By Rajesh Narain Gupta
Conventionally, the real estate sector in India has been a highly preferred asset class for a majority of Indian investors with a possible appreciation of property values. However, real estate transactions in India come with its own set of risks. Buying a property in the country requires large capital investment. Similarly, real estate investments are also illiquid assets to an extent that they cannot be immediately converted into cash at the desired price-point.
institutionalization of real estate
The real estate segment has also witnessed institutional investor interest over the last decade especially in the commercial office and warehousing space. This has led to the institutionalization of this segment with large specialized domestic corporates such as developers, multinational companies as tenants and global & sovereign funds as investors being the key stakeholders. This has provided a conducive ecosystem for the development of REITs and InvITs in the country.
How do REITs function?
In layman terms, REITs /InvITs function like mutual funds by pooling the capital of a large number of investors to purchase and hold stakes in income-generating real estate assets. Investing in REITs enables investors to include real estate as a key asset class in their investment portfolios. It enables investors to invest in real estate without undergoing the complexities of actually buying property as well as makes investment liquid in this segment. It also provides an annuity-like return on investment to the investor.
REITs generate income primarily by leasing the real asset owned by the trust and by creating value through efficient asset management.
REIT units are distributed in the form of interest and dividend at regular time intervals for investors. The REIT assets are generally well spread across different geographies with multi-tenants thereby providing a well-diversified asset pool that can potentially mitigate any untoward scenario in a particular asset. It also provides for enhanced long-term potential portfolio appreciation for investors to preserve and increase their wealth through active asset management, new asset construction & acquisition and an increase in rentals over a period of time.
REITs may provide a solution to investors from the risks and market volatility that comes along with the direct acquisition, leasing and management of the real asset. By investing in direct real estate or rental properties, an investor who does not have the understanding or bandwidth may stand to suffer losses if the property underperforms on account of specific reasons like low tenant income, unleased property or costs incurred for the upkeep of the property.
Understanding the tax implications
The option of investing capital gains which are applied to buy property to save tax implications cannot be invested in REITs by an investor to avail exemption from capital gains. The rental income of house property is calculated and taxed as per the applicable slabs for individuals and corporate bodies. Capital gains can be availed on sale of direct real estate assets at applicable rates depending on long or short term nature.
The tax component of REITs is calculated on the nature of the underlying income generated. The resident unitholders will be taxed at the applicable slab rates. If the SPV has opted new tax regime under section 115BAA, then the dividend declared by SPV will be taxable in the hand of the unitholder as per applicable tax rate else dividend is exempt. The objective seems to provide benefit of exemption from tax on dividend or concessional corporate tax rate at SPV level.
In most cases, REIT acquired assets are through the acquisition of shares of the asset SPV. Hence, for unitholders of REITs, there are no additional costs in terms of conveyance charges. However, if any direct asset is acquired, the REIT incurs conveyance charges similar to any individual/body corporate. The charges mentioned in the REIT offer document are transparent. The fee model of the manager may be calculated on the basis of the net operating income. It can be all-inclusive of the management fee, buy/sell of asset fee, bifurcated separately towards various heads or may have a variable component based on increment achieved in the NAV.
With the aim of enhancing funding avenues for the real estate sector in the country, Finance Minister Nirmala Sitharaman proposed granting Foreign Portfolio Investors an entry into debt financing for REITs. The Finance Minister has also proposed exempting the TDS on dividend distributions made by REITs and InvITs. These are key investor-friendly initiatives by the government which make REITs an attractive investment option for investors and have the potential for attracting global institutional capital in the country’s commercial real estate and infrastructure space.
(Rajesh Narain Gupta, Managing Partner, SNG & Partners. Views expressed are the author’s own. Please consult your financial advisor before investing.)