A New Investment Avenue

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In the last 4-5 years many Tier-I cities in India have witnessed a huge boom in the prices of real estate and now even Tier-II cities are in the race. There is an investment vehicle which uses real estate as a tool to generate decent returns for the investors called as Real Estate Investment Trusts or REITs. Real Estate Investment Trust is a collective investment vehicle which helps the investors to invest their money in real estate asset class. REIT carries out its functions through a real estate investment management company (REIMC) which can be either a privately held company or a public one whose shares are traded on a stock exchange.

History of REITs

The REITs find their origin in the US way back in the 1960s when the US Congress created the REIT. Today, the US has the largest REIT market which however is facing a tough time since last couple of years more so because of the sub-prime crisis which left the mortgage markets all over the world in the doldrums. Thereafter, REITs spread their wings in Singapore as well as in Japan. They also gained popularity in Canada, where they were introduced in 1993.

How a REIT functions:

The real estate is an asset class which includes, land, building and any other structure built on the land. For an individual investor, it’s very difficult to invest in real estate assets as the prices are too high and a long gestation period is involved. Even if you take an example of “ready to move in” proper-ties, as the prices are too high, very few people can actually afford to think of it as an “investment option”. Here comes into play the REIT.

A real estate investment management company (REIMC) pools the money from investors and in turn invests such money in real estate properties. This is just like the many mutual funds in the market which invests the money of common investors in equities. Various investment options available with a REIT are commercial establishments, shopping malls, large residential projects, hotels etc.  The income generated out of investments made in these real estate assets is distributed in the form of dividends to the REITs investors.

In case of REITs whose shares are listed on a stock exchange,  the investors enjoys  the benefit of easy and quick liquidity as they can sell the shares of the REIT as and when they want and thus their capital is not blocked unnecessarily for a long period of time.

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Salient features:

Real estate per se is a costly asset class and hence it’s difficult for a common investor to invest in it and generate returns.
This is made possible by REIT. REIT provides diversification benefit within real estate as well so that investors are not exposed to undue risk. Investors in a REIT get the benefit of expert advice by REIT managers who are masters in the field of real estate investments. REITs are required to distribute 90 per cent of their income to the investors in the form of dividends and thus investors enjoy a hefty dividend.

As in the case of mutual funds, the per head management fees and expenses are lower in REIT because the costs are spared over on a large number of investor population. Investors enjoy the benefit of quick liquidity because in the case of REITs whose shares are listed on a stock exchange, investors can sell their shares any time.  Because this type of collective investment scheme is based on a two tier structure involving the REIT and the real estate IMC, it provides the scheme with adequate control mechanisms and checks so as to avoid any conflict of interest or prospective frauds.

Types of REITs:

Broadly speaking, REITs can be divided into 3 types, based on the types of investments they make i.e. equity, mortgage and hybrid.

Equity REITs :

These types of real estate investment trusts invest a large chunk of investor’s money primarily in residential or commercial properties. To elaborate, these types of REITs enter in the real estate developments at a very early stage and make the investments at regular short intervals to take advantage of averaging. Then, as the prices of real estate developments start rising, the REITs sell their investments in such properties, and thereby the investors are benefitted.

The REITs can perform well because of the fact that they have professionals in the field of real estate that have the expert knowledge of the property market in a particular geographical area. They understand the movements in prices of realty and accordingly guide the investment decisions.

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Mortgage REITs :

As the name suggests, mortgage REITs invest in mortgages.  These types of REITs invest in financial instruments which have an underlying in the form of mortgages. Because of its complex nature, these types of REITs are not very popular amongst the investors.

Hybrid REITs :

These are a combination of Equity REITs and Mortgage REITs. They combine the best features of both these types and thus help investors to maximize their returns.

REITs  Global perspective:

As far as the REITs market in the US is concerned, there are 124 REITs traded on the New York Stock Exchange and 139 REITs are in the FTSE NAREIT All REIT Index. As of 31 August, 2009, the total equity market capitalization of the REITs in the US stood at $232 billion of which equity REITs form $207 billion. REITs have raised $24.2 billion in initial, debt and equity capital offerings in 2009 alone.

As per the historical data, way back in December 1971 there were only 34 REITs in the US with an aggregate market capitalization of close to $ 1.49 billion. The enormous growth and popularity is evident from the fact that as of 31 December, 2008 there were close to 135 REITs in the US and the market capitalization had grown to $191.65 billion.

Following table shows some of the best performing REITs for the second quarter of 2009. The return is calculated after considering the price change as well as the dividend yield.

REITs in India:

As of today, REITs in India are in a very infant stage. A lot of India companies from the real estate sector have a potential of launching and managing REITs. However, all such prospective players are waiting for the proper regulatory guidelines to be introduced for setting up REITs in India.

Understanding the market needs, capital market regulator in India, i.e. The Securities and Exchange Board of India (SEBI) has introduced draft guidelines for setting up of REITs in December, 2007. They are known as draft Securities and Exchange Board of India (Real Estate Investment Trusts) Regulations, 2008.

The draft regulation deals in great details with the legal framework, registration procedures, capital requirements, dividend policies, audit and inspection, business activities of the REITs. These draft regulations are right now open for public comments. It’s expected that in next couple of years, REITs may make an entry to the Indian markets.
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Conclusion:

As our country witnesses the boom in real estate sector supported by the investors’ interest and ever increasing government expenditure on infrastructure there can not be a better time for the REITs to make a splendid launch in India.
With the most stringent regulations on REITs already in place, rare are the chances that there will be any issues regarding their functioning in India. On the contrary, such kind of strict regulations instill faith in the minds of the investors and they can put their hard earned money in REITs. With the all round development in our country there is still a lot of untapped potential in the real estate or infrastructure sector which will work in favor of the REITs. I am pretty sure that a couple of years down the line REITs will be as famous among investors as the equities, commodities or derivatives are today.

 So, let’s give a warm welcome to this alternative investment – REITs. After all “a penny saved (and invested) is a penny gained”.