Rushabh Vora is the Co-Founder and Director at SILA.
Anyone who has read about real estate in India over the past couple of years has likely come across the terms REITs. REIT stands for Real Investment Trust. To understand what REITs are, one needs to understand how institutional investors make their investments in the real estate sector.
So how does Institutional Equity Investing in Real Estate work?
Institutional investors typically make investments through one of the following investment methods: » Traditional Real Estate Private Equity - Direct Investments into Projects
» Investments into Private or Publicly Traded Development Companies
» Investments in yield generating Real Estate Investment Trusts (REITs)
» Real Estate Mutual Funds (served as kind of a proxy to REITs in India until the REIT legislation opened out)
Regardless of which aforementi8o9oned method they use; institutional equity investors need to pick a strategy depending on their risk vs return profile.
The different kinds of strategies are:
Investing in existing leased out income or yield generating retail, industrial, apartment, and office properties, mostly in metropolitan areas. These deals tend to be the most expensive for funds given that they are the least risky.
Investing in core properties that require some value-added enhancements, minor modifications and capital expenditure, which are expected to result in higher yields (rental income) from the asset.
Investments in assets that require significant changes: namely operational changes, physical improvements, or capital restructuring.
Investments in distressed assets or redevelopment properties. Typically takes place in niche sectors and in developing economies where there is an opportunity to add value to the acquired asset. In this case, the PE firm takes on both a financial and developmental risk; however, the returns are typically the highest.
Real Estate Investment Trusts (REITs)
A REIT by definition is "any corporation, trust or association that acts as an investment agent specialising in real estate and real estate mortgages" under the US Internal Revenue Code.
Simply put, REITs are securities that are traded on stock exchanges. For someone new to investing, a REIT works like a mutual fund. The underlying asset in the REIT is real estate, such as a building or commercial property, whereas the underlying asset for a mutual fund is the share of a company. REITs use the money that is collected from investors to buy real estate instead of using it to buy bonds or shares of company. Just like a mutual fund, which receives periodic dividends from its owned companies, a REIT receives rental income (referred to as yield) from the operations/leasing of asset or development.
One major attraction of REITs – they get special dividend distribution tax benefits in most countries. In many countries REITs pay out close to 90 percent of their profits to investors as dividends and qualify for special tax considerations on the dividend distribution.
Once a REIT is listed on a public stock exchange, it allows any size or type of investor to invest in real estate by buying units of the REIT. Small investors, who typically cannot afford to invest in expensive yield generating real assets can indirectly invest in them via REIT structures. For developers, REITs provide another avenue to raise funds for projects.
REITs typically follow a specific asset strategy and are classified accordingly.
Key Stakeholders of a REIT:
Trustees are responsible for taking custody of the assets owned by the REIT and its unit holders. They typically ensure that legal compliances related to the asset are in order and that the rights of the unit holders stand protected. Trustees are appointed and paid a fee for their duties.
The sponsor is the company that supplies or sources the underlying real estate that is then rolled into the REIT. Developers with a large portfolio of real estate or Institutional Real Estate Funds generally act as sponsors of REITs.
These are the people appointed to manage the underlying investments of the REIT, i.e. the properties held by the REIT. They are like general partners of a private equity fund. Managers are responsible for the REIT's performance, investments and strategy. They ensure that the underlying properties are generating maximum yield by efficiently monitoring property management and leasing activities. REIT managers typically appoint asset or property managers to oversee activities such as leasing and property operations.
There are retail and institutional investors that own units (similar to stocks) of the REIT once it is listed on an exchange.
So how does a REIT make a profit?
The profit a from a REIT = The income generated from renting out the underlying assets less (-) the cost of operating all the assets for during a given period.
The costs typically include those of running the facilities, utilities, leasing, marketing, the fees paid to the REIT Managers and to the Trustees.
REITs in India
REITs have been a successful investment vehicle in developed capital markets since the late 1990s. However, the first draft of REIT Regulations in India was issued by the Securities and Exchange Board of India (Sebi) in 2007. A revised version of the draft was amended and issued in September 2013 and REITs were formally announced in the Union Budget for FY15. Sebi has issued guidelines that need to be adhered to for REIT listings – specific requirements from each of the above-mentioned stakeholders.
REITs will soon be listed on the Indian stock exchanges, giving retail investors a chance to include Real Estate in their asset portfolios.
The author is a Co-Founder and Director at SILA.