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Understanding Real Estate Investment Trusts (REITs)

Real Estate Investment Trusts (REITs) offer investors a unique opportunity to participate in the real estate market without directly owning properties.

Similar to mutual funds, REITs pool funds from multiple investors to invest in income-generating real estate assets. This makes real estate accessible at lower entry costs and gives way for easy redemption.

This article delves into what are REITs, their life cycle journey, benefits, shortcomings, and taxation.

What are REITs?

Real Estate Investment Trusts (REITs) are companies that own, operate, or finance income-generating real estate properties such as residential complexes, offices, hotels, hospitals, shopping malls, and industrial estates.

Essentially, REITs act as mutual funds for Real Estate, allowing investors to collectively invest in a diversified portfolio of properties.

Types of REITs

In India, there are typically three types of REITs:

  • Equity REITs: These invest primarily in rental income-generating properties.
  • Mortgage REITs: Also known as (mREITs). They primarily lend money through mortgage services and earn interest income.
  • Hybrid REITs: These invest in both equity and mortgage REITs. Hence, they earn both rental and interest income.

Benefits of investing in REITs

  • Dividend Income: REITs distribute nearly 90% of their earnings as dividends to investors, providing a regular income source.
  • Lower Entry Cost: Pooling funds in REITs helps lower the entry cost by allowing investors to collectively contribute their capital to a diversified portfolio of real estate assets. This enables access to assets that investors may not be able to afford individually.
  • Diversification: REITs offer investors exposure to a diversified portfolio of real estate assets across various segments and geographies, reducing the risk associated with investing in individual properties.
  • Professional Management: REITs are managed by experienced real estate professionals who oversee property acquisition, management, and leasing, alleviating investors from the burden of property management.

Shortcomings of investing in REITs

  • Sectoral Risk: As the underlying asset is real estate, any slowdown in the real estate sector can have a negative impact. During COVID-19, as work from home became the new normal, demand for commercial real estate took a hit.
  • Volatility: REITs are traded just like shares of any other normal company.
    Therefore, they are subject to market volatility.
  • New Product: REITs are relatively new products compared to other investment avenues. Hence, penetration is still quite low.

Taxation on REITs

  • Interest Income: Taxable as per the investor’s tax slab.
  • Dividend Income: Taxable based on REIT’s special tax concession status:
  1. If opted, dividend income is taxable as per the investor’s tax slab.
  2. If not, dividend income is not taxable.
  • Capital Gains: Short Term Capital Gains (STCG – sold before 3 years) are taxed at 15%, while Long Term Capital Gains (LTCG – sold after 3 years) are taxed at 10%, subject to Rs1 lakh exemption.

Summing Up

While REITs offer benefits such as asset diversification, liquidity, and dividend yield. However, they may be sensitive to market fluctuations, charge management fees, and have different tax implications compared to direct real estate ownership.

*Disclaimer – This is for information purposes only and not an investment advice.