; this is called a REIT (Real Estate Investment Trust).
But how does this compare with just straight-up owning physical tangible property and is it even worth owning REIT, to begin with? Let’s find out.
What is a Real Estate Investment Trust?
A Real Estate Investment Trust, popularly known as REIT is nothing but an investment company which majorly owns, operates or finances real estate assets such as land, apartments, office parks, real estate securities etc with the intent to get returns and generate income.
Real Estate Investment Trust is comparable to Mutual Funds. Such as mutual funds pool monies from investors to make investments in securities like short-term debts, stocks, bonds or other assets which generate returns. REITs also work in the same way. The only difference is that the REITs invest the pooled funds in the portfolio of rent-generating real estate assets.
Image Source – https://getmoneyrich.com/reit-funds-in-india/
Let’s understand this with the help of an example.
Consider some A-grade rent-generating real estate properties such as malls, office spaces, warehouses, hotels or apartments etc. at prime locations of metro cities like Chanakyapuri or Golf Links of Delhi or BKC of Mumbai, where purchasing a property individually can cost you an arm and a leg.
In such a situation Real Estate Investment Trusts come into play. They raise monies from investors through an initial public offering (IPO) and then use the pooled amount to purchase, maintain and expand the portfolio of such A-grade properties. Further, these properties are leased out to the tenants. The REITs mostly earn by either rental income or by capital gains on the selling of these properties at an appreciated price.
REITs allow you to own property without physically owning any real estate at all and as a shareholder within a REIT, you are able to collect scheduled income in the form of dividends. In such a way, through small amounts REITs give you access to the best properties developed by quality builders at prime locations, managed by the professionals.
REITs vs buying physical property
A and B are two friends, both having 25 lacs rupees in hand. They both want to invest in the real estate sector. ‘A’ decided to purchase a piece of land while ‘B’ decided to put the savings into the REITs.
Now let’s analyse this situation and understand the difference between investing in REITs and direct investment by physically owning a property.
- Ticket size
Ticket size in real estate means the total cost of the property which includes the basic sale price and additional charges.
Considering, A wants to opt for a direct real estate investment route by purchasing a piece of land. Price of property varies from place to place and market to market. With 25 lacs rupees in hand A certainly cannot purchase a property at prime locations, which are more lucrative. He either has to resort to less or he has to finance the purchase through loans, which is further a task.
Whereas in the case of REITs the ticket size is way smaller as compared to directly owning any other property. According to the SEBI norms, the smallest amount of investment required in a REIT i.e. subscription amount is only Rs. 50,000. Further, given the small ticket size, it is very liquid and beyond that, you can cash out the amount by selling the unit on public stock exchange at any time.
You must have heard that you should not put all your eggs in one basket, which simply means to diversify the interests. Diversification is an important factor one must consider for safer investment and to reduce overall risk.
When you invest in any physical land or property you interest is centralized to that particular standalone land or building. Since markets are very volatile such investment is more exposed to risk. Therefore in order to make a safe investment one has to spend hours researching markets, locations and governing regulations.
Whereas in the case of REITs the risk is diluted as the funds are managed by professionals, who are responsible for proper asset allocation. Hence, investment is made into a basket of A-grade properties located across geography to spread the funds and lower the risk.
Buying and maintaining your own rental properties is a little bit more extensive because in the background you need to have access to real estate agents, the contractors, the attorneys, the accountants and the property manager etc. keeping this aside periodical renovations, maintenance and up-keeping is also a task. Therefore, investments in real tangible properties require more involvement.
This is where REITs come in handy because when you are investing through REITs you as an investor will be in a passive role and a special asset management team will be looking after all such issues including leasing, vacancy, property up-keeping, renovation, maintenance etc.
REITs vs Real Estate Stocks
Now, another question may pop-up in your mind that if I want to invest in and earn through real estate only then why should I consider REIT and why shouldn’t I invest in the shares of a company engaged in the domain of real estate such as Sunteck Realty, Godrej Properties, Indiabulls Real Estate etc.
At first glance, both the investment options may look similar as both offer an accessible mechanism to invest in diversified prime properties with a little capital that might otherwise be beyond reach.
But there is a significant difference between the two. Let’s give an eye to these key differences and find out what is a better investment option REITs or Real Estate Stocks.
First of all, when you invest in Real Estate Funds or purchase a share of a Real Estate Company, the management of the company holds a free will on the investment strategy of the company.
Management of the company is at liberty to decide the fund utilization strategy. They can either invest in commercial real estate, residential properties or exhaust the whole of the funds for land acquisition and do nothing for the next couple of years and let the money sink. Thereby, your profits majorly depend upon the fund utilization and execution strategy of the company. Hence, such investment due to lack of proper regulations is subject to execution risk.
Whereas, REITs on the other hand is governed by the Securities and Exchange Board of India (Real Estate Investment Trusts) Regulations, 2014.
According to this regulatory framework, a Real Estate Investment Trust is required to invest at least 80% of the total value in completed and income-generating properties and further it imposes restrictions on speculative land acquisition. Other than this, a REIT has to distribute at least 90% of its taxable income to its shareholder semi-annually. In such a way, you will be getting a guaranteed dividend income. Hence, REIT is a safer option as the SEBI regulations prevent the mis-utilisation of funds.
How will you make money?
Since REITs are similar to that of shares and mutual funds, therefore the manner of earnings through REITs are more or less similar to that of mutual funds and shares i.e. dividend income.
Dividends are nothing but a return of the investment made by a unit-holder (investor). In simple words, when you are making an investment in REIT, and it is generating some profit out of it then the REIT is liable to pay a share of profit to its investor in the form of dividends. These gains can further be compounded by reinvesting the dividend earned.
Other than dividend income investors also earn through capital appreciation. As the price of the underlying property hike unit price will also increase simultaneously hence raised income.
In which REIT you should invest?
Here comes the question: In which REIT you should invest?
Considering that in India REIT is a new age concept and is in developing stage with only two listed REITs, Embassy Office Parks, backed by Blackstone, and Mindspace, also backed by Blackstone and developer K Raheja Corp. Third in the line, a Canada-based Brookfield Asset Management Inc. also filed with SEBI for launching another REIT in India.
Although the market is very young and we don’t have many options to choose from, but to make the best choice you must consider the following –
- Before investing, it is important to check the portfolio of the Real Estate Investment Trust. The portfolio of the trust gives you a clear picture of the range of properties in which investment has been made by the trust. By looking through the property portfolios of different REITs you can speculate where your money will be invested and accordingly make the finest choice.
- Further, REITs are required to invest 80% of the total funds into rent-generating properties. In such a way, returns will depend upon various factors such as location, occupancy status etc. So before making the final call it is important to scrutinize investor presentation to look over occupancy level of invested properties.
- Other than this, you can also check the promoter (builder) and clients of the REIT. Trustworthiness of builder and clients ensure stability hence safer investment.
Taxation on REIT income
Taxation is also a paramount factor one must consider before making investment.
- Dividend income
Firstly, let’s look at the tax implication on dividend income received by a unitholder (investor).
After the April 2020 amendment, there exist two possibilities:
- Firstly, if the REIT has opted for a new concessional corporate tax regime i.e. (22% + 3% cess) then the unitholder has to pay tax on dividend income according to applicable tax slab.
- Or else, if the REIT has opted for the old tax regime i.e. (30% + cess), then in that case dividend income shall be exempt in the hands of the unitholder.
You can refer to the Annual report investor presentation of the REIT to determine the applicable tax regime.
- Income from capital gains
Other than dividends, capital gains realized on the sale of a property unit is also taxable as:
- If the units are held for not more than 36 months immediately before the date of transfer then the capital gains realized on the sale of that unit would be taxable at the rate of 15% as Short term Capital Gains (STCG).
- Whereas, if the units are kept for over 36 months then capital gains would be taxable at the rate of 10% as Long term Capital Gains (LTCG).
Real Estate Investment Trust can be an excellent investment option as it provides access to the Class A income-generating properties with the little capital as low as Rs. 50,000. With such a low entry point it provides you with a greater diversification and guaranteed stable returns hence making real estate a feasible option for the common man and small investors.
For investing in REIT, all you need is a Demat account. Through this Demat account, you can apply online for making an investment in the REIT of your choice or you can also fill up the Initial Public Offer (IPO) form with making an indication of your Demat account.
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