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Saturday, November 02, 2013

What are REIT (Real Estate Investment Trusts)

REITs (Real Estate investment Trusts) first originated in the United States. REITs were created in order to give all investors the opportunity to invest in large-scale, diversified portfolios of income-producing real estate in the same way they typically invest in other asset classes – through the purchase and sale of liquid securities. See whats happening in India on the REIT front now a days, and this can potentially change the way we manage our wealth portfolios today.

Securities and Exchange Board of India (Sebi) issued a consultation paper on draft Real Estate Investment Trusts (REITs) Regulations, 2013. Once it has received feedback from the public, the regulator will come out with the final regulations on REITs. Thus, it appears that after a long wait REITs may finally start operating in India soon.

What is a REIT?
A REIT is a pooled investment entity, just like a mutual fund. After registering with Sebi, REITs will launch initial offers that investors will subscribe to. While mutual funds invest their corpus in equity, debt and money markets, REITs will invest primarily in real estate, and that too mostly in completed, revenue-generating real estate. The rental received from these properties will be distributed among investors as dividend.

Advantages of REITs
  • Lower entry barrier: Real estate is a big ticket investment. With the advent of REITs, investors will be able to gain exposure to real estate with a smaller amount. Minimum unit size is expected to be Rs 1 lakh and minimum subscription size of Rs 2 lakh. Thus, deep-pocketed investors will be able to take exposure to real estate via REITs, thereby diversifying their portfolios beyond the asset classes available currently (equity, debt, money market, and commodities). In the future, the investment limit could be lowered further to include all kinds of retail investors. 
  • Lower risk: Since REITs will invest primarily in built-up property, the investor will not have to bear development risk, as happens when you invest in under-construction properties.
  • Greater transparency: REITs will provide an above-board source of funding to the realty sector, which currently depends heavily on black money. Limiting the use of black money will go a long way towards making the sector more transparent and consumer friendly.
  • Easy liquidity: As envisaged by Sebi, the units issued by REITs will be listed on stock exchanges. Whenever an investor wants to exit, he will be able to sell his units on the exchange. Today, liquidity is one of the biggest inhibitors to real estate investment.
  • Diversification: The minimum asset size that a REIT will be required to have is Rs 1,000 crore. Having such a large corpus will allow REITs to diversify across locations and types of real estate, such as offices, warehouses, and shopping malls. Such diversification will reduce risk. It is impossible for an individual investor to achieve diversification in his small portfolio.
  • Professional management: As with most mutual funds, REITs too will have managers who will manage the realty portfolio and try to earn higher returns for investors.
  • Asset allocation strategy: At present, it is impossible for retail investors to apply the asset allocation strategy to real estate. The essence of asset allocation is that you invest in a variety of asset classes. Such diversification lowers risk and ensures that some part of your portfolio does well under all market conditions.

The risks
As with any other investments, investing in real estate entails a few risks too. 
  • Real Estate is a cyclical asset. Just like equities, real estate markets also see bull and bear phases. These cycles tend to be longer and deeper than in the case of equities. Another risk is that real estate is an illiquid asset. Since the ticket size is large, it is not easy to sell and exit your investments even in good times.
  • During a slowdown, when you are more likely to need money, buyers become even more scarce. Both these risks will exist even when you invest via a REIT. To some extent, by listing on the exchanges, REITs may lessen the liquidity risk associated with real estate but they will not fully eliminate it. In difficult times, you may have to sell your units at a steep discount.

Who should invest?
REITs are well suited for investors with the following characterstics:
  • Investors seeking a regular income from their portfolio. 
  • The investor should not be already overweight on real estate. 
  • According to Sebi's consultation paper, REITs will declare NAV twice a year. Investors will have to take into account their liquidity needs before investing in them. Those who already have high exposure to illiquid assets (PPF, insurance policies, physical real estate) should not take a heavy exposure to REITs as well.

The right allocation
Once REITs become a reality, how much should you allocate to it? Depending on yourrisk appetite, 30-50% of your total allocation must go to growth assets, which include both equities and real estate, could be to REITs. 
Thus, if you are, say, 30 years old, it is expected that you should have 70% of your portfolio allocated to growth assets. In that case, REITs could occupy around 20-35% of your portfolio (or roughly half of your growth assets)

Cheers


Manoj Arora
Lead a Financially Free Life !!

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