REITs: a safe mechanism to invest in commercial real estate sector

Real Estate Investment Trusts (REITs) are set up as a trust, which offer their units to investors, and utilise those funds to purchase leased out commercial real estate. Thus, providing an exit route to developers from leased out properties.

For an individual investor, investment in commercial real estate through REITs is much safer as compared to a direct investment with a developer. Returns to unit holders are serviced through the lease income or from sale of property.

Some major benefits of REITs over direct investment are listed below:

Easy entry and exit

The units issued by REITs are listed on an exchange like the shares of a company. This allows an investor to quickly purchase or sell the units of a REIT. This further enables an investor to take short-term bet on commercial property market and to an extent transform investment in commercial properties as liquid.

Lower ticket size of investment

REITs, just like mutual funds, collect funds from its investors and issue units to its investors. The funds collected are invested in large commercial properties which are generally out of the reach for an individual investor. Thus, REITs allow even a small investor to purchase a commercial asset. This is particularly beneficial for an individual investor who prefers to have exposure of real estate sector in their investment portfolio.

Higher transparency

REITs would have to operate under strict regulations and guidelines framed by the Securities and Exchange Board of India (SEBI), ensuring increased transparency for an investor. A REIT would have to disclose and adhere to the detailed terms and conditions regarding its investment in commercial property helping an investor make an informed decision, which is often lacking in direct investment with a developer.

Investment security

It is mandatory for REITs to invest 90 percent of their corpus in completed and leased out properties. Completed and leased out properties are much safer compared to under-construction properties, since visibility of cash-flows is higher in the former.

Regular income and appreciation

A REIT is required to distribute at least 90 percent of its net distributable income to avoid tax on its income. Thus, investors can expect a regular income on their investment in REIT. They may choose to re-invest this income, should they not require it.

In addition to regular income, an investor may also benefit from fluctuation in the value of the underlying commercial property. Any appreciation (or devaluation) in the value of underlying property owned by a REIT is likely to reflect in the net asset value (NAV) of the unit listed on exchange.

An investor should note that investment in REITs is only in completed commercial properties. Thus, for investment in residential properties or under-construction properties, an investor would have to take a direct exposure by investing through a developer. However, the transparency and safety in residential under-construction properties is also expected to improve after the draft Real Estate Regulation Bill is cleared by the Parliament.

Globally, REITs is a preferred tool for investors looking to invest in commercial property. With REITs expected to soon become a reality in India, the transparency and liquidity in domestic real estate sector are expected to improve significantly, further strengthening the global appeal of Indian real estate market.

Neeraj Bansal, Partner and Head-Indian Real Estate sector, KPMG in India

Source:  magicbricks.com

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