A Real Estate Investment Trust (REIT) is a collective investment pool that allows investors to purchase units of income-producing real estate assets. REITs can effectively be thought of as mutual funds where the assets involved are real estate holdings or loans secured by real estate.
How can you make money through REITs?
To understand how you can earn through REITs, let us look at how a REIT is structured. There are three tiers, quite similar to that of a mutual fund.
- Sponsor: Sponsors of REITs are the major shareholders of the REITs. The sponsor is the original owner of the real estate asset, which is then encashed. It is the sponsor’s duty to set up the REIT and appoint the trustee. SEBI regulations mandate that sponsors have skin in the game. Sponsors are legally mandated to hold a minimum of 25% of the units for the first three years after formation and a minimum of 15% after three years.
- Manager: REIT managers, typically AMCs, are in charge of asset management as well as the acquisition of new properties. They ensure that the real estate assets are well maintained during the tenor of the investment, get the assets fairly valued and audited as and when needed.
- Trustee: The Trustee of a REIT holds the real estate assets in a Trusteeship. The role of the trustee is to ensure that the interest of the unitholders is safeguarded. They monitor the managers closely and ensure that dividends are paid on time.
The sponsor, manager, and trustee all work in the interest of REIT investors.
As an owner of a REIT, you can make money through a combination of capital appreciation, rental income, dividend payouts, and interest. Capital appreciation of REITS is directly correlated with the change in the value of the properties involved. Depending upon the investment technique incorporated by the manager, as an investor, you can earn either rental or interest income. Regulations mandate that at least 90% of the Net Distributable Cash Flow (NDCF) is distributed to investors every six months.
You can earn higher levels of dividends as well as higher than average capital appreciation in the long run. This makes REITs the perfect intersection between the risk and rewards producing ability of bonds, stocks, and cash.
Types of REITs
REITs can be categorized on the basis of the type of asset being held. A few examples are listed below:
- Residential REITs: Residential properties, including but not restricted to manufactured housing and apartment buildings, are the main focus of Residential REITs.
- Retail REITs: These REITs invest in commercial properties such as retail stores or shopping malls.
- Office REITs: Office REITs invest in office spaces, which are directly impacted by factors such as the unemployment rate, the economic condition of the area, and the overall state of the economy.
- Mortgage REITs: Mortgage REITs lend money to owners or developers of real estate. They can also purchase existing mortgages, effectively investing in real estate debt.
Why Invest in REITs?
- Diversification: Investment in REITs has additional benefits compared to simply investing in real estate directly. Other asset classes are not highly correlated with this segment, which in turn is an effective technique for diversification. During this, the hassle of managing directly owned properties is eliminated.
- Professional Management: AMCs are directly managing REITS, thus ensuring a higher level of professional knowledge on the most profitable investment methods.
- Regular Income: SEBI requires that investors are obligated to receive 90% of NDCF at least twice a year.
- Capital Appreciation: REITs that perform well can increase in value over time, and investors earn a profit.
What are the risks involved?
Just like regular mutual funds, REITs have a risk of potential loss. As interest rates rise, there is a risk of loss of value. This, in turn, drives capital investment towards low-risk assets, such as bonds.
Market conditions play a vital role in the performance of REITs. Rent levels determine payouts. Considering the present COVID-19 pandemic, rentals have fallen significantly, which has had an adverse impact on REITs globally.
In India, REITs are a relatively new phenomenon. At present, there are three publicly listed REITs: Embassy Office Parks, Brookfield India Real Estate Trust, and Mindspace Business Park REITs. The overall exposure in the country to this asset class is quite limited, although it is a growing segment.