Avoid Real Estate Investment Trusts (REIT’s) & InvITs! FAQ on Basics

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Here is a ready reckoner FAQ on the basics Real Estate Investment Trusts (REIT’s) and Infrastructure Investment Trusts (InvITs) in the form of an FAQ. This covers key information for the layman and is meant to serve as a basic introduction. With Embassy office Park REIT IPO, there is a renewed interest in these instruments. However, investors should be cautious and avoid them as the risk are unknown and the expected reward not high enough.

Avoid Real Estate Investment Trusts (REIT's) & InvITs! FAQ on Basics

Table of Contents

FAQ on Real Estate Investment Trusts (REIT’s)

1: What are REITs? It is a mutual fund that invests in real estate. It has a structure that is similar to how mutual fund houses operate. The following a screenshot from page 64 from the offer document of Embassy Park REIT (download link below)
Embassy Park REIT Structure

2: Where can they invest? Commercial real estate only through a special investment vehicle (a 3rd party firm) or directly.

3: What is the asset allocation? Eighty per cent in completed rent-generating properties. Rest in cash, money market bonds, govt or corporate bonds, realty stocks and property under construction.

4: What is the minimum investment required? Two lakh. And when it is listed in the exchange the trading lot will be worth one lakh.

For the Embassy Office Parks REIT, You will have to buy a minimum of 800 units at Rs. 300 per unit or Rs, 2.4 Lakh.

5: Will I get a dividend?   There is no “growth” option! Twice a year (at least), the REIT will have to distribute 90% of the income as a dividend. There will also be some growth in the value of the units

6: How are they taxed? The dividends are tax-free. The dividend distribution tax associated with them has been scrapped. Moreover, capital gains from units less than 3Y old will be taxed at 15%+ cess and above that is taxed at 10% +cess.

7: What are the risks? The REIT combines the concentration risk of a sectoral mutual fund and the credit risks of a debt mutual fund.  Legal issues in ownership and construction or occupation delays can hit income. Recessions can hit developing commercial real estate pretty bad. There can be defaults or lack of tenants. There is no benchmark to compare with, aside from say, a fixed deposit. Rental yields are low and hence one cannot expect inflation-beating returns (inflation will be the at the lending rate).

8: How much return can I expect from a REIT: If you refer to page 79 of the Embassy Office Parks Offer Document, the RE income yield from India is about 7.5-8.5%. In a nice review, S R Srinivasan calculates a projected yield of 7.44% for Embassy Parks REIT in FY 2020. This is simply not worth the associated risk in my opinion.

9: My equity or debt mutual fund wants to invest in REIT. Is it okay to continue with it? Yes. The investment limit is capped at 10%.  If you invest directly in a REIT, the risk would be much higher. Even if the REIT portion does not result in better returns, it could  (repeat, could) lead to better diversification and lower risk. This remains to be seen though. There is no need to exit a fund just because it wants a slice of the REIT or InvIT pie.

10: What is the structure of a REIT? Besides the unit holder (you or me) on one end and the asset (the property) on the other, there are three other entities:

  • The sponsor who set up the REIT and hold the min no of units to make it valid.
  • The sponsor appoints a Trustee who holds the investor units and oversees the fund management.
  • The fund manager who is responsible for security selection
Real Estate Investment Trusts (REIT's) and Infrastructure Investment Trusts (InvITs)
Mumbai Skyline. Source: Wikipedia

A FAQ on Infrastructure Investment Trusts (InvITs)

1: What are InvIT’s? An InvIT is a mutual fund that investments in infrastructure projects as defined by the Ministry of Finance.

2: Where can they invest? In projects such as these. Source: RBI

Real Estate Investment Trusts (REIT's) and Infrastructure Investment Trusts (InvITs)

3: What is the asset allocation?

There are two types of InvITs.

Public InvITs have to invest greater than 80% in completed revenue generating projects and not more than 10% in under construction projects.

Private InvITs can have more than 10% in under construction projects.

4: What is the minimum investment required?

Public InvITs: 10 Lakh

Private InvITs: 1 Crore

5: Will I get a dividend?   There is no “growth” option! Twice a year (at least), the public or private InvIT will have to distribute 90% of the income as a dividend.

6: How are they taxed? The dividends are tax-free. The dividend distribution tax associated with them has been scrapped. Moreover, capital gains from units less than 3Y old will be taxed at 15%+ cess and above that, it is 10% +cess.

7: What are the risks?  In addition to the risks associated with REITs, the possibility of government intervention is a risk to the amount of income one can generate with this instrument.

8: What is the structure of an InvIT? In addition, the three entities associated with a RIET, an InvIT also has a project manager to undertake projects (need to learn more about this).

This covers the basic ground on both these instruments. Do let me know if there are any mistakes or anything important has been left out. Will update this FAQ from time to time.

Should you invest? As of now enjoy the 10% REIT or InvIT stake in equity/debt mutual funds and don’t get your hands messy directly.  My impression is that the reward may not be in proportion to the investment ticket and risks involved. Once the NAV data is available, we can take a deeper look. If I am going to get fixed income kind of return, then I must only take on fixed income kind of risk. REITs have far higher risk and therefore make no sense.

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10 Comments

  1. Great summary (as always).

    I have a suggestion for the picture of the REIT structure. The Manager for Embassy Office Parks REIT is doing a ‘double dipping’ – acts as Manager for the REIT as well as the property manager of the assets. From what I know, the REIT regulations don’t require it. It may be useful to provide a simpler picture of REIT in the overall review.

    And thanks a lot for the reference to my analysis.

    1. My pleasure sir. Also on page 39:
      “Competition from other developers in India may adversely affect our ability to sell or lease our projects, and continued development by other market participants could result in saturation of the real estate market which could adversely impact our revenues from commercial operations. We may also have conflicts of interest with our Sponsors, the Embassy Sponsor and the Blackstone Sponsor Group. See “Risk Factors—There may be
      conflicts of interests between the Lead Managers and/or their associates and affiliates and the Manager, the
      Embassy Sponsor, the Blackstone Sponsor Group, the Blackstone Sponsor, the Trustee and/or their respective
      associates/affiliates.”

  2. Dude get a grip on yourself. Some of your articles are very good. Others am not sure – today included – reits are globally very good retail investment options. Agree embassy has priced its ipo steeply. Doesnt mean the entire structure is bad. 80pc+ of reit assets have to be operational – means little execution. And rental growth in india will easily beat inflation long term. Near term economic/downturn risks ate steeper in stocks – so why invest in mutual funds. If you can get 8-9pc rental yield with 5-6pc rental inflation – thats a deadly combo. And I am sure we will such reits in future.

      1. Risk-return should be comparable – so compared to what. Residential real estate good enough for you. Bought a house in Mumbai in 2012 – had to recently shift out (put house on rent) seen good cycle of cap appreciation and rentals now. Bought for 1.4cr – current price is 2cr (approx.) so 5% cap appreciation. Gross rent is 60K – net is 50K. So around 3-4% rental yield. Embassy REIT is better on rentals (7.5%) but maybe not so greater on appreciation. Yet overall better – take note my residential development was rated among top-5 in Mumbai by Proptiger, so average residential performance would be weaker. And Mumbai prices have at least held up – Delhi I am told prices continue to decline. And this when so many smart people’s money is stuck in residential real estate. Even a dumb Embassy REIT would do better.
        Good enough risk-return for you??

          1. Thats convenient. Given that there are no reits in india historically, there cannot be be a measurement/track record. If that is your logic of investment, then there would be no reits. At least got your investment philosophy chief.

    1. 8-9% rental yield increasing 5-6% every year is too much of a wishful thinking. In Mumbai commercial market, rents have not gone up in last 4 years. In fact some deals are even happening at discount to market rates. Bangluru is only city where commercial rents have gone up in past few years. We can’t say this will continue for sure.

      Plus REIT rental yield of 8% is 7% for investors after management fees. REIT is globally an alternative to debt and bonds. Can’t be compared to Equity.

      1. Reits are hybrid structures. Pure debt is fixed income. Reits given you rental yield but potential for higher rentals also in a growing economy (like india). Surely the expectation of rental growth carries risk (competiton, more supply – similar to equity risk). The question is does instrument provide enough expected return – in this case I admit probably not – but that does not give you license to say that stay away from reits completely! That is a very absurd claim, imho (as the title of the article itself suggests – it does not say stay away from embassy reit). As it turns out, embassy reit has >50pc exposure to blore/it sector, which you say has seen attractive rental growth. Mumbai I am not so sure – nariman has seen tenant exodus but bkc, suburbs have done roaring business last 10 years.

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