The hidden risks of emotional property buying; how REITs offering regular income could be a better alternative

Real estate and property have had a draw since time immemorial. Owning property has always meant prestige and security, across the ages.

Even today, that sentiment has not dimmed one bit! That primal instinct is strong as we as advisors see that people have properties when they approach us. But just like any other Do-it-yourself activity, random property purchases give patchy results. More than any other purchase, property is bought on emotion. And many of them don't end well.

Solving for property

Many times, we forget why we are investing. If returns are the thing, one can get that in so many ways. It need not be just through property investment. Even assuming property is appealing, there are other ways to invest rather than random punts. One such avenue is Real Estate Investment Trust (REIT).


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REITs are pooled investments, managed by a professional manager with the underlying assets being properties, which are regulated by SEBI. They are similar to a Mutual Fund where the underlying assets would be securities. REITs own and manage high grade income generating commercial assets like office buildings, hotels, malls etc. The assets acquired are held in a trust and managed by professional managers who charge a fee for it.

REITs are a great vehicle for property developers who can sell their properties to REIT, get liquidity and move on. It is great for Investors as well as this provides them the opportunity to invest in high quality properties, which they can never invest otherwise.

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Investors can buy units of REITs from the stock exchange where it is listed. To protect small investors, the sponsors need to maintain at least a 15% contribution, for a period of three years from listing.

The primary source of income for REIT is the rents they receive from the properties. As per regulations, REIT needs to distribute at least 90% of the taxable revenue to unit holders. This ensures sustained regular income for the unit holders.

Returns from REITs

There are two clear sources of returns from REITs - regular income arising out of rents received and capital appreciation of the property assets. The rental income in case of A-grade commercial property is very good and can be between 6-9% pa. Commercial properties are typically on long leases ensuring consistent rental incomes.
Apart from this, the property values appreciate which are reflected in the Net asset value of the units held.

Unit holders of REITs hence get returns from both these sources and can expect high single digit returns from it.

Positives of REITs

REITs sit between equity and debt in terms of risk and reward. The attractive thing here is that the underlying assets are different, though the return profile is somewhat like debt instruments.

Moreover, the property profile is very different from what most people have in their portfolios. Property assets tend to be concentrated. REITs have multiple underlying properties, across geographies, and have clients from various industry verticals, making for a very diversified portfolio and lower exposure to the risk of rental income stoppage. The underlying properties are chosen with care and managed professionally which ensures good rental incomes and property value appreciation.

REITs are very liquid as they are listed on the stock exchange, unlike the traditional properties. Also, investors are insulated from the hassles of checking property bonafides when they buy, managing a property, finding a tenant, collecting rents, etc.

Apart from all these advantages, the taxation is benign, overall.

Taxation in REITs

The taxation of the income from REIT depends on what that income is. For instance, the REIT may distribute dividends (which is the primary one), return capital borrowed from the unit holders and pay interest on such borrowed capital.

Dividend distributions by the REIT through a SPV, which has not taken any special concessions, is not taxable for REITs or investors. Capital return is not taxed till it equals the capital borrowed. Interest is taxed at the IT slab rates.

When selling the REIT units one will incur capitals gains. If the holding period is 12 months or less, short-term capital gains tax at 20 % applies. Else, long-term capital gains taxes of 12.5% applies.

The clear enumeration of distributions will be given by the REIT based on which the investor needs to calculate the applicable taxes.

Who should consider this

REITs are suitable for those who want a diversified exposure to high quality property but do not want to manage it, will find REITs a compelling proposition. Those who want liquidity in their property portfolio would find REITs attractive. If one does not have the time or inclination to invest and manage properties, then one would find REITs well-suited as they are curated and managed by professionals.

Since REITs are investing in a different asset class as opposed to equity, debt, commodities, etc. it offers strategic diversification at the asset class level and consequently the type of risks too.

Property investments in the form of REITs have many positives and will find many takers. An attractive option to consider for regular income and wealth creation.

The article is authored by Suresh Sadagopan, MD & Principal Officer at Ladder7 Wealth Planners and the author of the book "If God Was Your Financial Planner"