All About Real Estate Investment Trusts (REITs): Research Report By HDFC Sec

Real Estate Investment Trusts (REITs)

About REITs:

REITS are investment trusts which own and manage income-generating real estate assets such as commercial real estate assets such as offices, hospitality assets and malls. A REIT raises money from unit holders by issuing units. This money is used for purchasing/investing in real estate assets (either directly or through SPVs). REIT generates lease rental/ other income through these real estate assets. The income so generated is distributed to the unit holders. In India, units of 3 public REITs are listed and traded on the stock exchanges (NSE/ BSE) viz., Embassy Office Parks REIT (Embassy REIT), Mindspace Business Parks REIT (Mindspace REIT) and Brookfield India Real Estate Trust (Brookfield REIT).

REITS were first introduced in the US in the 1960s. REITS are now prevalent in more than 40 countries in the world. The total market capitalization of the FTSE EPRA/ Nareit developed REIT index is around USD 1.5 trillion. According to Crisil, India’s top 10 commercial real estate owners alone, which include both developers and funds, have a portfolio of around 184 million square feet (msf) translating into an annual lease rental income of over Rs 17,000 crore. This portfolio has the potential to raise as much as Rs 1.5 lakh crore through the real estate investment trust (REIT) route.

REIT Taxation:

REITs are gaining popularity as such structures are tax friendly and avoid taxation at multiple levels of the REIT structure. The taxation for a resident Indian individual unit holder of a REIT is shown below:

Distribution from SPVs to REIT: Interest Payments, Dividend Payments and Debt/Capital Repayment are not taxable

Distribution from REIT to Unit holders:

• Interest Payments are taxed at applicable slab rate of the investor.
• Dividend Payments are tax-free if the SPVs are under the old regime of corporate taxation
• Dividend Payments are taxed at applicable slab rate of the investor, if the SPVs are under the new regime of corporate taxation
• Debt/Capital Repayment are not taxable
• TDS for resident individuals @10% for both interest and dividend (if taxable)

Sale of units by unit holders on exchange: Long Term Capital Gains are taxed at 10% and Short Term Capital Gains are taxed at 15%. Period for gains to be considered long term is 3 years or more.

Investment rationale:

Asset Diversification of portfolio:

REITS should be viewed as a distinct asset class compared to either debt or equity. Returns from REITs would depend, inter alia, on the performance of the commercial real estate. Returns from REITs would generally have low correlation to equity market returns. REITs therefore provide benefits of asset diversification in multi-asset portfolio.

Well diversified, high quality real estate assets:

REITs have a well-diversified asset base with income accruing from multiple properties often spread across multiple cities. Diversification of asset base reduces the volatility of rental income and the investor is less exposed to a single asset risk.

Also, the assets of REITs are generally Grade A office buildings which witness higher rentals and occupancy levels within a micro-market.

Increase in Net Operating Income (NOI):

The increase in NOI would be driven by the following factors: