Breaking down REIT

REITs stands for Real Estate and Infrastructure Investment Trusts. The to-be introduced instruments have the potential to attract investors to  the cash starved real estate sector.

History 

In 1960, President Eisenhower signed legislation that allowed both equity and real estate  investors to purchase and sell liquid real estate equities. People got access to huge returns  from commercial real estate which was initially open only to wealthy individuals

REITs looked inviting because trusts bought income -producing property and avoided paying taxes as they passed the bulk of their gains as dividends to the shareholders

Purpose

Infrastructure demands for the 12th Five -Year plan is around INR65 lakh crore 

• Additional window of funding for infra and real estate sector
• Reduces the exposure limit of public sector banks
• Saves many despondent developers from huge interest rates that they sign up for as part of financing their projects. Many real estate developers in spite of taking advances for their project end up cash-strapped.

What does it mean to retail investors ?

• Minimum investment amount has been fixed at INR 2 lakhs for REIT and  INR10 lakhs for InvITs 
• Retail investor could trade in units of REITs and InvITs like any other security in stock exchange
• Returns from REITs have been less correlated with the performance of the broader market. 
• Returns have hugely outpaced the inflation numbers as the investment of REIT has normally been in diversified assets
• Investors can reduce their portfolio volatility by allocating funds as per their risk appetite in REIT units
• Low entry level investment, high liquidity, high probability of capital appreciation
• Long term income generating instruments

 Infrastructure which remains a major bottleneck to the development of our country can be eased through new capital inflow.  Many infrastructure projects which are stalled due to capital crunch can get a lifeline with this investment instrument.New guidelines expected are inlines with that of developed countries like US , UK, Singapore, Hong Kong etc

How to choose your REIT ?

Apart from the history of dividend yield which the investor has to keep tracking, investor have to maintain prudence , do their homework on checking the underlying property , and check if the REIT is heavily invested in any particular area. Over concentration in certain markets , deteriorating tenant quality should be checkpoints for the investors.

Because property owners should deduct non-cash depreciation expenses when calculating earnings, even if the property is, in fact, appreciating in value, reported income is reduced unrealistically. REITs mandate 90% distribution of cash flow to investors non cash expenses  reduce dividend yield drastically. For that reason, the REIT trade association created a measure called “funds from operations” (FFO), which reflects the actual cash profits generated by a REIT’s operations.

Growing FFO would be one of primary numbers to be verified before investing in REIT. Having major shareholders to participate in reinvestment decisions can prevent managers from squandering wealth generated.

Word of caution would be that there is huge market risk  plus known unsystematic  risk as real estate has been notorious for its significant contribution to multiple bubbles in financial history

For the financial technicalities of REITS

• Indian REITs are allowed to invest only in commercial properties
• REITs are allowed to raise funds from foreign investors. 
• REITs must distribute 90% of its cash flows to its investors
• Tax treatment is pass through for REITs
• Minimum size of REIT asset has been lowered to INR500 crore from INR1000 crore. Multiple sponsors with minimum 5% holdings is permitted. 
• Up to 20% of investment can be in under construction assets,shares/debts of real estate companies, and mortgage backed securities
• Minimum initial offer size would be around INR250 crore with a minimum public float of 25 %
• Sponsors would need to have mandatory holding of 25% for 3 years and then continuous 15 %  thereafter  
• Minimum net worth of manager would be raised to INR 10 crore 

P.S.   Blog has been written as per the current draft guidelines issued by SEBI and is subjected to change with time. The purpose of the blog is to introduce the reader to a new plausible financial investment instrument . But the readers should use their own wise discretion to make investment decisions