Investing in REITs: Is the 'low risk, high yield' approach fit for your portfolio?

The primary offering of Nexus Select Trust has put real estate investment trusts (REITs) again in the spotlight, with investors boggling what are REITs, if it matches their investment thesis, should they invest in such issues and what are the consequences of investing in REITs.

Real estate investment trust (REIT) is a company that owns and operates real estates to generate income. Real estate investment trust companies are corporations that manage the portfolios of high-value real estate properties and mortgages. The income collected is distributed among shareholders as income and dividends.

REITs offer investors an opportunity to possess high-priced real estate and help them to earn dividend income to boost their capital over the period of time. Investors can earn a stable passive income and appreciate their capital by investing in such asset classes.

Putting in simpler terms, Real estate investment trusts (REITs) are like mutual funds, but with a portfolio of commercial real estate assets. In India, REITs are not permitted on residential property and only commercial properties are allowed for it.

The minimum investment is not high, which enables small investors to participate in such asset classes. A few years ago, minimum investment was Rs 50,000 with a lot size of 200 units. However, Sebi in order to increase the liquidity and increase participation, brought down the minimum investment to Rs 10,000-15,000 with a lot size of one unit.

Indian REITs have to distribute 90 per cent of income and 80 per cent of the properties held by the REIT must be rent generating, said Nehal Mota, Co-Founder & CEO, Finnovate, a hybrid WealthTech platform.

"REITs cannot invest more than 10 per cent in under-construction properties. Thus, REITs reflect the overall pricing of a portfolio of properties so some may be up and some may be down," she said. "However, the REIT is only obliged to disclose NAVs twice in a year."

At the outset, there are several advantages for investors in investing in REITs but such investments are not a fit for all investors. Aggressive IPO lovers should not invest in REIT issues as they are different from mainstream issues and liquidity is also a concern. However, investors looking for hedging, passive income and capital appreciation in the long run can consider them.

REITs can be a proxy for commercial property investments for those who can not buy the entire property.  However, REITs should be seen as exposure to real estate as financial assets. To that extent, these fractional units of commercial property are significant.

"It provides diversification and is a good hedge against inflation. Investors with a longer term perspective can consider REITs. However, REITs do have some challenges like lack of liquidity, opaque methods of property valuation, and concentration in select metro cities is a challenge," Mota said.

"The bigger advantage is the very attractive dividend yield of these REITs, since the REITs are obliged to distribute 90 per cent of their income earned as dividends. If you look at the 3 REITs listed in India- Embassy REITs, Brookfield REITs and Mindspace REITs, they all have dividend yields in the range of 5.5-7.5 per cent," she said, citing REITs as an attractive source of stable income.

Currently, there are three listed REITs in the Indian market, all of which are office REITs. As such, there is currently no listed retail REIT in India. Indian REITs have significantly outperformed its global peers, delivering an IRR of 13.4 per cent since April 2019, outperforming US office REITs by 2,662 bps, said a report from Geojit Financial Services.

India is expected to witness continued demand for quality Grade-A retail assets which are typically single owner/ institutionally owned, centrally located, full experience UCCs with well-designed circulation plans offering well-known international and domestic brands to the consumers, Axis Capital in its report.

According to market expectations, REITs own and manage high-value real estate properties, they are one of the most expensive avenues of investments. Investors with substantial surplus funds as disposal capital park their funds in REITs. A decent number of investors invest in REIT as a part of their retirement. However, it is not a passive investment completely.

A REIT is passive in the sense that there is not much active effort from the investor. However, the fund manager of the REIT still has to adopt an active approach, Mota said.

"This is not like investing in a real estate index, which would be a passive investment. REITs have some downside risks like low liquidity, lack of transparent valuation data, concentration in select regions and tax inefficiency," she adeed.