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Can REITs become a viable alternative for real estate investments?

Despite muted economic sentiments during the past two years, REITs have emerged as a new asset class in India.

Real estate comes with the inherent benefit of leverage, wherein the potential of investment can be maximized with the help of borrowed capital.

In India, there are presently 3 registered REITs, namely Embassy, Brookfield, and Mindspace. Despite muted economic sentiments during the past two years, REITs have emerged as a new asset class in India. On a quarterly basis, REITs have been giving 5-6% returns, painting an overall optimistic picture.

In the past, the requirement of high cash flow has plagued investment in commercial assets. However, REITs, which are modelled on mutual funds, gave an alternative platform for various investors to get exposed to commercial real estate. REITs pool investments from a bundle of investors and use them to hold and operate income-generating commercial assets. A sizable part (~ 90% in India) of the dividends earned is distributed amongst investors. Besides, REITs also offer the option to their investors to earn through capital appreciation. There are a few more REITs in the offing that will soon join the bandwagon.

Will REITs Surpass Actual Real Estate Investments?

REITs will emerge as an alternate investment platform in Indian real estate. Its importance will be felt far and wide. Meanwhile, the pressing question is will REITs trump actual real estate investments in India?

If empirical data is reviewed, it has done so in USA and Singapore. In the USA, currently, ~ 90% of the investments in commercial real estate are channelized via the REIT instrument. In Singapore, close to half of the investments in commercial reality are routed through REITs.

However, believing that REITs will trump actual realty investments in India might not be possible, at least in the near future. In an emerging economy like India, there is too much focus on owning a piece of real estate. An RBI study conducted in 2017 revealed that more than 80% of the wealth of average Indian households is directed towards real estate, while just 5% have poured into the financial markets.

In a country wherein there is so much emphasis on owning actual real estate, REITs will never have the scale to reshape the industry.

More Feasible Instruments than REITs In Terms of ROI

Besides scale, REITs are also not the highest yielding instrument. Owning a grade-A property in a prime location (provided the pocket allows) can give returns to the tune of 6-9%. Investing in a specialized IT park or business cluster can give returns to the tune of 6-7%. As offline shopping activities are restored, retail is once again a profitable investment to bet on. Owning a piece of retail space in the city centre could give elevated yield to the tune of 10-12% during the previous decade. Though a double-digit yield is not possible now, it can still give returns to the tune of 8-9%.

As market sentiments are shifting, new asset classes are also moving up the curve and luring investors with elevated yield potential. Alternate asset classes such as co-living spaces, retirement homes, and rental homes can give yields in the range of 7-9% provided they are marketed properly.

Greater Mortgage and Tax Incentives in Real Estate Purchase

There are also a few other benefits with actual real estate purchases, which are missing in REITs. There are attractive tax concessions associated with real estate investments. Likewise, a piece of real estate can always be used as a mortgage, which is missing in the case of REITs. Real estate comes with the inherent benefit of leverage, wherein the potential of investment can be maximized with the help of borrowed capital. Presently, the rate of loans is at its all-time low and this further makes real estate an attractive proposition.

(By Sanjeev Arora, Director, 360 Realtors)

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