SM REITs: A New Way to Get Rich in Real Estate

Can real estate make you rich?

If you ask most people, they will say yes.

But that's not the full picture. What they probably mean is that if you buy a property, it will appreciate in the long term.

This is true. But the property they talk about is often the same house they're living in. You see, when calculating net worth of individuals, the value of primary residence is usually excluded.

Most people who have a high net worth tied up in real estate, fall into one of a few cases.

• They inherited a valuable property.
• They bought land/apartment long ago in a location that developed well over time.
• They did a good commercial real estate deal which paid off handsomely.

In all these cases it's possible to get very rich in real estate but it's still very difficult. And there's a lot of luck involved. Almost no one builds a Rs 100 crore real estate portfolio from scratch.

The ones who do this usually have a successful business. They invest the spare cash generated by the business into real estate.

This is a time honoured strategy to get rich. But for this strategy to work, you need to have a successful business first. The real estate portfolio comes later.

The rich use real estate (along with bonds and gold) to preserve their wealth...not to create it. Unless their business is real estate development itself.

Real estate may not be the best asset class strictly from a returns point of view because fundamentally strong stocks can do better, especially in the long term.

However, real estate has many advantages.

• It provides steady capital appreciation over time.
• It holds its own against inflation quite well.
• It provides income via rent which tends to increase with time.
• It enables a large investment at a time which could be potentially life changing.
• It's part of an inter-generational wealth transfer, i.e., it can be passed on to the kids.
• It can be improved. For example, land can be developed into a commercial property.
• It provides many advantages from a taxation perspective, especially for businesses.

For many people these advantages are enough to make real estate the best asset in the world.

But there is another way to invest in real estate and potentially get rich too.

Real Estate Investment Trust (REIT)

In simple words, a REIT is a company, that raises funds from investors and invests the funds in a portfolio of real estate assets. It also controls and manages the real estate portfolio.

The real estate assets generate rental income which is distributed to the shareholders of the REIT.

Thus, investors in a REIT earn steady income in the form of dividends from the real estate assets in the REIT, without having to directly invest in these assets themselves.

REITs are listed on the stock markets. So, they behave as stocks with much lower volatility than the rest of the market. Still, they will be subject to general market risk.

Now, the purpose of REITs is to generate regular, stable income for its investors. So, REITs mostly invest in income producing real estate. All other things being equal, the higher the rental yield the better.

The REIT yield is easy to calculate as they are required by law to distribute 90% of their income as dividends. This can be reasonably estimated on a per share basis by investors based on past dividends.

REIT Yield (%) = REIT Annual Dividend Per Share / REIT Share Price * 100

It's important to understand that there isn't much capital appreciation in a REIT and investors shouldn't expect any. The purpose of REITs is to distribute most of their income as dividends.

As they pay 90% of their income as dividends, they can only reinvest 10% of their income back into the business to buy new properties.

Property types in REITs include but are not limited to, residential buildings, housing complexes, office buildings, commercial parks, hotels and resorts, data centers, hospitals, warehouses, retail spaces, etc.

REITs are a relatively new asset for wealthy investors. Ever since REITs became available in India, there has been an attraction towards them as a top choice in the portfolios of high-net-worth individuals.

Stable cash flows are a major advantage of investing in a REIT. It is the reason why wealthy investors choose REITs as an investment.

Buying real estate aways involves concerns about transparency and potential fraud. That is not the case in a REIT investment. Investors can rest assured they are investing in high quality real estate.

What's New?

The Securities Exchange Board of India (Sebi) has introduced amendments to the REIT Regulations 2014. These have provisions for Small and Medium Real Estate Investment Trusts (SM REITs).

The idea of the regulator has been to oversee the fractional ownership of real estate in India - both commercial and residential properties - and also protect the interests of investors.

These SM REIT funds will be used to buy and manage real estate assets. The ownership of these assets will be organised under special purpose vehicles (SPVs).

Proptech and Fractional Ownership in Real Estate

In a fractional investment, investors co-own a property with other investors. Every investor earns income and capital appreciation in proportion to their investment.

Over the last few years, several online fractional investment companies have hit the market. These are a kind of fintech called proptech (Property + Technology).

They operate by aggregating funds from investors to buy stakes in pre-leased commercial real estate. The minimum ticket size is usually Rs 2.5 m. Currently, these platforms are unregulated.

Due to the lack of regulations, these firms operated under their own rules. Thus, there was a lack of standardisation in this market. There were also transparency concerns.

The new regulations will formalise this sector. Investors can now be assured that their investments are being managed by a regulated entity.

New Rules for SM REITs

1. The minimum ticket size has been reduced to Rs 1 m.
2. It can pool funds starting from Rs 500 million (m).
3. Units can be issued to a minimum of 200 investors.
4. No single investor can own more than 25% of any scheme.
5. The investment manager should have a net worth of at least Rs 200 m out of which Rs 100 m should be liquid net worth.
6. The REIT can buy and own assets priced above Rs 250 m and less than Rs 5 billion (bn).
7. 95% of the investor funds must be invested in completed rent-yielding assets.
8. There must be separate schemes investing in specific assets so that investors can pick and choose the assets they want to invest in.
9. Point 7 will be valid even after listing. So, investors in a SM REIT will not have the same ownership over all the assets as is the case in a regular REIT.

This is an encouraging change in regulations as far as REITs are concerned. We believe, the new regulations will boost investor participation in real estate.

However, only time will tell how this form of fractional investing in real estate plays out.

Watch this space.

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such. Learn more about our recommendation services here...