Real Estate Investment Trusts (REITs): Unfit for Goal-based investing

Published: August 23, 2014 at 2:35 pm

Last Updated on

A real estate investment trust (REIT) is like a mutual fund that invests in property. Here is why I think REITs are not suitable for goal-based investing.

I know very little about how REITs work and I have sourced my information primarily from three articles.

If you wish to understand,

  1.  how REITs work, check this illustrated article from the Economic Times: How can you buy property for Rs 2 lakh? REITs to help investors 
  2. why they will not work, read Subra’s post: Will REITs work in India?
  3. the nitty-gritty, read Deepak Shenoy at his brilliant best:  REITs: The New Way To Make Less Money Than Inflation, in Real Estate

I don’t claim to understand everything because I stopped trying when I learnt about two crucial aspects from Deepak and the ET article.

  • “REITs must distribute 90% of the income they get. It can’t be reinvested. Also, if the underlying assets are sold the income generated must be distributed too” – Deepak Shenoy (CapitalMind)
  • Much of the income will be rental income and it will be taxed at 30% before distribution (much like DDT). Deepak quotes, Nishith Desai in this regard. There are also tax rules concerning interest received and capital gains!

REIT seems like a risky debt mutual fund with dividend option.

Even if the dividends were free from DDT, even if real estate in India is well regulated with no black money in it, even if rental yields are attractive, I see no point in investing in REITs.

For the simple reason that there is no ‘growth option. Had there been no mandate to distribute 90% of the income, I would have considered REITs for diversification. I would like to think RE volatility is lower when compared to gold. So instead of the usual 10% exposure to gold that ‘experts’ recommend, one could have a 10% exposure to REITs.

Unfortunately, REITs appear to be a dividend product, with a focus on ‘income’.

When I am in the so called ‘wealth accumulation stage’, where I am creating a nest egg for retirement, and a corpus for my other long term goals, why on Earth, would I choose a dividend-based product?

I have better things to do than to receive dividends and reinvest them.

KISS: Keep it simple and sufficient

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Stick to a well defined diversified asset allocation. Invest each month in ‘growth’ oriented products. I cannot think of a simpler way to keep track of a portfolio in every conceivable way.

Not convinced? 

If your goal is ten years away, would you choose an instrument in which you will have to declare gains each year and pay tax on it (like a fixed deposit) or would you choose a debt fund (growth option!) in which gains are taxed on upon redemption?

Investing in an REIT is like trying to fill a bucket with holes!

If I understand the power of compounding, why would I willingly choose to interrupt the compounding with taxes (assuming I am disciplined enough to reinvest the dividends)?!

What about retirees?

Can they invest in REITs to receive periodic (if not regular) income?  The title of Deepak Shenoy’s post answers that, does it not?!

So if you have two lakhs (or more) to spare, you are better off investing in ‘growth’ products irrespective of your age.

What do you think?

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