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Home / Money / Personal Finance /  Key factors to consider before investing in Reits

Key factors to consider before investing in Reits

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  • Experts say Reits offer a good buying opportunity. This asset class currently offer yields in the range of 5.3-6.8%

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Shares of real estate investment trusts (Reits) have delivered decent returns since their listing in the last two years but experts believe that this asset class still offers investors a good buying opportunity. This belief stems from recent reports of strong hiring in the tech industry, and an expected pick-up in demand for office space leasing in India as more employees return to offices.

Shares of real estate investment trusts (Reits) have delivered decent returns since their listing in the last two years but experts believe that this asset class still offers investors a good buying opportunity. This belief stems from recent reports of strong hiring in the tech industry, and an expected pick-up in demand for office space leasing in India as more employees return to offices.

A Reit is a trust that owns a pool of income-generating real estate assets that are held as special purpose vehicles (SPVs). There are three listed Reits in India—Brookfield India Real Estate Trust (Brookfield Reit), Embassy Office Parks REIT (Embassy Reit), and Mindspace Business Parks REIT (Mindspace Reit).

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A Reit is a trust that owns a pool of income-generating real estate assets that are held as special purpose vehicles (SPVs). There are three listed Reits in India—Brookfield India Real Estate Trust (Brookfield Reit), Embassy Office Parks REIT (Embassy Reit), and Mindspace Business Parks REIT (Mindspace Reit).

Even as experts are in favour of investing in Reits, investors need to consider these factors before taking an investment decision.

Distribution yield

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As per market regulator Sebi’s guidelines, Reits in India must distribute at least 90% of the cash available to unitholders. Thus, distribution income—which comes in the form of a dividend, interest, or loan repayment to unitholders—forms a significant share of the return from REITs. Checking the current distribution yield of REITs gives a fair picture of the returns one can expect from their investments. It is calculated by dividing the distributed income per annum by the current market price. Thus, Reits in India currently offer yields in the range of 5.3-6.8%.

 

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Experts say that the actual yield in the hands of investors may go up in future years. “If the renewal of leases happens at a higher rate in the future than the current rate, then the cash flows will automatically increase, resulting in higher yield on investment," said Vishal Chandiramani, chief operating officer at TrustPlutus. “This is also a reason why Reits are considered a good asset class in the inflationary environment as a lot of agreements with tenants have an escalation clause to cover the rise in costs."

Note that the opposite is also true. The distribution yield at the time of investment is not a guaranteed return that can be expected from Reits.

Another important component of return is the capital appreciation of the investment value. While many factors determine the price at which a Reit trades in the stock market, one simple step to ensure you are not overpaying is to check the net asset value (NAV) per unit, which is reported by the company every quarter.

Tax structure

Each return component from a Reit is taxed differently (see table). A higher component of interest in the distribution of income will be tax-inefficient for individuals in the higher tax bracket. Note that companies give the break-up of income distribution and also the guidance of expected tax structure of future income. “Typically, every quarter, the management of Reits gives the guidance of what the tax structure will be going ahead," Sahil Kapoor, senior executive vice president at IIFL Wealth.

Portfolio matters

The health of the Reits portfolio can be assessed using a few metrics disclosed by the company periodically. First is the geographical location of the assets—the more diversified it is, the lesser the concentration risk to the portfolio. Similarly, a mix of tenants from various sectors mitigates the industry risk.

The occupancy ratio and weighted average lease expiry (WALE) give an understanding of the cash flow generation capability of the Reit’s portfolio. The occupancy ratio indicates the ratio of rented units to the total available units in a building. “An occupancy rate of 85-90% is a good number," said Srinivas Rao Ravuri, chief investment officer at PGIM India Mutual Fund.

Investors should also follow the management commentary on Reit expansion plans . Reits also take leverage to invest in new properties. “The ‘loan to the gross asset value’, which denotes the proportion of assets that are debt-financed, is a good metric to assess the leverage position of Reits" said Divyesh Shah, director, CareEdge

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