Real estate as an asset class has always attracted investors, but the high-ticket size has made it out of reach for many.
Claim: Today, in India, you can invest in commercial real estate by shelling out as low as Rs 55,000. Sounds dubious? Well, SEBI has made sure that the claim isn’t dubious.
But how do you invest in commercial real estate with an amount as low as Rs 55,000?
The answer is a Real Estate Investment Trust (REIT).
The recent Mindspace IPO was a blockbuster and showed tremendous confidence of investors in the REIT/Commercial real estate sector of India. The minimum lot size being offered was 200 units for Rs 55,000 (275 Rs per share).
But what is a REIT?
Real estate investment trusts (REITs) issue shares that trade publicly like shares of stocks. REITs are often identified by the type of real estate assets they hold: mortgages, hotel properties, malls, office buildings, or other commercial property. The rental income from these assets is distributed to the shareholders as dividends.
The REIT market in India is underdeveloped as compared to the US, or other Asian counterparts. As of 2019, the share of REITs in the overall Real estate market cap stands at 96% for the US, 55% for Singapore, and 51% for Japan. With the Mindspace issue, the share of the REIT market cap might go up to 29% from 17% (As of 2019).
Win-Win for REIT, REIT investors, and commercial developers
To get listed, it is mandatory for the REIT to have the minimum underlying asset valuation at Rs 1,000 crores. Once listed, funds are collected from retail and other institutional investors during its IPO. The initial corpus coupled with the funds from the IPO is pooled together to primarily invest in completed, income-generating commercial real estate properties.
A REIT can make money for its shareholders in two ways:
Dividends: As per the SEBI guidelines, at least 90% of the profit after tax must be distributed to shareholders in the form of dividends, paid twice a year.
Capital appreciation: As REIT stocks are listed on BSE and NSE, price appreciation of its shares because of the performance of the underlying assets also earn returns for the investors.
But what is in it for the commercial real estate builders?
They get to monetize the portfolio of their operational assets, unlock capital, and deleverage their balance sheets/expand.
For example, consider the case of a builder X. X owns an office park that generates a monthly income of Rs 8 lakhs. X has also borrowed from a bank to start the construction of another project Y. However, construction has come to a complete standstill because of COVID-19 and heavier than normal monsoons. The interest and the principal payments for project Y to the bank need to be made on a timely basis, and X could use some extra cash to make these payments.
Well, how does X generate cash? By selling X’s stake in the office park to a REIT for a mutually agreed sale price. This would help X generate extra cash, make timely payments to its creditors (the bank in this case), and scope out new opportunities for investment.
But why should a common man invest in REITs?
Consider yourself buying a property for the purpose of investment. A good property would be identified, it would be booked, a token amount will be paid, a sale deed will be prepared, the sale deed will be registered, and the ownership of the property would finally be transferred to you upon fulfilling the contractual obligations including making full payment.
Seems like a lot of hassle?
One can invest in the commercial real estate market, without going through the above-listed hassles by simply purchasing shares of a REIT. Also, reasonable assurance of dividends, small ticket sizes of investment, transparency, and capital appreciation opportunity act as incentives for a common man to choose this asset class.
Why is the REIT market still underdeveloped if it seems to show so much potential?
The REIT asset class certainly shows a lot of potential, but there are a few reasons why it is still underdeveloped in India. Some of the reasons could be:
Share price can get heavily influenced by market conditions versus the actual value of the underlying properties. As a result, investors may experience volatility in a publicly-traded REIT.
Lack of awareness.
Since they must pay at least 90% of the income back to investors, REITs exhibit low growth. Thus, a maximum of only 10% of the net income can be reinvested back into the business.
REIT investors cede control of all the operational decisions that an individual property owner would make (increasing the perceived risk for the investors).
For a highly unregulated and opaque real estate sector, SEBI has done a good job by issuing stringent guidelines to making sure that the investors take informed decisions and chances of getting defrauded are minimized. The residential real estate sector has not come into the picture so far, but it shows an untapped potential worth lakhs of crores of Rupees.
The Indian economy is trying to navigate its way out of a deep recession, and the real estate market has lagged behind. The silver lining here is that there are a lot of good long-term investment opportunities in the real estate space, and REITs seem to give an opportunity to investors looking to diversify their investment portfolio, as they show the potential of an attractive income-producing investment in a low-interest rate environment.