Key factors to consider before investing in Reits

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

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 registered Reits in India – Brookfield India Real Estate Trust (Brookfield Reit), Embassy Office Parks REIT (Embassy Reit) and Mindspace Business Parks REIT (Mindspace Reit).

Although experts favor investing in Reits, investors should consider these factors before taking an investment decision.

Distribution yield

As per the guidelines of market regulator Sebi, Reits in India have to distribute at least 90% of available cash to unit holders. Thus, distribution income—which comes in the form of a dividend, interest, or loan repayment to unitholders—forms a significant portion of REIT returns. Checking the current distribution yield of REITs gives a clear idea of ​​the returns that can be expected from their investments. It is calculated by dividing the distributed annual income 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 real returns in the hands of investors could rise in the coming years. “If lease renewals happen at a higher rate in the future than the current rate, then the cash flows will automatically increase, leading to a higher return on investment,” said Vishal Chandiramani, chief operating officer of TrustPlutus. “This is also why Reits are considered a good asset class in an inflationary environment, as many tenant agreements have an escalation clause to cover rising costs.”

Note that the reverse 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 the return is the increase in the value of the investment. 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 Reit return component is taxed differently (see table). The higher interest component of the income distribution will be tax inefficient for individuals in the higher tax bracket. Note that companies provide a breakdown of income distribution and also guidance on the expected tax structure of future income. “Usually every quarter the management of the Reits gives guidance on what the tax structure will be,” Sahil Kapoor, senior executive vice-president at IIFL Wealth.

Portfolio matters

The health of the Reits portfolio can be assessed using several metrics disclosed by the company periodically. The first is the geographical location of the assets – the more diversified it is, the lower the concentration risk for the portfolio. Likewise, a mix of tenants from different sectors mitigates industry risk.

The occupancy rate and weighted average lease expiration (WALE) provide insight into the cash flow generating capacity of the Reit’s portfolio. The occupancy rate indicates the ratio of occupied units to the total available units in the building. “An occupancy rate of 85-90% is a good figure,” said Srinivas Rao Ravuri, chief investment officer at PGIM India Mutual Fund.

Investors should also follow management’s commentary on the Reit’s expansion plans. Reits also use leverage to invest in new properties. “The ‘loan to gross asset value’, which denotes the proportion of assets that are financed through debt, is a good indicator to gauge the leverage position of Reits,” said Diviesh Shah, Director, CRISIL Ratings.

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