Real Estate Investment Trust have low correlation with equities and help in lowering volatility  in  financial  portfolios.

Real Estate Investment Trust (REITs) were launched in India almost 3 years back, in April 2019. REITs are entities that ‘own, operate or finance income-generating commercial real estate’. Simplistically, REITs are similar to Mutual Funds – multiple investors pool in money, the corpus is managed by a professional fund manager and the investors are called ‘unit holders’ (owners of beneficial interest). However, the underlying asset class is commercial real estate, unlike equity or debt in the case of mutual funds – offering an ‘alternative’ investment opportunity.

Alternative Asset class

Indian REITs are structured as Trusts, mandated to invest at least 80% of the corpus into rent generating commercial properties and further to distribute 90% of the ‘net distributable cash earnings’ to the unitholders. Regulated by SEBI, the capital markets regulator, REITs are classified as ‘Alternative’ asset class, as distinguished from Equity and Debt but, at the same time, possessing salient features of both i.e. regular income and scope for capital appreciation.

Diversification and Regular income

Since the underlying is (commercial) real estate, REITs act as a good diversification tool in an investment portfolio, primarily comprised of equity and debt. The correlation between equity and real estate is low and hence an appropriate mix could help reduce volatility in the portfolio. Moreover, REITs enable investors to earn regular, stable returns through rental cash flows, at the same time helping address the biggest issue of real estate asset class – illiquidity. Moreover, REITs are listed on stock exchanges and are publicly traded, and unlike physical real estate, are highly liquid.

Emerging opportunity

REITs invest in the Grade-A commercial properties, which are those that enjoy a premium over the average rent prevailing in the area where they are located because they may be newly built, well located, and have all the requisite infrastructure. As per a report published in Moneycontrol, India has approximately 650 million sq ft of Grade-A office space, of which about half, 310-320 million sq ft, is REIT-able. The 3 REITs in India, currently cover 87 million sq ft. and shall continue to grow through acquisitions, in the future. Due to the unprecedented global liquidity situation, inflationary pressures are leading to increased commodity prices. The rising inflationary trend presents benign conditions for REITs to outperform as rentals are directly related to inflation, and in fact, act as a hedge in an inflationary environment.

Improving Covid situation and increased vaccination has helped the economy to rebound faster and REITs are benefiting on that front too. With actual gross yields between 6% and 8% in the last year, the post-tax returns offered by REITs are twice as much as those offered by most fixed income products like fixed deposits, government securities, etc.

The regulator’s decision to reduce the minimum application value (investment) will make Real Estate Investment Trust a viable choice for a large number of retail investors. Also, REITs have now been allowed to raise funds through the debt market and this shall enable the developers to take the REIT route to raise funds for their future projects, enhancing investor interest.

Conclusion

The Real Estate Investment Trusts are a great diversification tool in a financial portfolio – enable investors to add ‘real estate’ (commercial real estate, as of now) component to their primarily equity, gold, and/ or debt holdings. REITs are structured to provide regular and stable income, unlike equity, and at the same time have the potential for capital appreciation, over a period of time. At the same time, it is important to bear in mind the fact that REITs do not have a long track record in India (though globally they have been around for decades and have performed well).