Right Time For REITS

A REIT is a company that owns, operates or finances real estate, and it produces rental income and provides an investment opportunity, like a mutual fund

Right from the start of the year, we are witnessing heightened volatility in the equity market that is continuously sliding down. The key equity indices are already technically in a correction mode as they are down by more than 10 per cent from their recent peak and year till date they are down by almost 8 per cent as of March 4, 2022. There are various reasons for such a fall in equity prices. However, the dominating one is higher inflation and the current geopolitical uncertainty that is once again fuelling commodity prices and adding to inflation.
 

Nonetheless, there are a few pockets within the equity market that are generating positive returns. One of them is the Real Estate Investment Trusts (REITs). In India there are three REITs. These REITs have generated return in the range of 2-10 per cent from the start of the year compared to BSE 500 which has been down by 6.2 per cent in the same period. This means an outperformance or alpha by these REITs in doubledigits.

What are REITs?

A REIT is a company that owns, operates or finances real estate, and it produces rental income and provides an investment opportunity, like a mutual fund. This lets investors benefit from valuable real estate and get dividend-based income and returns. REITs also help provide capital appreciation. Similar to other industries, REITs can be private organisations, public but non-traded, or they can be publicly traded on a stock exchange. By being publicly traded, REITs are similar to mutual funds that are accessible to all investors, who can benefit from receiving real estate income without purchasing, managing or financing property directly.

By leasing space and collecting rent on its real estate, the company generates income which is then paid out to shareholders in the form of dividends. REITs are required to distribute 90 per cent of their income to unit-holders in the form of dividend or interest income, or both what would otherwise be taxed as ordinary income. While REITs can invest in all kinds of income-generating real estate assets, including residences, offices, hotels, malls and warehouses, REITs in India are primarily focused on commercial real estate.

REIT is an investment vehicle that is quite like mutual funds because of its structure. REIT, similar to a mutual fund, has a sponsor who is responsible for promoting the REIT with his own capital. There needs to be a fund management company, which is responsible for selecting and operating the properties and finally a trustee who ensures that the money is managed in the interest of investors.

Though the first REIT was listed in 2019, there were some barriers that did not allow the wide acceptance of REITs in a retail investor’s portfolio. Now most of these barriers are removed. Market regulator SEBI in 2021 lowered the minimum investment amount required in a REIT. Earlier it was ₹ 50,000; now it has been lowered between ₹ 10,000- 5000. Besides, SEBI also approved the amendment to the SEBI (Real Estate Investment Trusts) Regulations, 2014, which helped to revise the trading lot cap of 200 units to just one unit. These two changes will help retail investors to get REIT in their portfolio.

Currently in India we have three REITs listed with exchanges. The three Indian REITs are: Embassy REIT (started in 2017), Brookfield REIT (commenced in 2019) and Mindspace REIT (began in 2020). All three of them are listed and traded on both the BSE and the NSE.

Should you Invest in REITs?

One of the prime reasons why many investors invest in REIT is because they offer attractive dividend yields compared to government bonds and other investments. For example, in the past 12 months, Brookfield India Real Estate Trust has declared an equity dividend amounting to ₹ 12 per share. At the current share price of ₹ 299, this results in a dividend yield of 4 per cent. Embassy Office Parks REIT has declared 29 dividends since August 20, 2019. In the past 12 months, Embassy Office Parks REIT has declared an equity dividend amounting to ₹ 16.90 per share. At the current share price of ₹ 373.43, this results in a dividend yield of 4.52 per cent. Mindspace Business Parks REIT has declared eight dividends since February 17, 2021. In the past 12 months, Mindspace Business Parks REIT has declared an equity dividend amounting to ₹ 14.01 per share. At the current share price of ₹ 353.91, this results in a dividend yield of 3.95 per cent.

Besides better dividend yield, there are many more equally compelling reasons to include REITs as part of a well-balanced portfolio. Two such reasons are that for if you remain invested in REITs for a longer duration, they have a tendency to generate returns equivalent to equity if not outperforming them. In India we do not have a longer history of REITs but taking cues from global REITs, it shows they have historically generated returns in double-digits. The following graph shows the performance of global REITs. The returns generated by REITs are 10.4 per cent in the last 20 years ending March 2021.

Source: Morningstar as of 3/31/2021. Global REITs represented by the S&P Developed Property Index, private real estate by the NFI-ODCE, short for NCREIF Fund Index-Open End Diversified Core Equity, stocks by the S&P 500 Index, and bonds by Bloomberg Barclays U.S. Aggregate Bond Index.

Another reason why REITs are preferred is that dividends generally increase faster than inflation (as measured by increases in the Consumer Price Index), making REITs an effective hedge against inflation. Real estate rents and values tend to increase when prices do, due in part to the fact that many leases are tied to inflation. This supports REIT’s dividend growth as it boosts the stream of income during periods of rising inflation.

REITs are a proven diversification tool for portfolio management, a fact that has been demonstrated in multiple studies by various prominent investment advisory firms using different techniques, data sources and time periods. In simplistic terms, diversification means that adding a particular investment to a portfolio increases the overall expected returns of that pool of investments while also reducing risk. Last but not the least, investing in REITs provides investors with a way to add real estate returns to their portfolios without the liquidity risk associated with direct real estate investments. The following graph shows the correlation between three REITs and BSE 500 in the last one year. We see very low correlation between equity and REITs.

Make a Right Choice

Despite all the lockdowns and work from home, REITs braved these headwinds and there is no reason why they will not continue. Their portfolio occupancy is above 80 per cent and weighted average lease expiry of around seven years. So, the risk of high vacancies at their portfolio levels is lower and as people start returning to offices, it will only increase the occupancy and dividends. REITs also demonstrated lower volatility compared to equity or gold. With the current inflationary trends and a possible rise in interest rates, investors would do well to diversify their portfolio with negatively or low correlated and alternative assets and REIT is one of such assets. Global inflationary pressures present a suitable time for REITs to outperform bonds and stocks.