REITs can be a good investment option; know more about tax impact and risks

Real Estate Investment Trusts, or REITs, are companies that own and operate properties that generate income.

With a structure similar to that of mutual funds, REITs enable persons to invest in a portfolio of commercial income-generating real estate assets – such as shopping malls, office spaces, and hotels — without having to buy, manage, or finance any properties by themselves. These assets are then leased out with the aim of acquiring rental income for investors.

REITS are designed to provide investors with a regular stream of rental income, and capital appreciation from the increase in the value of real estate assets. It is mandatory for REITs to distribute 90 per cent of the taxable income to their investors every year. If they fail to do this, taxes are imposed on their undistributed taxable income.

Nascent in India

According to a report titled REITS: Gaining larger ground in Indian real estate, by  real estate and advisory firm Colliers India, investment in REITs in India is still at an early stage. Unlike the US and Singapore, India is one of the countries that has very low market capitalisation of REITs, at less than 10 per cent.

The publicly listed Office REITs Embassy Office Parks REIT, Mindspace Business Parks REIT and Brookfield India Real Estate Trust together cover 74.4 million square feet (msf) of office space stock. This accounts for around 11 per cent of the total existing Grade-A office stock — that is, stock at a premium over the average rent prevailing in the area where they are located.

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“The underlying office sector has demonstrated resilience, particularly in the top six cities — Bengaluru, Chennai, Delhi-NCR, Mumbai, Hyderabad, and Pune — with strong occupancy levels, despite looming externalities affecting demand. Office vacancy levels remained stable in the first quarter of 2023 at 16.4 per cent, pointing to a fundamentally strong commercial office market. The outlook for the office sector remains optimistic, led by rising rentals, technology and flex space, with the market likely to bounce back in the latter part of the year,” said the report.

In May 2023, India’s first Retail REIT — Nexus Select Trust — was listed on the stock exchange, expanding the number of available investment options. Nexus Select Trust owns 17 Grade-A urban retail centres across 14 cities, covering a leasable area of 9.8 msf.

About two-third of the overall REITable stock in India falls in Secondary Business Districts (SBD) – areas on the outskirts of a city.

Good diversification option

Speaking to The Federal, Amar Ranu, Senior Vice-President and Head – Investment Products and Insights, Anand Rathi Shares and Stock Brokers, said: “We believe that investor appetite for REITS is increasing, as India’s real estate segment has started picking up after a long pause. Against this backdrop, REITs are a good investment option for those who want to diversify their portfolios, as they can take exposure to real estate with fractional ownership. Also, REITs provide regular income, typically every quarter, so it is a good opportunity for those who are looking for consistent cash flows.”

To date, REITs listed in India have provided an annualised distribution yield return of 6 to 7 per cent to its investors. Along with being a hedge against inflation, REITs are also said to be tax efficient.

Tax impact

The Union Budget this year brought in parity in the taxation of income for REIT unitholders by taking “repayment of debt” under the tax bracket. Also, the tax impact on REITs has been softened. As per the revised norms, “taxes will be paid only towards the amount after the deduction of cumulative distribution and initial issue price,” said the Colliers report.

Commenting on this development, Ranu said, “Now, when a property in REITs has an outstanding loan and it is sold, the net acquisition cost would be the initial price of the property minus the loan amount. In the earlier tax regime, only the initial price of the property was considered, increasing the tax burden, and reducing the net cash flows to investors by 0.5 to 0.7 per cent.”

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In India, REITs need to be listed on a stock exchange to avail tax benefits. 

The minimum investment limit in REITs has been reduced to ₹10,000-₹15,000, with a lot size of one unit. Earlier, the minimum investment was ₹50,000, with a lot size of 200 units. This initiative is expected to increase the participation of retail investors. Now, foreign portfolio investors (FPIs) can invest in debt securities issued by REITs.

As per the report, about 40 per cent of the existing tenants in REIT assets work in the technology sector. The share of sectors such as e-commerce, healthcare and renewables is increasing. It is expected that in the next few years, the tech sector is likely to boost the expansion of Indian REITs. The market outlook for the office sector is likely to remain strong, led by healthy demand from tech companies, data centres, and life sciences.

Risks with REITs

There are certain risks associated with REITs. For one, their performance and valuation are directly linked to those of the commercial real estate market in India, making them vulnerable to adverse market conditions. Secondly, there is execution risk, wherein a delay in the completion of under-construction assets can impact projections. Also, regulatory changes could impact taxation, property development, etc.

The Colliers report, however, said that there is immense potential for REITs to grow as an investment option in India. The untapped REITs market in India stands at 57 per cent, with 380 msf of existing Grade A office space qualifying to be listed as REITs.