Direct Commercial Real Estate Investing Vs REITs: Which is better for you?

August 31, 2020 4:18 PM

Apart from real estate funds and REITs, investors, today can also, participate in CRE opportunities directly through tech-enabled platforms that list, manage and sell income-generating assets on an entirely online platform.

real estate, stamp duty, stamp duty cut in Maharashtra, homebuyers, housing sales, pune, delhi NCRRetail investors participate to a smaller degree through pooled vehicles like Real Estate Investment Trusts (REITs) that invest in a portfolio of real estate assets.

Commercial Real Estate (CRE) has been a popular asset class for HNIs and institutional investors around the world. CRE provides monthly cash yields linked to an underlying lease along with a capital appreciation kicker that can together lead to returns in the high teens for investors.

HNIs and institutional investors (like pension funds, sovereign wealth funds, endowments) have traditionally accessed CRE via blind-pool close-ended real estate funds that run for 7-10 years. Retail investors participate to a smaller degree through pooled vehicles like Real Estate Investment Trusts (REITs) that invest in a portfolio of real estate assets.

REITs were allowed in India only in the last couple of years and since then there have been two major REIT portfolios that have been listed on the stock exchanges – Embassy Office Parks and Raheja Mindspace Business Parks.

Apart from real estate funds and REITs, investors, today can also, participate in CRE opportunities directly through tech-enabled platforms that list, manage and sell income-generating assets on an entirely online platform.

Monthly Cash Flow:

Both REITs and Tech Platforms provide the investor with the monthly cash-on-cash yield on his/her investment. REITs are mandated under law to distribute a certain proportion of their income while tech platforms distribute rents as and when they accrue. Real estate funds are close-ended funds that return money to investors only at the end of the fund term (7-10 years).

Frequency of distributions:

Real estate funds return capital at the end of the fund period while REITs distribute rents on a quarterly basis to unitholders. Tech platforms distribute rents every month.

Diversification:

Real estate funds are blind pool vehicles where the fund manager allocates capital to various opportunities and diversifies the investments on behalf of investors.

In a REIT the investor knows the portfolio in advance but all new investments are made solely by the Manager. Tech platforms leave that decision to investors allowing them to diversify across locations, asset classes, and tenants as per their requirements and knowledge.

Liquidity:

Real estate funds are totally illiquid for the duration of the fund. REITs are the most liquid as the units are traded on the stock exchanges. Tech platforms have a separate resale platform that allows investors to liquidate their investments.

Property Management:

All three modes of investment help investors manage the property including vacancy, leasing, building upkeep, and maintenance through separate Asset Management teams.

Choice of investment:

REITs and Real Estate funds decide on which properties to invest on behalf of investors while tech platforms list properties and allow individual investors to make that decision.

Volatility:

REITs are the most volatile as the units are traded daily on the stock market. Any external news – positive or negative impacts the value of the investor’s holdings and the yields. Real estate funds and tech platforms have little or no volatility as they are either not traded or traded in much smaller lots privately.

Fees:

Real estate funds charge the highest fees (2/20, meaning 2 per cent management fees and 20 per cent performance fees) owing to high operating costs and distributor fees.

REITs charge slightly lower fees but have high operating costs on account of being a listed entity. Tech platforms have the lowest fee structure (1/20 or 0.75 per cent/15 per cent) due to low operating costs and the absence of middlemen like distributors.

Direct Investing:

Both real estate funds and REITs are pooled vehicles and hence investment in them automatically leads to a pool of assets decided by the fund manager or the REIT.

Tech platforms allow direct investment into individual assets according to the investor’s requirements. For example, an investor from Bangalore may be comfortable in investing only in Bangalore properties.

Leverage:

Real estate funds use leverage (debt) in almost all investments, which eliminates monthly cash distributions to investors (due to interest and EMI payments) but could lead to higher overall returns with associated risks.

REITs, by law, are allowed to take only a certain amount of leverage. Tech platforms are entirely unleveraged.

Yields:

Rental yields on both real estate funds and tech platforms vary as per the prevailing interest rates but are generally between 8-10 per cent in India. REITs are listed at a premium and generally trade 200-300 basis points lower.

Investment platforms like PropShare Capital allow ordinary investors to access the CRE asset class at much lower investment thresholds of Rs 25-50 lakhs. Investors benefit further through the team’s institutional investment experience spanning more than $1 billion.

By, Kunal Moktan, CEO and Co-founder at PropShare Capital (a SEBI registered portfolio manager)

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