• Tue. Jun 21st, 2022

Can REITs become a viable alternative for real estate investments?

ByWillie M. Evans

May 17, 2022

In India, there are currently 3 registered REITs, namely Embassy, ​​Brookfield and Mindspace. Despite muted economic sentiments over the past two years, REITs have emerged as a new asset class in India. On a quarterly basis, REITs gave returns of 5-6%, painting an overall optimistic picture.

In the past, the requirement for high cash flow has hurt investments in commercial assets. However, REITs, which are modeled after mutual funds, have provided an alternative platform for various investors to gain exposure to commercial real estate. REITs pool the investments of a group of investors and use them to own and operate income-generating business assets. A significant portion (~90% in India) of the dividends received is distributed to investors. In addition, REITs also provide the opportunity for their investors to earn through capital appreciation. There are a few other REITs in the offing that will soon join the bandwagon.

Will REITs overtake real estate investments?

REITs will emerge as an alternative platform for investing in Indian real estate. Its importance will be felt everywhere. In the meantime, the pressing question is whether REITs will trump real estate investments in India?

If empirical data is examined, this is the case in the United States and Singapore. In the United States, currently, ~90% of commercial real estate investments are channeled through the REIT instrument. In Singapore, nearly half of commercial reality investments are channeled through REITs.

However, believing that REITs will prevail over real property investments in India might not be possible, at least in the near future. In an emerging economy like India, there is too much focus on owning real estate. An RBI study conducted in 2017 found that more than 80% of average Indian household wealth is channeled into real estate, while only 5% has flowed into financial markets.

In a country where there is so much emphasis on owning real estate, REITs will never achieve the scale needed to reshape the industry.

Instruments more feasible than REITs in terms of return on investment

Besides scale, REITs are also not the most profitable instrument. Owning a Class A property in a prime location (provided pocket allows) can yield returns in the 6-9% range. Investing in a specialized computer park or a business center can generate returns of around 6 to 7%. As offline shopping activities are restored, retail is once again a profitable investment to bet on. Owning a downtown retail space could yield a high return in the range of 10-12% over the previous decade. Although a double-digit return is not currently possible, it can still yield returns in the 8-9% range.

As market sentiments change, new asset classes are also moving up the curve and attracting investors with high return potential. Alternative asset classes such as co-living spaces, retirement homes and rental homes can yield returns in the 7-9% range provided they are marketed correctly.

More mortgage and tax incentives in the purchase of real estate

There are also a few other benefits of real estate purchases, which REITs lack. There are attractive tax advantages associated with real estate investments. Likewise, real estate can still be used as a mortgage, which is lacking in the case of REITs. Real estate has the inherent advantage of leverage, in which investment potential can be maximized using borrowed capital. Currently, lending rates are at historic lows, making real estate an attractive proposition.

(By Sanjeev Arora, Director, 360 Realtors)