Just like a mutual fund pools money from different people and invests it in various assets, an REIT will collect money from investors and invest them in real estate assets. These assets will generate income in the form of rents and capital appreciation when the value of the real estate units rise.
Let us look at the advantage of REITs for the retail investor -
1. REITS give the common man an opportunity to fulfil his dream of investing in the real estate market with a smaller amount of investment. The minimum initial investment is Rs. 2,00,000. With REITs, one need not have to take a big loan or amass a lot of capital to buy real estate.
2. REITs allow investment diversification. The investor can invest in real estate with a smaller sum. This helps him in diversifying his portfolio. Even within real estate, his investment will be across many real estate projects like residential projects, commercial spaces and across areas. This reduces risk further as compared to a lump sum investment in one real estate project.
3. It offers a new opportunity to invest in the form of investing in commercial properties with less hassles and lower capital requirements .
4. If REITs are managed properly, investors can invest in real estate with much less hassles. If one has to invest in real estate directly, there are many processes and complexities like documentation, loans, taxation issues, research on the right property etc.
REITs are new investment vehicles. Investors need to be wary while investing. Let us look at the potential disadvantages -
1. Capital Gains – Normally an Indian retail investor invests in real estate to maximise capital gains as they have many options to earn regular investment income like Fixed Deposits, Provident Funds and Mutual Funds. REITs across the world provide returns to investors from the rental income on commercial as well as residential property and this is normally in the range of 6%-9%. If REITs need to be successful in India, the returns generated should be more lucrative than returns on various other investment options.
2. REIT's NAV – The units of the REIT scheme will have a NAV. It is not clear how this will be calculated given the wide variation in prices in real estate. The real estate market is prone to have sharp swings in prices as well. So the NAV might be an average indicative value and not the market value of the real estate properties in consideration.
3. Bubbles and Busts – There are many bubbles and busts in the real estate market. REITs will also move along these waves and might accentuate it as people will be following their prices as well. Investors, developers etc. would react sharply to changes in valuations of REIT units and mirror the same behaviour in actual purchase and sale of real estate.
4. Taxation – REITs will also earn income via dividends which have to be distributed to investors. Retail investors will then have to pay capital gains tax as well as dividend distribution tax which might not be attractive to the retail investors.
SEBI has set up regulations to ensure that a corporate governance framework works to safeguard interests of all parties. This framework ensures that owners of real estate are incorporated in the REIT. They stay invested for a defined period. A trustee will be appointed to independently monitor the REIT's activities. REITs will be operated by managers just like mutual funds have mutual fund managers. There should be fair and transparent valuation of the real estate assets. Regular disclosure requirements are set up. Investors will have to pay tax similar to tax rates to be paid when shares are sold. Investments in REITs for 36 months or more will be treated as long term capital assets.
REITs are helpful to the developers and the real estate industry as it provides the potential of a huge cash inflow for the industry. It is good for retail investors in terms of asset diversification and one more income generation tool. But considering the fact that the real estate industry is known for not so clean records and less than transparent transactions, retail investors need to be cautious before investing in REITs. They need to understand the REIT's investment strategy, income generation strategy, fund manager's investment philosophy thoroughly and only then make the investment decision.
This article was originally published on Indianotes.
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