Debt Like Income, Equity Like Taxation! Likey Likey?

A large number of retail investors have begun to lock into high yielding assets to plan for their retirement years via REITS- which are offering yields of almost 6.5% in the recent past (apart from capital gains) – but an even larger number of people have still not participated. With SEBI in the picture and investing/redemption in seconds in this powerful asset class, its time investors understood this new kid on the block and begin skinnydipping into the pool of wealth that’s possible from the growth of India’s real estate sector offering high post tax dividend income minus the disadvantages of real estate!

INTRODUCTION

REITs were first introduced in the USA back in the 1960s on similar lines as mutual funds. These were initiated to boost real estate development through existing investments from investors who were interested in real estate exposure.

Over the last decade, REITs and InvITs have grown into a mature market, providing easy access to high-quality assets and enabling a stable return on investments. The number of countries offering REITs as an investment vehicle has increased to 43. Countries including Australia, Canada, France, Spain, Hong Kong and Germany have established large REIT markets.

As far as the Indian market is concerned, REITs were first introduced here by the Securities and Exchange Board of India (SEBI) in 2007. As the investment vehicle started gaining popularity, there were many regulations announced to facilitate smooth operations of these investment funds. Today, REIT companies that are listed on the Indian stock exchanges are constantly monitored and fall under the regulation of the Securities and Exchange Board of India or SEBI.

Currently, there are three REITs in the market and the last REIT grabbed the attention of many and was subscribed 7.94 times at a 2.43% premium to its offer price.

WHAT ARE REITS

In general terms, REITs are investment vehicles that own and operate real estate and infrastructure related assets and allow individual investors to earn an income without actually buying any assets. Typically, the income-producing real estate assets owned by a REIT include office buildings, shopping malls, apartments, warehouses and mortgaged property. For instance, some of the best Hilton hotels in India are managed by REIT companies. Over the years, REITs have constructively changed the way in which the real estate market operates, and benefitted investors as well as real estate developers.

Within real estate, commercial real estate , despite its higher yield potential of between 7%- 10%, has for long remained inaccessible primarily to retail investors due to high-ticket prices, illiquid long-term nature of investments, tax implications, and difficulties in administering and managing significant assets. Now, retail investors can build wealth through commercial real estate through the REIT product – a liquid, tradable unit with tax efficiency and high-quality management. And available for just Rs 300-400 (versus minimum Rs 50,000 earlier , thanks due to a change made by SEBI).

Today, Indian REITs typically boast quality office or hotel assets, leased to some of the best companies in the world, including the best Indian names , MNCs as well as Fortune 500 companies. The product is professionally managed, highly tax-efficient, and is backed by a strong regulatory framework at par with the developed world.

Moreover, they offer regular tax-efficient yield through quarterly distributions, and in tandem offer potential for capital appreciation owing to the increase in value of the underlying physical assets as occupancy rentals increase or new markets get formed. This makes them an attractive diversification instrument across market and economy cycles.

The three listed REIT’s have in aggregate raised over Rs 16,500 crores as primary equity and touched a combined market capitalization of Rs 59,000 crores even as the pandemic ebbed and flowed over the last two years. In fact, since it listed in 2019, Embassy Office Parks REIT has clocked a 100% payout for 10 consecutive quarters, distributing over Rs 4,800 crores to unitholders with over 30 per cent total returns.

High-growth potential for the asset class, a rebounding business environment, reduction in entry price-points and improved liquidity, the comfort of a strong regulatory framework and asset management, tax-friendliness, and low volatility even amidst the pandemic. Indian REITs can deliver so many items on the wish-list of retail investors in 2022.

What are the types of REITs?

Mentioned below are some of the commonly available varieties of REITs in India:

Equity REITs: These REITs primarily invest in offices, residential complexes, industrial estates, hotels etc. They buy, manage, set up, and sell real estate. The income earned is distributed to investors as dividends. Income is mostly generated through rentals and the sale of properties.

Mortgage REITs: These REITs loan out money to buyers of real estate, and some may even buy out existing mortgages. They are also referred to as mREITs. These derive income from the interest received through mortgage loans. They work somewhat like a debt mutual fund, however, the risk component is often higher in REITs.

Retail REITs: Retail REITs invest in the retail segment like shopping malls, grocery stores, hypermarkets, supermarkets, etc. However, retail REITs do not run these retail outlets. They only focus on renting out space to various retail tenants. In this case, returns, depend on the performance of the retail sector.

Residential REITs: Residential REITs buy and operate apartment buildings, gated communities, and other such housing establishments. Whenever the residential property demand in India grows, these REITs reflect positive growth.

Healthcare REITs: Healthcare REITs invest in real estate for hospitals, medical establishments, health clinics, etc. Since the demand for healthcare services has been on a rise in the last few years, these REITs present a good investment opportunity for investors.

Office REITs: These REITs focus on office properties and earn through rental income.

An Overview of Existing REITs

After considerable modifications, the Real Estate Investment Trusts Regulations, 2014 (REIT Regulations), were enacted in India on 26 September 2014. The listing of Embassy Office Parks in April 2019 broke through with the first listing in the Indian REIT industry. This was followed by the listing of the Mindspace REIT in August 2020 and Brookfield REIT in early 2021.

SEBI requires REITs in India to have a three-tier structure like mutual funds. The sponsor sets up the REIT, the manager runs the portfolio and the trustee is supposed to watch over both. To ensure that doubtful entities don’t promote REITs, sponsors need to have a minimum net worth of Rs 100 crore and at least 5 years of experience in the real estate industry. The Manager is a company or an LLP or a body corporate which manages and operates the REIT. A manager has to have at least 5 years of related experience along with other requirements as notified. A trustee  oversees the activities of the REITs who is appointed by the Sponsor.

A REIT in India is mainly allowed to invest in completed and revenue-generating assets and other approved investments. Also, REIT has to distribute the majority of the income they produce among the unitholders.

REITs can mainly invest in commercial real estate through two ways – (i) directly and (ii) through a Special Purpose Vehicle (“SPV”) which has to invest more than 80% of their assets in properties. The remaining 20% can be in under-construction properties, listed or unlisted debt of real estate companies, listed or unlisted equity shares of real estate companies, mortgage-backed securities, g-secs, and money market instruments. If the REIT is being done through an SPV, their ultimate holding in the SPV should be at least 26%.

In terms of leverage, REITs are not allowed to take leverage of more than 49% of their total assets making sure that they are not over borrowing.

Returns 

Unitholders earn income through rentals received from properties owned by REITs which could be through dividend income, interest income, or capital gains via the sale of units in the secondary market.

The REITs make money through 3 sources:

  • They receive rent from the commercial properties which have been leased out.
  • Interest payments from their subsidiaries or SPVs which they have funded to develop the property.
  • Capital appreciation of their properties.

THE THREE LISTED REITS

Embassy REIT

Sponsored by Embassy & Blackstone, Embassy REIT is the first listed REIT in India & the largest in Asia (by area). The company owns & operates 42.8 MSF (million square feet). It has a portfolio of eight office parks, six hotels (two are under-construction) & a 100 MW solar power plant. It comprises 33.8 MSF completed operating area with an occupancy of 87% as of March 31, 2022.

Bangalore is their biggest market with 74% of the asset value, followed by Mumbai (10%) & Pune (9%). Top 10 tenants contribute 39% of rentals. The company has a WALE (Weighted Average Lease Expiry) of 7 years. In the last 3Y the company has grown its revenue at a CAGR of 11.4% to 2962.6 Cr. EBITDA grew by 11.2% CAGR during the same period to 2425 Cr as of FY22.

Unlike other REITs, Embassy has exposure to hotels in its portfolio (4% of their GAV). The company took a rent escalation of 14% on 7.7 msf across 89 leases in FY22. This will aid 10-15% to the NOI growth.

Mindspace REIT

Mindspace REIT is sponsored by K Raheja Corp Group. It has a strong portfolio of office spaces across Mumbai, Pune, Hyderabad & Chennai with a total leasable area of 31.8 msf.

Top 10 tenants contributes 36.5% of rentals. They are at 84.3% occupancy. WALE stands at 6.9 years.In the last 4Y, the company had grown its revenue by 6.9% CAGR to 1750 Cr. It was up by 53.77% in FY22. The NAV has moved up from 326.1 at the time of IPO (July 2020) to 364.9 as of Mar 2022.

Mindspace offers a higher post tax yield (90% of NDCF). All SPVs are 100% owned by REIT except for Mindspace Hyderabad (11% is owned by Government of AP).The distribution yield currently is at 5.37%.

Brookfield India REIT

It is sponsored by Brookfield AMC & is India’s only institutionally managed commercial real estate vehicle. They have commercial properties in Mumbai, Gurugram, Noida & Kolkata. Their total portfolio comprises 18.6 Million SqFt, out of which 4.7 Million SqFt will be developed in the future.

NCR region contributes 67% of the total asset value. The company has an occupancy of 83% & WALE of 7.3 years. The company is heavily dependent on a few clients as  Accenture, TCS & Cognizant contribute 41% of the leased area.

The revenue is down by 12.28% to 756.8 Cr (TTM). Loan to value stands at 33%. The company has a total debt of 2250 Cr. The cost of borrowing is relatively high at 6.76% when compared to its peers. The portfolio has a well-staggered lease expiry profile. This will increase the Mark to Market to 34% by FY23.

The company has Right of First Offer (ROFO) on certain properties owned by Brookfield Group. These new assets have the potential to increase leasable area substantially

How to invest in REITs in India?

You can buy units of REITs just like shares through regular trading accounts on BSE and NSE, the major exchanges.

Investing through Stock Exchanges

Similar to ETFs, REITs are listed and traded on stock exchanges.  The price of a REIT unit can change depending on the demand supply for these on the stock exchanges. Prices are also influenced by the performance of the REIT. At present, there are 3 options of REITs in India–Embassy Office Parks REIT, Mindspace Business Park REIT, and Brookfield India Real Estate Trust.

PL DigiTrade App can help you buy the REITs online – Please see screenshot below as illustration

Your can research more about REITs volumes and prices at https://www1.nseindia.com/live_market/dynaContent/live_watch/get_quote/GetQuote.jsp?symbol=EMBASSY

Investing through mutual funds

In India, very few domestic Mutual Funds invest in REITs, and the actual exposure to real estate is very limited. One can also invest in REITs through mutual funds. In India, investors looking for exposure to international real estate can invest in Kotak International REIT Fund of Fund as it invests mainly in International REITs.

Taxation

The cash distributed to the unit holders is a combination of three parameters – Interest income, Dividend income & Repayment of debt. Taxation works the same for all REITs except for Dividend income which depends on the tax regime the SPVs has opted for.

In the hands of the Unitholder:

  • Transfer of units by unit-holders shall be chargeable to Capital Gains Tax at applicable rates. Any short-term capital gains arising on the transfer of units shall be chargeable to tax at 15 percent. Long-term capital gain is taxable at 10% if the amount exceeds INR 1 lakh.
  • Unit-holders receiving any income distributed by trusts such as interest or dividend shall be treated as income of the unit-holder for that previous year. Tax on dividend income depends on whether the REIT had obtained special tax concession from the government.

RECOMMENDATION

Given the low size, exchange availability, high yields and of course, capital gains advantage, we believe REITs are one of the best ways for fixed income investors to build their portfolio. Given however that avaiability of units is very low, as institutional investors typically gulp whatevers available, one good way to accumulate units would be via an SIP route – staggered investments over a period of time that lead to a large retirement corpus as well. We believe someone who has a conservative risk profile looking for better post tax returns should ideally diversify across all 3 listed reits and if you have some time to go for retirement, Brookfield and Embassy which have potential capital gains from access to more leasing space could be more ideal.

To invest in REITs, do contact your relationship managers or visit PL DigiTrade (Download from Playstore or Applestore) app to invest today!

Read more about REITS at https://www.pwc.in/assets/pdfs/research-insights/2022/indias-real-estate-and-infrastructure-trusts-the-way-forward-seventh-edition.pdf

 

Leave a Reply