What are REITs? What are the pros and cons of investing in them?

What is REIT?

A real estate investment trust (REIT) is an investment instrument that is modelled on mutual funds. Just as a mutual fund company allows investors to pool in money and invests it in a portfolio of companies, a REIT enables people to invest in income-generating properties that are owned by a trust and managed by a company.

These properties can be residential or commercial and the income is generated either in the form of rent or as capital gains earned from the sale proceeds. It is distributed among investors in the form of dividends, interest or capital repayment. Investors are issued units similar to that in mutual funds and these can be redeemed as desired.

REITs can be listed and traded on stock exchanges and are regulated by the market regulator, Securities and Exchange Board of India (Sebi).

Benefits of investing via REITs

Accessibility: While not everybody can invest in real estate due to the high-ticket size, REITs allow investors to put in small amounts and acquire fractional ownership of properties.

Liquidity: Being listed on the exchanges, these can be easily bought or sold, unlike physical real estate, which is highly illiquid and can be cumbersome to buy or sell when needed.

Transparency: As REITs are governed by Sebi, investors can easily access financial information on the trusts.

Diversification: A REIT enables diversification as one can own numerous types of properties via fractional ownership.

Steady income: It can be a good source of income in the form of dividends as REITs are required to distribute as much as 90% of the income to shareholders.

Limitations of REITs

Market risks: REITs are susceptible to market-linked changes or economic ups and downs, which can impact the rents or rates of properties.

Taxability: If the Special Purpose Vehicle (SPV) under the REIT has not opted for the concessional tax regime under Section 115BAA of the Income Tax Act, dividends paid to unitholders are exempt from tax in their hands. In other words, dividends are not taxable for the unitholders. However, if the SPV opts for the concessional tax regime under Section 115BAA, then the dividends become taxable for the unitholders at their applicable slab rates. Short-term gains, where the holding period is less than a year, are taxed at 20%, and long-term gains, with a holding period of more than a year, are taxed at 12.5% for gains exceeding Rs 1.25 lakh a year.

Interest rate sensitivity: Since the rise or fall in interest rates impacts the borrowing costs and EMIs, these can adversely affect the profitability of REITs.