What are the features, asset mix and risks involved in REITs?
As we know Mindspace REIT IPO is currently live in the equity markets from 27th July’20 to 29th July’20. REIT is a quite new concept in Indian market. It is a well-known and popular financial instrument in developed markets like US, Australia, etc. In this blog we will discuss what exactly an REIT is, its features and we will also compare REIT with Mutual funds.
What is REIT?
- REIT basically stands for Real Estate Investment Trust. It is a modern real estate instrument.
- REIT is basically pooled financial instrument similar to mutual funds. By investing in REITs, investors get to earn a chunk of real estate income in the form interest and dividends . This can be earned without actually having to own , manage or finance any real estate properties.
- The main reason why REITs are gaining traction in Indian markets is because of the change in preferences of mainly millennials and Gen Z generation.
- This new generation is averse to investing in traditional real estate because of its way too higher ticket size, illiquidity , financing issues, etc.
- Here REITs come handy as they have comparatively smaller ticket size as compared to traditional real estate, are traded on stock exchanges and hence are more liquid.
How are REITs different from mutual funds?
- REITs are much similar to mutual funds. The main difference is in the minimum ticket size of REITs and Mutual funds.
- The other difference between REITs and mutual funds is that of investment platform. REITs are listed on stock exchange and one can transact in REITs through demat account only.
- Whereas, one can invest in mutual funds offline/online through their website. Mutual fund investment can be done through stock exchanges as well however there is liquidity problem on stock exchanges.
REIT Asset Mix
REITs mainly invest in real estates only. Out of the real estate investments, ~ 80% investment is made in rental properties. Remaining 20% investments are made in properties that are under construction.
Risks associated with REITs
- SEBI regulates REITs with the set of rules formed in 2014.
- Earlier in 2019, Embassy had issued a REIT IPO with a minimum ticket size of INR 2 lakh. The minimum ticket price of Mindspace REIT is INR 50,000 which is lesser than Embassy REIT IPO. But still it is quite higher as compared to other financial instruments like mutual funds, etc.
- This higher minimum ticket price of REITs is mainly as REITs is a new concept in Indian markets and entails higher risk. Hence, regulatory authority (SEBI) ensured that only those investors who have surplus cash and higher risk tolerance should invest in REITs.
- Let us discuss the risks in Real Estate sector .
- The COVID-19 pandemic poses a major threat to the commercial spaces. This is mainly because of the onset of “work from home” culture in India for social distancing.
- Companies, mainly from IT sector are looking forward to implement the work from home culture in India from now. For example: TCS is planning to implement 25-25 strategy, in which by 2025, 25% of the staff will work from office and remaining staff will work from home. This is because it helps in saving a lot of operational costs as well as overhead costs leading to better profitability.
- Thus, this risk to commercial spaces posed by evolving work from home culture in India is a thing to watch out for.
Income distribution of REITs
- In terms of Income Distribution, REITs are expected to distribute 90% of their net income to their unit holders at least twice a year.
- REITs can distribute this income either in the form of dividends or interest payments, depending upon their portfolio.
- REITs also inform the investors about the tax implication of this income distribution.
To conclude, we can say that before investing in REITs, investor should take a note of the risks involved, type of REIT portfolio, its income distributions and tax implications and geographies in which REIT has real estate allocation.