A Real Estate Investment Trust (REIT) is a company that owns, operates or finances income producing Real Estate properties which may comprise of apartment buildings, cell towers, data centres, hotels, healthcare units, offices, warehouses etc. Most REITs focus on a particular property type, but some hold multiples types of properties in their portfolios.
How does a company qualify as an REIT?
REITs lease out their properties, collect rentals and distribute dividends to their shareholders. Mortgage REITs do not directly own real estate, but finance real estate instead and earn income from the interest on these investments.
To qualify as a REIT, a company must meet the following requirements:
1.The entity needs to be taxable as a business trust or a corporation.
2.Must have at least 100 shareholders after its first year of existence.
3.Should be managed by board of directors or trustees.
4.Invest at least 75% of the total assets in real estate.
5.Accrue at least 75% of its gross income from rents, real property, and also from the interest on mortgages, financing the real property or from sales of real estate.
6.Pay at least 90% of the taxable income in the form of shareholder dividends each year.
7.Less than five or fewer individuals should not have held 50% of its shares during each taxable year.
8.At least 95% of the REITs total income should be invested.
The different types of REITs: –
1. Equity REITs
The most popular one where the common source of income here is rents.
2. Mortgage REITs (mREITs)
They mostly lend money to real estate owners and operators directly or indirectly through mortgages or loans or through the acquisition of mortgage backed securities and earn income from the interest of these investments.
3. Hybrid REITs
Hybrid REITs allow investors to expand their portfolio by placing their funds in both mortgage REITs and equity REITs.So, both rent and interest are the source of income for the Hybrid REITs.
4. Publicly Traded REITs. Their shares are listed on the National Securities Exchange and are regulated by SEBI. Investors can purchase and sell such shares through the NSE.
5. Public Non-Traded REITs.
They are non-listed REITs registered with the SEBI and not traded on the National Stock Exchange. As such, they are more stable and not subjected to market fluctuations.
6. Private REITs.
They have a selective list of investors, are not traded on National Securities Exchange and not registered with the SEBI.
How to Invest in REITs
One could invest in publicly traded REITs, as well as REITs Mutual funds and REIT exchange-traded funds (ETFs), by purchasing shares through a broker. By investing through Mutual Fund, individuals would be able to diversify their investment portfolio significantly. In Exchange traded funds; investors would avail indirect ownership of properties and would further benefit from its diversification. They could buy shares of a non-traded REIT through a broker or financial advisor who participates in the non-traded REIT’s offering.
Benefits of investing in REITs
1. Stable cash flow through dividend and capital appreciation
2. Attractive risk-adjusted returns
REIT offer attractive risk-adjusted returns to individuals and helps to generate steady cash flow in long term.
3. Diversification
A real estate presence can be good for a portfolio because it provides diversification and dividend-based income, and the dividends are often higher than you can achieve with other investments.
4. Transparency
REITs stocks are listed in stock market and hence all relevant details are available online for its investors. As it is regulated by the SEBI, REITs financial reports get audited by professionals. It enables investors get information on aspects like taxation and ownership.
5. Liquidity
REITs are easy to buy and sell, as most REITs trade on public exchanges making them highly liquid.
Limitations of REITs
1. Dividends are taxed as regular income
2. Subject to market risk
REITs are risk associated and susceptible to market-linked fluctuations. Investors with weak risk appetite should consider this before investing.
3. Low growth
Capital appreciation is quite low as they return as much as 90% of their earnings to the investors and reinvest just the remainder 10% into their venture.
4. Potential for high management and transaction fees
Some REITs have high management and transaction fees.
As REITs own and manage high-value real estate properties, they are one of the most expensive avenues of investments. Big institutional investors like insurance companies, endowments, bank trust departments, pension funds, etc. can easily invest in these financial tools.
Role of REITs in a Retirement Portfolio
REIT in one’s retirement portfolio is beneficial for investments in several ways.
1. Income opportunity
Since at least 90% of the taxable income is to be returned to shareholders as dividends each year, it serves as an avenue to generate steady income.
2. Unveils portfolio to a diverse mix of properties
If one includes real estate, one can diversify his /her asset classes significantly and does not require managing them personally. In addition, with diversification, price fluctuation of other investment options would not have an impact on REITs. Rather, in a falling market, the value of REITs does not drop as fast as stocks.
3. Helps to survive in inflation
REITs protect investors from the effects of inflation in the long run. By staying invested for many, investors can protect their funds from inflationary effects more effectively as compared to stock options.
4. Suitable for the long run
REIT is a profitable investment avenue for retirement planning and suitable for investors who looking for a long term investment horizon.
Put funds into REITs that hold diverse properties and tenants. Opt for ETFs and Mutual Fund options that invest in REITs, as with professional assistance, investors would be able to manage their funds more efficiently. Lastly, invest in companies that are active as well as experienced in the field for several years.
REITs provide investors not only the opportunity to own valuable real estate but also get dividend income and total returns both at the same time.
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– Satarupa Dutta (Data: Debraj Guha Thakurta)
