Can get even single REIT units; retail buyers need to understand this asset class

Real Estate Investment Trusts (REITs) is a relatively new asset class for investment by retail buyers in India. As in anything new, it is not fully understood and therefore can be intimidating. According to the new norms single REIT units can be traded like stocks. Therefore it is important to understand this asset class, if you are to invest in it.

REITS are funds that own, operate and manage a portfolio of income generating commercial property. They are an alternate investment asset that allow consumers to own small shares of high quality income generating commercial real estate assets. It allows investors to earn annuity and income in perpetuity. So if you buy a REIT asset, you can continue to hold it for as long as you wish and get regular income while you hold it.

You can buy REIT units from the National and Bombay Stock Exchanges (NSE & BSE) and these are listed on the Securities and Exchange Board of India (SEBI). There are three ways in which you can buy or sell a REIT unit -on the BSE and NSE, either online or through a registered broker. You can also buy REIT units when the company lists an Initial Public Offering (IPO).

The REIT sponsors and managers purchase AAA rated commercial office property with premium multinational tenants who are locked into the lease with long-term contracts. The monthly rents they pay contributes to the income of the REIT and 90% of the income must be distributed to the unit-holders. Some income also comes from the hotels, food outlets and food courts within the commercial complexes.

Real estate is an appreciating asset, provided the asset quality is maintained. To that extent, the REIT managers ensure that the property is well managed so that it can draw the best tenants and earn good rental returns. As the asset gains in value, that becomes part of the income of the unit holders. Explains Michael Holland, CEO Embassy REIT, “The capital value of the asset is revalued on a six-month basis by at least two independent valuers. This translates into higher market price of the units. So even if you buy REIT units, you get the unlocked value of the capital appreciation on a six-monthly basis.

Recently, SEBI declared that unlike earlier, single REIT units can be bought and sold in the market. A fear that many investors had voiced was whether the pandemic-induced lockdown and the subsequent Work From Home (WFH) culture would lower the value of these assets. Today, all three REITs are heavily skewed in favour of the IT sector.

The Blackstone-Embassy REIT has assets in Bengaluru, Mumbai, Pune and Noida. The K Raheja sponsored Mindspace REIT is present in Mumbai, Hyderabad, Pune and Chennai, while the Brookfield India REIT has assets in Mumbai, Gurugram, Noida and Kolkata. Clearly IT is the driver and mainstay of this investment asset.

The pandemic has been a boon to that sector as most businesses have steadily gone digital. Unlike in the US and UK, where the average age of the IT sector employee is 40 years, in India just 7-8% are above the age of 40.

The IT employees are largely in their 20s and 30s. As a result, the home environments are not very conducive to working and the extra amenities offered in the tech parks have been a draw to bring them back to work. As a result, the asset managers have ensured that the add-on recreational and entertainment facilities are managed well within tech parks. This brings more income to the REIT and translates into better returns for the unit holders.

Another indicator of the health of the IT sector is the fact that tech hiring has doubled in the last five years, says Holland. This is expected to translate into new leasing and additional leasing to accommodate that workforce. IT companies normally prefer secondary business districts where the cost of the property is at a manageable rate rather than in city centres, which are more expensive. This affordable rental value for large space users combined with the fact that there is endless demand for that space and once given up it may not be available for lease again in that development, has led to IT companies keeping the space even during the lockdowns. When the annual rental value per sq foot is less than or equivalent to the cost of furnishing that space, companies hold on to it, explains SC Jaisimha, Executive Director, Cresa India. All these factors translate into steady rental income for the REITs.

As a result, all three REITs rank among the top 10 listed real estate players in India: Embassy REIT with Rs 329 billion, Mindspace REIT with Rs 174 billion and Brookfield REIT with Rs 77 billion, as of June 30, 2021. Since rules mandate that at least 80% portfolio must be completed and income earning projects and a maximum of 20% can be under-construction assets, the regular rental earnings are ensured.

So let’s compare REITs to other property-based asset classes like equities or direct investment. Both REITs and equity shares can be purchased in single units, are freely transferable listed securities and are professionally managed.

Direct investments in real estate, on the other hand, have an entry barrier of at least Rs 25 lakh normally, are locked-in, illiquid and with transaction costs involved. The management standards too are not regulated, and therefore not assured.

REITs, according to present regulations, must necessarily have Grade A assets in prime locations and are primarily office properties with marquee tenants across sectors. This leads to steady rental income. Equity stocks are a mix of Grade A and B stocks of office, residential and retail sectors with multiple tenants across sectors. Rental income and occupancy rates can be more varied in this asset class. Direct investment is usually in standalone buildings which are exposed to single tenant risks. If the tenant leaves or the sector underperforms, that investment will not earn a steady income.

REITs returns are through capital appreciation and regular cash distribution (90% mandatory), RE equity shares give returns based on capital appreciation and dividends which are not mandatory, while direct investments give returns only through a timely and profitable exit.

REITs and RE equity dividends are tax exempt, while direct investments are taxable.

The biggest positive about REITs is that regulation is stringent. It de-risks the retail investment as at least 80% of value must be in completed and income producing assets, ensuring regular cash flows. There are restrictions on speculative land acquisition. At least 90% of distributable cash flows must be distributed semi-annually.

There is a restriction on debt. Majority unitholder approval is required if debt exceeds 25% of asset value. Debt can also never exceed 49% of asset value. At least 50% of independent directors on board must have a 50% representation on all committees. The REIT manager can be removed with 60% approval of unrelated unitholders. There is alignment with the unit holder interests due to a distribution-linked management fees structure.

Safeguards include prohibiting sponsors from voting on their related party transactions. Majority unitholder approval is required for acquisition or disposal of assets that exceeds 10% of REIT value. Acquisition value cannot deviate more than 10% from average valuation of two independent valuers.

Fairness opinion from an independent valuer is required if a related party leases more than 20% of the underlying asset.

As of now buying into IT assets backed REITs is a good idea for the short and medium term as digital businesses and solutions providers are witnessing booming business. Going forward many more categories of REITs are expected to hit the market as the regulator opens up more categories of rental income earning assets to be aggregated under this umbrella.

(Data is drawn from a recent press conference, where Michael Holland, (CEO) Embassy REIT, and Srikanth Subramanian, Head Senior Executive Director, Investment Products, Kotak Mahindra Bank, explained the nitty gritty of investment in REITS and why these are good products to invest in)