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What are REITs and InvITs?

Real estate in India has been a market that has been particularly profitable over the last 20-30 years. It is, however, currently in a lull period. The prolonged period of prosperity had to reach a cooling point eventually, and that is where we appear to be right now. Developers caught up in the frenzy built houses and apartment complexes relentlessly, thinking that demand would always be there. A number of factors, including the slowdown of the Indian economy in general, have led to people cooling-off their interest in purchasing new homes for the time being.

The number of unsold units has been increasing in the big cities like Mumbai, Bangalore, etc. There is also a shift in trend from ownership to renting, as many of the people in these cities are migrant workers from other parts of the country. The IT industry in Bangalore for example attracts talent from every corner of the country, primarily people in their 20s and 30s. The attitude towards work is also changing.

The current generation does not necessarily believe in working at the same company for 20 + plus years. They are quite happy to keep switching jobs and even careers as they deem fit. This transient characteristic is evident in a lot of aspects of their lives, and home ownership is no exception.

This change in attitude is now coinciding with the rise of ‘Real estate investment trusts’ (REIT) and ‘Infrastructure investment funds’ (InvIT). REITs, while being a relatively new investment vehicle in India, have actually been around for quite a while in other countries. They were first established in the early 1960s in the US under President Eisenhower. REITs are much like a mutual fund, wherein investors give their money to a trustee who then invests it in a diversified portfolio of real estate on their behalf. InvITs are the same, except the investment is in infrastructure projects like roads, gas pipelines, power transmission lines, etc.

 The reason as to why these funds are becoming more popular in India now is because it was only as recently as 2014 that the government properly defined what the rules and regulations surrounding these funds are. There are still a few aspects that need to be addressed, but they are nonetheless a fully legitimate investment option for people today.

REITs v/s Real Estate

Naturally, investors will compare REITs and InvITs with actual real estate and infrastructure investment. There are a number of differences and each will appeal to different investors based on their needs.

When investing in real estate, people generally look at two distinct strategies. For individuals looking to make money quickly, they buy up a property with the intention of making improvements via renovations and quickly selling the property in order to make a relatively small but sizable profit. This is known as the ‘fix-and-flip’ strategy. Long term investors, on the other hand, will look to purchase a property and hold on to it for a period of time earning money through rental income and asset price appreciation before eventually selling it later on for a much bigger profit.

Real estate prices generally go up and the market in most countries with solid institutions are usually healthy. Apart from periods of major crisis (eg.  Financial Crisis 07-08) it is never really a badinvestment. Of course one can make a poor investment which relates to buying an overvalued asset based on location, accessibility to resources like water, need for repairs, etc. Owning a property also requires active involvement from the owner. The investor will have to look for tenants and pay for maintenance and renovations. It is a highly illiquid asset as well and provides no opportunity for diversification.

This is where REITs come in. People who are interested in entering the real estate market without actually taking on the burden of ownership can do so by investing in an REIT. REITs, like stocks, are highly liquid. Investors can cash out as and when they feel like it. They need not worry about the active management of the property and can simply collect the dividends that the investment pays out. REITs also allow for a lot of diversification. Trusts will almost always invest in a number of different properties, in the same way that a mutual fund will invest in a number of different companies and even sectors.

In the US, REIT returns have also consistently outperformed the S&P 500 Index over the last 40 years, returning 12% annually as opposed to the 10% that the S&P has generated. There are, however, a few downsides to REITs in comparison to directly owning a piece of real estate.

For instance, investors will have absolutely no say in what properties the trust invests in and how these properties are managed. Another potential issue for investors is that the law requires at least 90% of of the profits to be distributed amongst the investors as a dividend. While this will be a positive for some, others may not feel the same way. What this means is that the trust can only use 10% of its profits to reinvest and will need to seek out more investors if it wants to invest larger sums, which could be inconvenient.

InvITs also toss up an interesting opportunity for investors. Compared to REITs, they are longer term investments and are considered to be less risky. More so than being an avenue through which money can be made quickly, InvITs act as a huge advantage for the sponsors (infrastructure developers). They help secure funding for new projects while maintaining their capital structure. InvITs also help developers monetize their revenue generating assets and offer a path to deleveraging their balance sheets.

The main risk with InvITs has to do with the sponsor and how they manage the project. In the same way that the developer of a real estate project needs to maintain their property so that the REIT performs well, infrastructure developers also have a responsibility to ensure that their project is in good shape so that returns to the InvIT investors are healthy.

The markets for REITs and InvIT are still quite small, but are expected to grow in the coming years with a few rule changes. For instance, the minimum investments in REITs are Rs. 50,000 while it is Rs. 1 lakh for InvITs. These are a reduction from the previous figures which were Rs. 5 lakh and Rs. 10 lakhs and have generated more interest, but if they are to become a regular part of an investors portfolio, individuals should be allowed to buy single units in the same way that they can do with stocks.

For feedback, comments and views, please write to pavan@bclindia.in

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