REITs: A failed investment avenue or the next big opportunity?

REITs have taken a hit due to higher borrowing costs.. (Hindustan Times)
REITs have taken a hit due to higher borrowing costs.. (Hindustan Times)


  • Get your head around this less-understood product and figure out whether the opportunity is already here

I have an interesting story about Real Estate Investment Trusts or REITs. Incidentally, it also reflects how at times relatively lucrative low-risk investment opportunities could be staring one in the face, and yet one could miss them.

This transpired in early 2021, when the vaccine was starting to roll out. There was lots of optimism in the air. This was of course cut short by the onset of the devastating second wave of Covid.

This second wave led to a sharp fall in unit prices of REITs. Perhaps because the expectation that officegoers will no longer return to work, and work from home instead, got reinforced.

I happen to buy units of various REITs between February 2021, and April 2021. A majority of what I bought was post the sell off due to the second wave.

At the time of making this investment, the units were available at discounts of up to 25% on the net asset value, and offering a dividend yield as high as 9%.

It was an opportunity crying out loud to be acted on.

The only call that needed to be made was whether people will actually return to office. Or whether working from home was a permanent feature.

No one could not have known for sure what would happen. But the broad trends of back to office were already there. Of course, the expectation was that people will go back to work for perhaps part of the week.

So, the call really one had to make is this:

The market is pricing REITs, assuming hardly anyone will come back to work, when the data is clearly showing that a lot more people will come back to work. In other words, the bad news was overblown.

Add to this the margin of safety (discount to NAV) and the high dividend yield, and it makes sense to atleast dip your toes into this opportunity.

That’s what I did. And the rest is history.

Why I am narrating this story today is because the REITs, atleast the ones I had invested in 2021, are once again trading at big discounts.

Now, don’t rush to do something with this information. Why? Perhaps the units of these REITs do indeed deserve the discount!

I don’t know. But the fact is, how did this very exciting investment avenue get pushed to the fringes?

I did a little bit of digging around. This is what I could understand:

First, most investors do not understand the concept of a REIT. Some think it’s a stock, others a property mutual fund kind of product. It’s neither.

You need to think of a REIT as a basket of commercial/office property, that is leased out to earn a rent. The properties the REIT owns are not tradeable per se, so there’s no capital appreciation available to you in case there was a spurt in property prices. However, higher property prices over time, will lead to higher absolute rentals.

So, at the risk of oversimplifying, the only thing you really earn is the rent.

Having said that the properties do have a value attached to them. That’s kind of factored into calculating the value of each unit i.e. the Net Asset Value (NAV).

The opportunity here is that if you know the true value of the asset, and you can buy it at a 35% discount, you are in a good place. And since you buy it lower than the NAV, then your rental yield is even better.

Makes sense? Now there are many kinds of REITs, but we are dealing with only the plain vanilla REIT here (some REITs by the way, including Embassy, also own hotels).

Second, there is confusion in the way income from REITs is taxed in the hands of the investor. Even though I owned REITs, I could not figure this out fully. Perhaps that was also because there were changes being made at that point in time. So, if you are a tax paying citizen, your income from REITs is impacted to the extent that income is taxed (or not taxed).

I think if you owned units of the REIT in a non-tax liable account, then perhaps you could do away with this concern altogether! 

Third, I believe the lack of understanding of a REIT is complemented by the fact that neither your distributor from who you buy funds, nor your broker, who is interested in F&O, are talking to you about this. There is little incentive for these intermediaries to do this.

These are of course the more fundamental factors, and perhaps these could take time to be addressed in any case.

But are there any short-term factors at play here, which could get addressed in the coming months and years, which could make REITs an appealing near-term opportunity?

First, the rising interest rates have made bonds and deposits relatively more attractive than a REIT. While this is not a fair comparison, but then, most people compare it this way.

Then of course REITs have taken a hit due to higher borrowing costs.

While it appears that interest rate cycle is topping out, no one will know for sure till the cycle turns. But overall, it's likely we are at or near the top. So, this should be good news for REITs going forward.

Second, the REITs we are discussing here are all predominantly office REITs. And they all launched just about when the pandemic hit. So, they have yet not had the opportunity to showcase their real earning power to the investor. How long will it take for them to reach peak performance is anyone’s guess. But safe to say, they are headed in that direction.

Third, REITs are not very liquid on the stock markets, and hence, any large trade can make prices volatile. This of course will not go down well with investors since these are meant to be relatively low risk investment opportunities. Perhaps, this will get addressed incrementally as time passes by, and the opportunity in REITs becomes apparent to more investors.

Already, if one were to see the data, large institutions and mutual funds (I double checked – many!) have bought into REITs. Perhaps this coupled with retail interest will address this issue.

Now, while we have discussed the long-term and short-term challenges, the question that begs to be asked is this.

Is the discount at which REITs are trading justified?

I will take the middle ground here. Yes and no.

The “No" case is easy, I just articulated the temporary reasons that are hurting REITs.

But the key is whether there more permanent issues standing in the way of the REIT becoming more mainstream.

For instance, the very complicated structure of the REITs. Or for that matter, the lack of growth over the last few years. Or could it be the fact that they are very closely linked to large builders, which for some investors, could be a cause of discomfort.

In short, could REITs in India be a value trap?

To conclude, in the US, REITs have a market cap of over $1 trillion. Here, we are just getting started. In my view, REITs have real potential in India…and oftentimes they are a very good fit in one’s asset allocation.

All you need to do is get your head around this less understood product and figure out whether the opportunity is already here. Or it lies in the future.

Rahul Goel is the former CEO of Equitymaster. You can tweet him @rahulgoel477.

You should always consult your personal investment advisor/wealth manager before making any decisions.

Catch all the Elections News, Business News, Market News, Breaking News Events and Latest News Updates on Live Mint. Download The Mint News App to get Daily Market Updates.


Switch to the Mint app for fast and personalized news - Get App