REAL ESTATE INVESTMENT TRUST (REITs)

Contents

1. What is a Real Estate Investment Trust (REIT)?

2. How to start a REIT

3. How did it evolve?

4. How Do REITs Work?

5. Registration of REIT

6. How to Invest in REIT

7. What should you look for in a REIT before investing?

8. Embassy

9. Brookfield

10. How Does a Company Qualify as a REIT?

11. Types of Real Estate Investment Trusts

12. Advantages and Disadvantages of Investing in REITs

13. Taxation

14. How to invest

15. Points to note

1. What is Real Estate Investment Trust?

Real Estate Investment Trusts are similar to mutual funds. They pool money from multiple investors and use that to buy income-generating real estate properties. REITs manage these assets so that they can earn capital appreciation and rental income. A REIT is created by a sponsor, who transfers ownership of assets to the trust in exchange for its units.

It invests in properties like office spaces, warehouses, malls, etc., where the investments can generate rental income. They can also mortgage properties in addition to this. Leasing properties to earn revenue is also a strategy.

REIT offers investors a share in the trust. Consequently, investors can reap profits from investments. In India, SEBI has brought down the minimum investment to INR 10,000-INR 15,000 with a lot size of one unit.

2. How to Start a REIT

• A REIT must be a trust set up under the Indian Trust Act, of 1882

• Registered under the SEBI REITs Regulations.

• The parties to the REIT should be fit and proper persons as per Schedule II of the SEBI (Intermediaries) Regulations, 2008

• The sponsor(s), on a collective basis, has a net worth of not less than one hundred crore rupees

• The REIT must mail annual letters to its shareholders requesting details of beneficial ownership of shares. Significant penalties will apply if a REIT fails to mail these letters on time.

SEBI GUIDELINES AND Section 4 of the Regulations

● The instrument of trust must be registered as a deed under the Registration Act, of 1908.

● The trust’s main objective should be to carry on the REIT activities. Responsibilities of the trustee

● The corporation must have a minimum asset base of INR 500 crores.

● 90% of the net distributable cash flow should be distributed to unitholders in the form of interest or dividends.

● 80% of the total investment should be placed in income-generating assets. Only 20% of the total investment can be made in under-construction assets.

3. How did REITs Evolve?

REITs were first introduced in the USA back in the 1960s on similar lines as mutual funds.

As far as the Indian market is concerned, REITs were first introduced here by the Securities and Exchange Board of India (SEBI) in 2007. 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.

India saw its first REIT (Real Estate Investment Trust) in 2019. Three years later there are now three (Mindspace REIT, Brookfield REIT, and Embassy REIT). REITs as an investment option have gained significant popularity among institutions & retail investors.

4. How do REITs work?

REITs have a similar structure to that of mutual funds with a sponsor, fund management company and a trustee. The sponsor promotes the REIT with its funds, and the fund management company selects and buys properties for the portfolio.

The trustee ensures that the funds collected are utilized and managed, keeping the investor’s interest in mind. Through REITs, investors gain by earning regular income in the form of dividends and also can diversify their investment portfolio.

REITs are of two types, Equity REIT and MREIT. Equity REITs hold properties in the vicinity like hotels, offices, and other large facilities and earn their revenue from rent. In contrast, MREITs finance the properties like residential or commercial and earn income from interest through mortgages.

5. Registration of REIT

● The sponsor shall file an application before the board on behalf of the trust in Form A

● The board may appoint any person to take charge of the records and documents.

● Grant of certificate – Form B

● Conditions of registration are subject to conditions

6. How to Invest in REIT

● Getting started is as simple as opening a brokerage account

● Then you’ll be able to buy and sell publicly traded REITs just as you would any other stock.

● If you don’t want to trade individual REIT stocks, it can make a lot of sense to simply buy an ETF or mutual fund that vets and invests in a range of REITs for you.

7. What should you look for in REIT?

● Weighted Average Lease Expiry

The biggest risk of running a commercial property is vacancy. WALE is used to calculate the time left for the property to go vacant. It is measured in years. The higher the better.

● Distribution Yield

By law, REITs have to pay 90% of distributable cash flows to the investors. Distribution yield is a metric to measure these payments. It depends on the trust performance. Again the higher the better.

● Loan To Value

Loan to Value (LTV) measures how much debt was borrowed compared to the underlying asset value. Just like any other business, the low leverage the better.

● Net Distributable Cash Flow

NDCF is a key metric to show how much money is left to distribute to the unit holders. Usually, all REITs have a two-layered structure.

▪ SPVs are owned by the Holding Company.

▪ The holding company is owned by the Trust.

As per SEBI guidelines,

▪ 90% of NDCF of the SPV must be mandatorily distributed to the REIT.

▪ 90% of the NDCF of the InvIT should be distributed to the Unitholders.

The consistency of NDCF is an important metric to keep an eye on.

● High occupancy

The occupancy rate is the percentage of the square foot available in the portfolio of REIT. This ensures consistency in payouts, increasing rental & dividend income. The higher the occupancy, the more stable the cash flows.

● Diversified portfolio

An oversupply of properties can reduce occupancy rates & rental income. REITs having diversified portfolios across geographies & tenants are less prone to oversupply & concentration risk.

● Net Asset Value

NAV is one of the best ways to assess REITs. Think of it like a Book value per share. It is calculated as the estimated market value of the properties minus all liabilities. This is divided by the number of shares outstanding.

● Sponsor

A strong sponsor will have many advantages like brand recognition, trust factor, on-time delivery etc. REITs will also have the Right of first offer (ROFO) on properties owned by the sponsors.

● 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.

8. Embassy REIT structure

Embassy Office Parks REIT owns and operates about 33.3 million square feet of commercial property (including Grade A office space, hotels and a solar park). Out of these 26.2 million square feet is complete with 92.8% occupancy

The embassy is the only listed REIT that has exposure to hotels (6% of their GAV). The company took a rent escalation of 15% on 4.6 MSF across 28 leases in H1FY23. This will aid 10-15% of NOI growth next year.

How does the REIT make money ?

The primary source of operating revenue for the REIT is the rental income followed by common area service charges. The office spaces are usually leased out for 9 to 15 years with a rent escalation of 10% to 15% every 3 years.

How REIT distribute income to investors / unitholders?

Interest – received on loans made to SPVs

Dividend – from the SPV’s incomes

Amortization of Debt to SPVs – Principal repayments from the SPV Loans

Trustee : Axis Trustee Services Ltd

Sponsor: Embassy Group and Blackstone Manager:

Embassy Office Parks Management Services Private Limited Share Price: 321.86

9. 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 18.7 Million SqFt, out of which 4.4 Million SqFt will be developed in the future.

In Dec 2021, Brookfield India REIT acquired Candor Techspace N2, one of the largest office parks in the NCR region with a 4.5 MSF leasable area & WALE of 8.5 years for 3970/- Cr. They financed this acquisition by a combination of debt & equity dilution. In Q2FY22, the revenues are up by 43.4% YoY to 303.6 Cr mainly on the back of this N2 acquisition.

Trustee: Axis Trustee Services Limited

Sponsor: BSREP India Office Holdings Pvt Ltd.

Manager: Brookprop Management Services Private Ltd

Share Price: 275.40

10. How does a company qualify as REIT?

● Firstly, an entity has to be a business.

● Secondly, a minimum of 100 shareholders.

● Thirdly, offers fully transferrable shares to investors.

● Subsequently, managed by a board of directors or trustees.

● Also, 90% of taxable income is paid as dividends.

● Collect 75% of gross income from the mortgage.

● 20% of the entity's assets are under taxable REIT subsidiaries.

● Finally, a total investment of 95% is mandatory.

In accordance with the SEBI guidelines and Section 4 of the Regulations, the following are the eligibility criteria for REITs:

● The instrument of trust must be registered as a deed under the Registration Act, of 1908.

● The trust’s main objective should be to carry on the REIT activities.

● Trustee, sponsor and manager should all be separate entities.

● The parties to the REIT are fit and proper persons as per Schedule II of SEBI (Intermediaries) Regulations, 2008.

● Whether or not any previous certificate applications have been denied.

● Whether any regulatory action has been taken against REIT participants.

● No multiple classes of REITs.

● The corporation must have a minimum asset base of INR 500 crores.

● 90% of the net distributable cash flow should be distributed to unitholders in the form of interest or dividends.

● 80% of the total investment should be placed in income-generating assets. Only 20% of the total investment can be made in under-construction assets.

11. Types of Real Estate Investment Trusts

There are six types of REITs in India based on the type of business they are involved in and whether they are private or public entities. Following is the list of different types of REITs:

● Equity REITs: These are the ones where it owns all the income-generating properties. It generates income through rent. This is the most popular type of REIT. The income earned will be distributed to all the investors.

● Mortgage REITs: Mortgage REITs or MREITs lend money to businesses that are in the real estate industry. They do not earn income from rent but through EMI or mortgage payments. which is shared with all the investors.

● Hybrid REITs: These have both owned properties and mortgage-based properties and earn regular income through rent and interest. It allows investors to diversify and earn through both sources.

● Private REITs: These have a limited number of investors and work as private placements. They are not registered with SEBI and are also not listed on any stock exchange.

● Publicly Traded REITs: It is listed on the stock exchange (NSE) and is also registered with SEBI. Investors can buy and sell shares of it through a stock exchange. They are more liquid but are subject to market volatility.

● Public but not listed REITs: This type of real estate investment trust is registered with SEBI but is not listed on the stock exchange. Hence, they are less liquid than publicly-traded but considerably more stable as the volatility is low.

12. Advantages of REITs

● In comparison to a direct investment in property, REITs do not require much capital.

● REITs are well-regulated by the Securities and Exchange Board of India and hence the chances of fraud are negligible.

● REIT is an easy route to invest in Real estate.

● They carry a low liquidity risk.

● Annual portfolio disclosures is mandatory for REITs so they are fairly transparent.

● It disburses 90% of the income. Investors can get a higher dividend.

● Diversification Buffer: In contrast to stocks, REIT’s follow a different cycle. Real estate investment trusts (REITs) follow a real estate cycle (18 years) as opposed to the economic business cycle (56 months). When stocks crash in a recession, REITs would do well and even out of the portfolio.

● Good Yields: REITs provide higher yields. Expected yields are around 7 to 7.5%.

● Inflation: As inflation increases, rent and leases increase as well. This is a benefit of REITs.

Limitations of REITs

● Zero Tax Benefits: Practically there is no concession for REITs in regards to tax savings. Dividends earned from REIT companies are subject to taxations.

● Minimal Growth Prospects: REIT’s are not of much help in capital appreciation. In addition, they return 90% of the dividend earned to the investors and reinvest lesser money into the scheme.

● Market-centric Risks: REITs are subject to market fluctuations. Low-risk appetite investors should consider the pros and cons of the investments before opting for REIT.

13. Taxation of REIT

● REIT’s have exempted status under Section 10(23FC). Interest received or to be received from SPV (Special Purpose Vehicle) or dividend mentioned under Section 115(O)(7) of the act.

● Total income may include interest and dividend income from SPV, rental income if it comprises of rent-generating assets. Capital gains under Sections 111A and 112.

● The income of a business trust by mode of renting or leasing any property which the trust owns is not part of the total income under section 10(23FCA).

● Pertaining to provisions under section 111A and 112, the total income of a trust shall be taxed at Minimum Marginal Rate (MMR=30% + applicable surcharge & cess).

● Specified domestic company to a business trust will not be taxed on its current income, on or after a mentioned date under section 115(O)(7).

● No taxation of the dividend declared, dispensed, or paid by the specified domestic company out of its profits up to a mentioned date.

● To ascertain taxation of dividends from SPV section 115(O)(7) has to be read with section 115BBDA.

Basis of Difference

REITs

Real Estate Mutual Funds

Investment

Directly invest in real estate

Invest in REITs and stocks that deal in real estate.

Diversification

Narrower diversification

Offer wider diversification

Dividends

90% of REITs’ taxable income is paid as dividends or interest to the investors.

Real estate funds offer value through appreciation, and therefore, are not regular income-generating options.

Trading

Trade on major stock exchanges, just like stocks. Their prices fluctuate during trading hours.

Real estate mutual funds do not trade on the stock market, and the prices are updated only once a day.

14. How to Invest in REITs in India?

Investing Through Stock Exchanges

Similar to ETFs, REITs are listed and traded on stock exchanges. Thus, purchasing REIT units is easy as long as an investor has a Demat Account. The price of a REIT unit can change depending on the demand 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.

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.

Investing Through IPOs

Investors can be on the lookout for REIT IPOs and invest in these when they are launched. This requires thorough research and understanding of all the risk factors of REITs. Since Indian REIT market is still evolving and there are only few REIT options available, investors have to wait for the next IPO to be launched.

15. Points to note

1. If the subscription amount is lesser than 90% of issue size, the REIT shall refund subscription money to all investors. 2. As investors hold units that are traded on the stock exchange, REITS have relatively lower liquidity risk as compared to directly investing in real estate.

 The REITs are transparent. There is a full valuation of the REIT every year along with a half-yearly audit.

 Diversification: As per the guidelines, REITs have to invest in at least two projects with the value of one asset comprising 60% of the investment.

● Occupancy Ratio: Check the occupancy ratio, which is the ratio of occupied or rented space to the total available space.

● Portfolio: It is essential to look at the portfolio holding of the REIT. Understanding the clientele is important. It is essential to analyse the tenant’s profiles as well. Non-payment or irregular rent payments can have an impact on the REIT. Furthermore, currently, there is no regulation by SEBI on the regularity of cash flows from leased or rented properties.

● Geographical Diversification: Assets focussed across one city can be dangerous. State-specific regulations control real estate movements, and these vary from state to state. The asset portfolio should be well-diversified across different regions to protect the interest.

● Sector Diversification: Historically seen, the IT sector has been the prime occupier of premium and high-quality office spaces. Over-dependence on one sector can be risky. As seen recently, working from home can be the new normal. Vacant spaces or non-payments will affect the REITs performance. Therefore, while choosing a REIT, ensure that the asset portfolio is well-diversified across different sectors such as Banking, FMCG, Healthcare, Pharma, etc.

● Rolling renewals and Re-leasing spread: Usually, the leasing commitment period is around five years. The rolling renewals indicate the number of tenants who are exercising their renewal options at the end of the lease period. A good number of rolling renewals will indicate stable returns. Re-leasing spread is the change in the per square feet (PSF) rate between the new and expiring leases. It is expressed as a percentage that signifies the REITs ability to execute the new leases at the increased prices for the same property.