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REIT: Treat or retreat for real estate investors?

Mar 29, 2010

Real estate, particularly commercial real estate as an asset class has traditionally been out of reach of an average Indian investor, financially. But what if there is an entity, which can pool in resources from various investors and then collectively invest in real estate to earn capital appreciation and dividends? There you have it! Yes, we are talking about REITs -investment vehicles- which buy, sell and manage real estate assets on behalf of the investors. REITs are to real estate what mutual funds are to equities and bonds and are publicly traded like common stocks on various exchanges. They provide hassle free and a convenient way to invest into real estate market providing diversification benefits with low liquidity risk (shares can be sold at low impact cost). In order to understand how REITs function, let us assume that you plan to buy a property in the near future and currently have Rs 5,000 in surplus for investment every month after meeting your needs. In absence of REITs, the obvious investment alternative (to accumulate money for buying a home) would be equities, bonds, G-secs or gold (as per your risk-return objective) and then subsequently liquidating those investments in the end to buy the property. But with REITs you can directly invest smaller sums in the security over a pre-determined time horizon and then liquidate your investments when the time is ripe to buy your home. REITs allow you to invest smaller amount of your savings into real estate which otherwise would not have been possible.

After originating in US, REITs were launched in various countries across the globe. However, India is still in the process of finalizing draft guidelines. Although the regulations were filed two years ago, SEBI has not managed to zero in on a final decision as yet. (Real estate companies like IndiaBulls real estate have raised money through REIT in Singapore while DLF and Unitech too have similar plans). REITs in US typically distribute 90% of their income to the investors and are classified into three categories namely equity, mortgage and hybrid. If we compare the total returns over the past 10 year period, equity REITs have significantly outperformed S&P 500, NASDAQ and bonds and their dividend growth rates have outpaced inflation.

As per SEBI guidelines, REITs have to be close ended schemes and can only invest in income generating real estate properties, prohibiting investments in vacant land. REIT schemes have to be rated by a credit rating agency and shall not invest more than 15% in a single real estate project. Introduction of REITs in India will provide a monetization vehicle for capital intensive projects like commercial real estate and retail malls injecting much needed capital in the real estate industry. With rapid urbanization on cards, real estate demand is expected to stay afloat, attracting more capital in future. REITs provide a suitable exit option to this foreign capital, (PE investors) that has made significant investments through FDI route in India. Considering the recent revival in demand across key cities, the launch of REITs in India could just be around the corner.

However, investing in REITs is a risky affair and rising interest rates could be a real dampener. Increasing rates will discourage borrowing and real estate prices may correct resulting in a fall in the value of REITs. The recent sub-prime crisis in US was a prime example on how predatory lending practices led to a boom and then a subsequent bust in real estate market, also reflected in tumbling REIT prices. Further, REITs by the virtue of standard setting bodies are required to distribute majority of their income as dividends (SEBI proposes a payout of 90%). Hence, basis of taxation (in overseas markets REITs are tax exempt subject to certain conditions) remains a key issue. Additionally, returns from REITs could be quite volatile due to their nature of investment in real estate.

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3 Responses to "REIT: Treat or retreat for real estate investors?"

Ankit Pandey

Jun 10, 2010

the fine print needs to be studied in to the restrictions of the REITs in residential projects and land holdings..the commercial property sector is rather lopsided where the growth is not even. in places one can see exponential growth whereas there are empty malls also.

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Ajay Punjabi

Apr 20, 2010

If REITs are not introduced soon, the Indian investors will loose out on the opportunity to invest in prime properties which might be bundled and listed overseas by leading RE players. This will be a sad situation, wherein there is immense potential to generate wealth nationally! Regulators need to act asap...

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Sadashiv Rege

Apr 4, 2010

Inspite of a country like Pakistan having considered an option of adopting REITS as an investment option to curb excessive speculation in real estate market, we are still in the preliminary stages for the last so many years in regulating this means of investment options for a middle class family. It would definitely be a treat for the middle class saving person against the capitalistic environment we are in.

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