But, while the underlying assets of mutual funds are typically stocks, debt, gold, or some combination thereof, the underlying assets in the case of REITs are primarily commercial real estate holdings. .

REITs have historically produced competitive returns, based on stable distribution income and long-term capital appreciation. Their relatively low correlation to other assets also makes them an excellent portfolio diversification tool that can help reduce overall portfolio risk and increase returns.

The Indian government has launched REITs to bring capital with long-term returns to the country and to increase private participation in infrastructure and real estate. India saw its first REIT in 2019.

Three years later, there are now three (Mindspace REIT, Brookfield REIT and Embassy REIT). REITs as an investment option have grown in popularity with institutions and retail investors.

Embassy Office Parks REIT, for example, has seen an absolute appreciation of around 22.67% (as of 18 Jul 22) since listing (3 Apr 19), while BSE Sensex and BSE Realty Index have recorded absolute returns of 10 .37% and 15.11% respectively in the same period. Thus, early REIT performance trends are encouraging.

The commercial reality market in India has grown over the past few years. A long rental period, stable occupancy rates, well-managed and high-quality properties provide good cash flow visibility, attracting more investment from global investors.

In addition, favorable government policies (e.g. allowing foreign portfolio investors to invest) and long-term investment prospects have attracted many well-known investors, including sovereign wealth funds and pension funds, to increase their interests in these assets.

While REITs have raised capital of over US$4 billion in India, a funding requirement of over US$1.4 trillion by 2025 is estimated by the National Infrastructure Pipeline announced by the Government of India.

The three listed REITs mentioned above cover 87 million square feet. of commercial real estate assets – Mindspace 31 million square feet, Embassy 42 million square feet. and Brookfield 14 million square feet.

Despite the short- to medium-term headwinds of COVID-19, it is possible that more stocks will be added to existing REITs or the listing of new REITs as the commercial office market rebounds.

Finally, to bridge the gap between large and small investors, SEBI recently made a series of announcements such as reducing the minimum application value and reducing the minimum number of trading units.

With these announcements, SEBI encouraged more retail investors to participate in this asset class.

With GDP growth estimated at around 8%-9%, REITs are expected to see accelerated market entry, providing a new investment opportunity for retail investors who are currently struggling to invest in commercial real estate assets due to high capital costs. and in the residential segment due to low/negligible returns.

Investors should consider these factors before investing in REITs:

Distribution yield

Distributions by REITs are based on net distributable cash flow (NDCF) unlike corporations where dividends are paid based on earnings. SEBI guidelines state that REITs in India must distribute at least 90% of available cash to unitholders in the form of dividends, interest and/or loan repayments.

If a RREC does not opt ​​for the new tax regime, distributions in the form of dividends are exempt from tax in the hands of unitholders.

This is an added advantage for a REIT investor over dividend distributions in the case of direct stocks and mutual funds which are now taxed at the marginal tax rate. REITs in India are currently offering yields in the 5.1-5.5% range.

These yields may increase further depending on the renewal rates of tenants’ rents (Re-leasing).

Investors should consider critical covenants such as weighted average lease expiration, escalation clause, guidance from company management, and cost of unit purchased to understand current and future distribution payments probable.

Underlying REIT portfolio quality

REITs should have a well-diversified asset base with income from multiple properties often spread across multiple cities and tenants from various industries.

The diversification of the asset base reduces the volatility of rental income and the investor is less exposed to the risk of a single asset.

Additionally, REIT assets are typically Class A office properties that experience higher rental and occupancy levels within a micro-market. An occupancy rate of 85 to 90% is a good number.

Net Operating Income (NOI)

The NOI determines the income and profitability of an invested property after subtracting the necessary operating expenses.

A higher NOI indicates good performance of the underlying portfolio and the REIT. The increase in the NOI would be motivated by the following factors:

• Increase in occupations.

• Completion of a portfolio under construction

• Contractual escalation of leases for leased properties

• Re-letting of expired leases at higher rents: As lease periods expire, re-letting typically occurs at market rents which, in most cases, are higher than existing rents.

[The author is Managing Partner- Products & COO at TrustPlutus Wealth (India).]