Real Estate Investment Trusts — A Primer
The what, the why, and what next of REITs along with a look at global and India specific trends…
Real Estate Investment Trusts, popularly known as REITs, is an ingenious concept brought into force by President Eisenhower’s 1960 signing of the REIT Act title contained in the Cigar Excise Tax Extension. Since then, it has spread worldwide, evolving into a sophisticated investment option.
REITs can be thought of as mutual funds for the real estate market, democratising real-estate investments. These companies pool in money from multiple investors and invest the funds into various income-generating real estate properties or finance such projects. Investors can purchase and trade REIT units like they trade shares of companies.
REITs start with a small portfolio of properties. Based on demand, they then increase their portfolio, add more spaces, and this pushes up revenues. The types of income-generating properties these firms invest in include apartment complexes, healthcare facilities, hotels, office buildings, warehousing facilities and malls.
Types of REITs
Equity REITs invest in income-generating real estate, and investors receive income from the rents generated. Further revenue can also be made from the sale of properties. These REITs possess properties of both stocks and bonds. The steady income from rents is akin to coupon payments from debt instruments like bonds, and the capital appreciation gains reflect equity-like returns.
Mortgage REITs, on the other hand, finance income-producing real estate via the purchase of mortgages and mortgage-backed securities. Portions of the interest payments on the loans are disbursed to investors.
Hybrids of the above two types of REITs constitute hybrid REITs.
Benefits of Investing in REITs
Numerous benefits accrue to various stakeholders involved in the REITs market, i.e. the investors, managers and real-estate developers.
A lot of different individual and institutional investors, including pension funds, endowment funds and insurance companies engage in REITs trading. While most individual investors can’t afford to purchase commercial spaces or income-generating properties, REITs allow them to benefit from the real-estate sector without having to shell out vast fortunes. Such a concept of pooled investment minimises risk while offering the opportunity to tap into returns.
REITs offer lucrative dividends to investors, thus finding favour with those seeking to have a predictable income stream. They have outperformed traditional financial assets like stocks. ‘The projected return on investments are anywhere between 8% and 14% in short to medium term (post adjustment of the fund management fee), with minimum risks,’ according to Shobhit Agarwal, MD and CEO, Anarock Property Consultants. Further, in many cases, the income thus obtained is accompanied by attractive tax benefits. Usually possessing a low correlation with traditional markets, REITs lend diversification benefits to portfolios.
Most REITs are traded on regulated exchanges, allowing investors to purchase and trade units of the same. This attributes to REITs two highly desirable features in any asset class: liquidity and transparency. Non-traded REITs are naturally less liquid and transparent. In India, REITs are treated as traded financial securities and come under the scrutiny of SEBI, thus requiring proper disclosures. Further, there’s always the added benefit of professional management of the portfolio assets.
The rising popularity of REITs and big-ticket sizes of various REIT IPOs offer immense opportunities to the managers and professionals involved. There is a demand for active management of different REITs in investment portfolios to generate higher alpha (returns), and multiple groups propound the case for active management over passive management strategies despite higher fees. This demand is highly beneficial for active managers.
Real-estate developers can also ride the REITs wave. With the traditional banks’ inclination towards investing in real estate and infrastructure projects waning as a result of past defaults and the general economic sentiment, REITs offer these developers an attractive financing stream. They allow developers to focus on building and developing real-estate while they handle the aspect of monetisation.
Risks Associated with REITs
Publicly traded REITs are exposed to interest-rate risks, whereby under increasing interest rate environment, investors may prefer putting their money in other safer income plays like Government bonds. Plus, issues pertaining to wrong choices of REITs brought about by miscalculation of trends do exist, and one needs to be fully aware of possible implications of one’s decisions concerning such investments.
REITs Evolution
REITs have witnessed a prodigious growth since inception in the US nearly 60 years ago. In 2019, REITs’ market capitalization was ~96% of the overall real-estate market cap in the US, 55% in Singapore and 51% in Japan.
Singapore can be termed as the global REITs hub, possessing the most number of foreign REITs. With over 41 IPOs of such firms since the maiden REITs share sale in 2002, Singapore’s REITs offer a yield of 6.2%, one of the highest globally. Its friendly regulatory and tax system and mature market invite foreign firms in droves, and over 7 REITs IPOs were foreign-currency denominated.
REITs in India
REITs in India is a relatively novel idea. While SEBI confirmed the regulations governing REITs in September 2014, there were multiple amendments through the years. REITs are registered with SEBI under the REITs Regulation of 2014, and units of all REITs must be listed on a recognised stock exchange, regardless of whether they’ve been privately placed or publicly issued.
80% of the asset value of a REIT is required to be invested in rent or income-generating properties, and the rest 20% can be invested in real-estate related securities or other instruments. Only 10% of the assets must comprise under-construction properties. Further, REITs are required to disburse at least 90% of their income to investors or unitholders at least twice a year. This ensures good income for investors but limits the ability of REITs to reinvest proceedings for growth.
India’s first REIT IPO happened only in March 2019, via the Embassy Office Parks REIT, a Bangalore-based real estate developer backed by Blackstone Group. The IPO managed to raise over ₹ 4500 crores, bringing the REITs market cap to 17% of the total real estate market cap in India. And it has delivered a reliable performance this April-June quarter despite the lockdowns, with office rental collections at 99.2%, 99.3% and 98.2% in April, May and June respectively. As of July-end, the REIT enjoyed returns of ~22% since its listing last year.
Joining Embassy, another Blackstone-backed REIT was announced this year, taking the share of REITs market cap to 29% of the total real estate market cap. Mindspace Business Parks REITs, backed by Blackstone and Raheja, was listed on the bourses at ~11% premium in August 2020. Its IPO was subscribed 13 times, an impressive performance indeed. This indicates an appetite among Indian investors for non-traditional investment products and the growing market conduciveness towards REITs.
SEBI has been proactive in framing policies that enable further development of this relatively nascent product in India and encourage non-institutional investor participation. Reduction of minimum investment amount from Rs. 2 lakh (800 units) to Rs. 50,000 (200 units), allowing for a change of REIT sponsors, and inclusion of mutual funds and insurance companies as strategic investors are some beneficial regulations. SEBI is also considering reducing the minimum REIT trading amount to that of just one REIT unit. That would further enhance retail investors’ access to the product and improve liquidity.
The Ministry of Finance has also made emendations to the tax structure surrounding REITs, making it more favourable for market participants.
The Industry vs Covid-19
At the surface level, one might be tempted to repudiate REITs and investments in office complexes considering the current environment. Companies have put expansion on hold, laid-off employees, and WFH trends are eroding the status quo. They seem to be flagging a red signal for REITs as occupancy rates may go down, affecting rental income.
In reality, REITs seem to be weathering the storm pretty well so far, with Embassy putting out strong numbers this quarter and Mindspace’s successful listing. Further, Brookfield Asset Management has also planned to raise $500mn to $700mn via a REIT listing by the end of 2020.
The uncertainty around H1B visas and work-related immigration in the US could culminate in US firms setting up bases in India for operations, targeting spots like Bangalore and Hyderabad. Amazon recently leased ~2.8 million square feet of office space in Mumbai, Bangalore and Chennai. Microsoft, Google, Morgan Stanley, and Standard Chartered are some other firms that have thrown their hats into the leasing ring. Deals totalling 11 million square feet have been finalised in the last month, and another 8 million square feet worth of deals is supposedly under discussion. However, experts also opine that deal volume may slow down by December, and the market may bounce back in 2021.
Future Outlook
While the cogency of the short-term outlook is debatable, there does seem to be a positive sentiment towards REITs from investors, regulators and companies. The Indian REITs market is expected to grow to $22–40 billion in the next few years. Once a few more REITs get listed on Indian bourses, the product would kick-off rapidly. Till then, hesitations and doubts regarding REITs are understandable.
There must be a focus on increasing awareness about REITs, its advantages and disadvantages amongst investors, real estate developers and fund houses. Proposals like reducing the minimum trading ticket size for REIT units which are under deliberation would be extremely helpful in improving the market. Transparency and sustainability would be key aspects impacting decisions in the coming decade and catering to them would do good.
According to Ramesh Nair, CEO of property consultants JLL India, ‘The anchor and strategic investors in Mindspace Business Parks REIT are the most sophisticated investors in the world and their investment call is not a short-term view. It shows that the India office story is here to stay.’
