REITs: A Smart Option to Invest in Real Assets

Hemant Rustagi
Chief Executive Officer, Wiseinvest Pvt Ltd.

"Simply put, REITs convert illiquid real estate investments into a tax-efficient liquid asset class"

Many investors aspire to include real estate in their portfolio. However, considering the lack of liquidity and the fact that one needs to invest a large amount to buy property, not many of them are able to do so. That’s where real estate investment trusts (REITs) can play an important role. For a better understanding of investors who are not familiar with REITs, they are quite similar to mutual funds. Multiple investors can pool their funds and invest in a portfolio of a variety of real estate assets. These assets are managed by professional managers. 

While mutual funds invest in equity, debt and gold or a combination of these, the underlying assets in the case of REITs are real estate holdings and | or loans secured by real estate developers. Simply put, REITs convert illiquid real estate investments into a tax-efficient liquid asset class. REITs can be bought and sold on stock exchanges. Investors can also invest in REITs mutual funds such as international REITs fund of funds without a demat account. REITs’ guidelines require 80 per cent of the assets to be invested in completed projects, and only 20 per cent can be invested in under-construction projects, equity shares, money market instruments, cash equivalents and real estate activities.

To ensure regular income to investors, REITs are mandated to distribute at least 90 per cent of the net distributable cash flows. Currently there are three REITs in India. All three of them invest in commercial real estate. However, there are a variety of REITs available for investment globally. Some of these are:

■ Equity REITs: Equity REITs mainly invest in residential complexes, offices, industrial estates and hotels. They buy, manage, set-up and sell real estate. Income is generated through     rentals and sale of properties.

■ Residential REITs: Residential REITs buy and operate apartment buildings, gated communities as well as such other housing establishments.

■ Retail REITs: Retail REITs invest in the retail segment like shopping malls, hypermarkets, supermarkets, grocery stores, etc. The focus is on renting out the space to various retail tenants.

As is evident, the major advantages of investing in REITs are diversification, small initial investment, professional management, regular income and capital growth. Of course there are limitations too! First and foremost, presently there are a limited number of options for investors as they have to choose out of three REITs in India – Embassy Office Parks REIT, Mindspace Business Park REIT and Brookfield India Real Estate Trust. Secondly, although REITs offer much better liquidity than owning a real estate, low liquidity for REITs can still be an issue for investors.

For any investment, one of the key aspects is how the returns are taxed. A holding period of more than 36 months qualifies for long-term capital gains and is taxed at 10 per cent exceeding ₹1 lakh. The STCG Tax rate on units held for less than 36 months is 15 per cent. Interest income received from REITs is subject to taxation. Tax on dividend income depends on whether the REIT had obtained special tax concession. If yes, dividend is taxed in the hands of investors. If not, then no tax is applicable. Income from amortisation of SPV debt is also not subject to any tax in the hands of the investor. 

However, the Union Budget 2023 has proposed taxing repayment of capital arising from distribution of business trusts like REITs at one’s marginal rate of income tax, with effect from April 1, 2023. Investments in international REITs FOF are taxed as per the rules of debt mutual funds. If the holding period is less than 36 months, investors have to pay STCG Tax at marginal rate of Income Tax. The LTCG tax rate for REITs mutual funds is 20 per cent with indexation if the holding period is more than 36 months. In short, those investors who have so far been investing only in equities and mutual funds would do well to take a closer look at REITs too.