The long-term view on India is one of uptrend on commercial absorption on the back of increasing pace of vaccination, return to office, robust pace of hiring, and gradual pick-up in international travel which will translate into a strong 2022. Vacancy levels which had been rising since the onset of COVID should start to decline from next year. Leasing discussions and site inspections have restarted pointing to a strong recovery in office market in 2022.
Real Estate Investment Trusts (REITs) are pooled investment vehicles that own and operate income-producing real estate assets. One can think of REITs like a mutual fund, where money is pooled from investors and in return, they get REIT units. Instead of shares of public companies, REIT units represent ownership of real estate assets. Like an IPO (Initial Public Offering), units in the portfolio are sold to investors through a public offer. Once the REIT lists, you can buy or sell units of REITs just like shares through regular trading accounts on BSE (Bombay Stock Exchange) and NSE (National Stock Exchange).
Globally, REITs manage and invest in multiple real asset types including from residences, malls, office spaces, data centres, hospitality, medical facilities and warehousing and logistics assets. In India, we have started with REITs only a couple of years back and have just seen the office REITs come to the market so far. As we go forward, we will see REITs from the other assets come to market as well.
Securities and Exchange Board of India (SEBI) mandates that at least 80% of a REIT’s portfolio by value needs to be invested in completed and income generating properties. This decreases execution risk. The remaining 20% can be in under-construction properties, listed or unlisted debt of real estate companies, listed or unlisted equity shares of real estate companies, mortgage-backed securities, GSecs (Government Security) and money market instruments. SEBI also mandates that REITs must distribute at least 90% of the cash flows that they receive every year to the unit holders. These distributions are mandated at least once every six months. Some REITs like Embassy, however, have committed to quarterly distributions. When the REIT sells any property, it must reinvest the cash in other rent-generating properties within a year, failing which it must distribute 90% of the proceeds to unit holders.
The three ways
REITs make returns in three ways: First, they receive rents from the properties they’ve leased out. Second, when market prices for the properties they own increase, this is reflected in their Net Asset Value (NAV), but the market prices of REITs can run ahead or behind their NAV, based on the market’s estimate of their income and potential very similar to equities. Third is growth, where they acquire or build new assets which adds to their rents and contributes to increasing their capital values.
RBI’s recent amendment to permit Foreign Portfolio Investment (FPI) to invest in debt of REITs and InvITs (Infrastructure Investment Trust) will expand and diversify the potential capital pool for REITs and InvITs and further reduce the cost of capital for the asset class. This amendment will also improve the returns for the unit holders as the cost of debt becomes cheaper. The lenders will benefit from cross-collateralisation of multiple assets and cashflows. Also, the recent decreasing in the trading lots has enabled more liquidity in the markets.
Capital gains
* The capital gains you make on your listed REIT units get treated as “long-term” capital gains if you held the units for more than 36 months
* Short term gains, where units are held for 36 months or less get taxed at a flat rate of 15% plus surcharge and cess. (Section 111A of IT Act)
Distributions
* Rental or interest income: applicable income tax slab rate
* Dividends: New Tax Regime: applicable income tax slab rate
Old Tax Regime: exempt from tax
* Repayment of loans/ Other income: exempt from tax
How to select a good REIT
* Occupancy/ Vacancy: The occupancy rate is the percentage of area of the portfolio of the REIT that is income generating. This is an important metric of its performance. The higher the occupancy, the stable are the cash flows.
* Weighted Average Lease Expiry (WALE): The biggest risk of running a commercial property is vacancy. WALE is used to calculate the time left for property to go vacant. It is measured in years. The higher the better.
* Distribution Yield: By law, REITs must pay 90% of distributable cash flows to the investors. Distribution yield is a metric to measure these payments. However, this is not guaranteed. It depends on the performance of the REIT. The higher the better.
* Loan To Value: Loan to Value (LTV) measures how much debt was borrowed compared to the underlying asset value. Just like any other business, the low leverage the better.
* Diversified portfolio: REITs having diversified portfolio across geographies & tenants are less prone to oversupply & concentration risk.
* Sponsor: A strong sponsor will have many advantages like brand recognition, trust factor, corporate governance. REITs will also have Right of first offer (ROFO) on properties owned by the sponsors.
India vs Global markets
Unlike India, where the listed REITs invests majorly in office spaces, globally one can build a diversified investment portfolio in residential, office, data centres, warehousing, retail, and hospitality. Globally, dividend yields in Asia are higher compared to developed markets.
The writer is Executive Director — Capital Markets, Knight Frank India.
