What is Real Estate Investment Trust (REIT)?
A real estate investment trust (“REIT”) is a company that owns, operates or finances income-producing real estate.
REITs are modelled on the lines of mutual funds and empower investors to get a stake in real estate and earn through rental yields and capital appreciation of the properties they park their money into. The best part that makes REITs a win-win for all is that one doesn’t need to have crores of rupees to invest. REITs can enlist themselves on a stock exchange.
REITs provide all investors the chance to own valuable real estate, present the opportunity to access dividend-based income and total returns, and help communities grow, thrive, and revitalize.
What is the Structure of REIT?
Sponsor
Sponsor is usually a Real Estate company that owned the assets prior to the creation of the REIT. The Sponsor is responsible for setting up the REIT and appointing the Trustee.
- Each sponsor shall hold atleast 5% of total number of units of REIT
- Shall have net worth not less than Rs. 100 Crores on a collective basis & each sponsor shall have a net worth not less Rs.20 Crores
- Shall have atleast 5 years’ experience in development of real estate or fund management in real estate industry
- Sponsor & Sponsor group shall collectively hold atleast 25% of total units of REIT for a period of 3 years from the date of listing. Units exceeding 25% shall be held for a period of 1 year. After completion of 3 years, the sponsor stake can be reduced up to 15% of outstanding REIT units.
Manager
Manager means a company or LLP or body corporate incorporated in India, which is responsible for managing the assets and investments of the REIT and undertakes operational activities of the REIT
- Shall have net worth of not less than Rs. 10 Crores, if manager is a company or net tangible assets of not less than Rs. 1 Crore, if manager is a LLP
- Shall have atleast 5 years’ experience in fund management or advisory services or property management in real estate industry
- Atleast 50% of the Board of Directors / Governing body shall be independent and not director or member of another REIT
Trustee
Trustee is responsible for holding the REIT assets in a trusteeship for the benefit of the unit holders. They are required to oversee the activities of the manager and ensure the timely distribution of dividends.
- Shall be a SEBI registered debenture trustee who is not an associate of Sponsor or manager
- Ensure that the REIT Manager complies with any applicable law.
- Making sure all future development plans are in the best interest of the unit holder
Hold Co:
- REIT shall invest in real estate assets either directly or through a holdco or SPVs
- REIT shall hold not less than 50% of Equity Share Capital / Interest
- It can make investments in other SPVs which ultimately hold the properties
- Shall not engage in any other activity other than holding of the underlying SPVs, holding of real estate properties or any other incidental activities
Special Purpose Vehicle:
- Must be an Indian Company in which REIT / Hold Co holds not less than 50% of Equity Share Capital / Interest
- Shall have atleast 80% of its assets directly in properties
- Shall not invest in any other SPVs
- Shall not engage in any other activity other than holding & developing property or any other incidental activity
Unit holder:
- Unit holder means any person who holds the beneficial interest of the REIT
- No superior or other voting rights over another unit holder
- No multiple classes of Units of REIT to unit holders
What are the types of REIT?
- Equity REITs: Most REITs are equity REITs, which own and manage income producing real estate. They own large real estate properties like shopping malls, office spaces, massive residential townships, etc. Equity REITs make money by giving these properties on rents or long term lease.
- Mortgage REITs: They are not the owners of properties. They only finance the debt for those real estate projects and earn interest from such financing transactions from the developer/builder/owners. Their earnings are generated primarily by the net interest margin – the spread between the interest they earn on mortgage loans and the cost of funding these loans.
- Hybrid REITs: These REITs use the investment strategies of both Equity and mortgage REITs and earn income by way of both rent and interest.
How REIT works?
REIT shall distribute 90% of its net distributable cash flows to its investors on a half yearly basis
What are the assets in which REIT can invest?
- At least 80% of the value of REIT assets shall be invested in completed and rent/income generating properties
- Upto 20% of the value of REIT can be invested in following
- Developmental properties
- Mortgage backed securities
- Listed/unlisted debt of companies in real estate sector
- Equity shares of companies which derive atleast 75% of operating income from real estate activities
- Government securities
- Unutilized Floor Space Index of a project where it has already made investment
- TDR acquired in respect of a project where it has already made investment
- Money market instruments or cash equivalents
How to invest in REIT?
REITs are listed and traded on stock markets in India. Therefore, purchasing units on the stock market is the best way to invest. Thus, a Demat Account is mandatory for investing in REITs in India. The price of REITs units on stock markets changes depending on both the demand for units as well as the performance of the REIT.
At present, only 3 REITs are listed in India – Embassy Office Parks REIT, Mindspace Business Park REIT, and Brookfield India Real Estate Trust.
Apart from stock market purchases, investment in REITs can also be made through mutual funds. Currently, Kotak International REIT Fund is the only International Mutual Fund in India that invests exclusively in International REITs. A few domestic Mutual Funds have also started investing in REITs in the past few years, however, the actual exposure of these schemes to this Real Estate Investment is quite limited. Thus, the only way to gain meaningful exposure to Real Estate is currently through the purchase of REITs Units on the stock market.
Benefits & Limitations of REIT:
| Benefits:DiversificationSmall Initial InvestmentProfessional ManagementRegular Income GenerationCapital Gains | Limitations:Limited OptionsLow LiquidityTaxable DividendMarket risk |
Returns from REIT:
- Dividend & Interest income: Dividends and Interest are paid out by REITs from their Net Rental Income. This refers to income that a REIT receives by renting out and leasing Commercial Real Estate after deduction of some key expenses related to management and maintenance of the facilities. Some of the charges that are deducted from Gross Rental Income to arrive at the Net Income of a REIT include management fees, depreciation, maintenance charges, etc.
The current SEBI mandate states that at least 90% of net rental income received by REITs need to be paid out as dividends and interest to investors.
- Capital Gains: REITs are listed and traded on stock exchanges, so the price of individual units changes depending upon their performance as well as market demand. Just like Equity Stocks and Mutual Funds, good performance by a REIT leads to an increase in the price of REIT units that can be sold at a profit and provide Capital Gains to the investor.
Taxability of income:
In the hands of REIT:
| Nature of Income | Taxability |
| Interest & dividend from SPV | Exempt u/s 10(23FC) |
| Rental income from real estate asset owned by REIT | Exempt u/s 10(23FCA) |
| LTCG u/s 112 | 20% |
| STCG u/s 111A | 15% |
| Any other income | MMR i.e., 42.744% |
In the hands of Unit holders:
| Nature of Income | Resident | Non Resident / Foreign Co |
| Interest from REIT (received from SPV) | 5% | Normal Tax rates |
| Dividend from REIT (received from SPV & SPV paid tax u/s 115BAA @ 22%) | 10% | Normal Tax rates |
| Dividend from REIT (received from SPV & SPV paid tax at normal rates) | Exempt | Exempt |
| Rental income from REIT | Normal Tax rates | Normal Tax rates |
| Capital gain on transfer of REIT units | ||
| Listed & STT paid – LTCG u/s 112A (more than 12 months) | 10% in excess of Rs.10 L | 10% in excess of Rs.10 L |
| Listed & STT paid – STCG u/s 111A(12 months or less) | 15% | 15% |
| Capital gain on transfer of REIT units | ||
| Unlisted or STT not paid – LTCG u/s 112(more than 12 months) | 20% | 20% |
| Unlisted or STT not paid – STCG(12 months or less) | Normal Tax rates | Normal Tax rates |
| Any other income not covered above | Exempt | Exempt |
In the hands of Unit holders:
- Interest & dividend from SPV shall be fully exempt u/s 10(23FC). Hence SPV is not required to deduct TDS on such interest
- Rental income of REIT from renting/leasing/letting out of any real estate asset owned by REIT shall be exempt u/s 10(23FCA)
- LTCG u/s 112 is taxable @ 20%
- STCG u/s 111A is taxable @ 15%
- Income of any other nature is taxable @ MMR i.e., 42.744%
In the hands of Unit holders:
- Interest received by Unit holder from REIT (which was received from SPV) shall be taxable at the following rates:
| Unit holder | Tax rate | TDS rate |
| Non Resident / Foreign Company | 5% | 5% |
| Other persons | Normal Tax rates | 10% |
- Dividend received by Unit holder from REIT which was received from SPV
- If SPV paid tax @ 22% u/s 115BAA, then such dividend is taxable at the following rates:
| Unit holder | Tax rate | TDS rate |
| Non Resident / Foreign Company | 10% | 10% |
| Other persons | Normal Tax rates | 10% |
- If SPV paid tax as per normal provisions, then such dividend income is exempt.
- Rental income received by Unit holder from REIT shall be taxable (since it is exempt in the hands of REIT) at the following rates:
| Unit holder | Tax rate | TDS u/s 194LBA |
| Non Resident / Foreign Company | Normal Tax rates | Rates in force u/s 195 |
| Other persons | Normal Tax rates | 10% |
- Capital gain on transfer of units of REIT which are listed in recognized stock exchange & STT paid
| Gain | Tax rate |
| LTCG u/s 112A | 10% in excess of Rs. 1,00,000/- |
| STCG u/s 111A | 15% |
- Capital gain on transfer of units of REIT which are not listed in recognized stock exchange or on which STT not paid
| Gain | Tax rate |
| LTCG | 20% |
| STCG | Normal Tax rates |
- Any other income received by Unit holders which is not covered above shall be exempt u/s 10(23FD)
PROS & CONS OF REIT
The following are some key benefits of investing in REITs:
- Diversification: REITs allow you to diversify your investment portfolio through exposure to Real Estate without the hassles related to owning and managing commercial property. This diversification allows you to go beyond the usual asset classes of Equity, Debt, and Gold as part of your overall Asset Allocation Strategy.
- Small Initial Investment: As mentioned earlier, one of the key problems associated with making Real Estate investments is the large ticket size especially in the case of commercial properties. REITs require a much smaller initial investment of around Rs. 50,000 to provide similar portfolio diversification benefits.
- Professional Management: Properties owned by a REIT are managed professionally. This ensures smooth operations and with no effort on your part towards managing Commercial Real Estate.
- Regular Income Generation: REITs generate income from rental collections and are required to mandatorily distribute 90% of this income to investors as dividends and interest payments. In this way, REITs provide regular income to investors.
- Capital Gains: REITs are listed and traded on Stock Markets and their price depends on their performance. A REIT that performs well can thus potentially increase in value over time and be sold at a profit. This provides Capital Gains to the investor.
There are also a few limitations of REITs that you should be aware of:
- Limited Options: Currently there are only 3 REITs and 1 International REIT Fund of Fund in India. This significantly limits the choices for investors.
- Low Liquidity: While REITs are listed and traded on Stock Markets, the number of market participants is currently low especially with respect to retail investors. As a result, selling REIT investments profitably might be a challenge especially in an emergency. This results in low liquidity of the investment.
- Taxable Dividend: Any dividend or interest earned from REITs is completely taxable in the hands of the investor according to the applicable slab rate. Thus those in the 30% tax slab will lose a substantial portion of their dividend income as taxes.
