9
This week sees the introduction of an investment asset class that is new to India –– the Real Estate Investment Trust (REIT).
Embassy, a Bengaluru-based real estate developer, has launched an IPO of a REIT.
A REIT is roughly like a mutual fund that invests in real estate although the similarity doesn’t go much further.
Essentially, it’s like a group of people pooling their money together and buying real estate except that it’s on a large scale and is regulated.
The obvious pitch for a REIT is that it enables individuals to generate income and capital appreciation with money that is a small fraction of what would be required to buy an entire property.
However, the resemblance to either mutual funds or to owning property ends there.
The basic deal on REITs is that you own a share of property, and so an appropriate share of the income from it will come to you, after deducting an appropriate share of expenses.
According to Indian regulation on REITs, these are meant to primarily own finished and rented out commercial properties –– 80 per cent of the investments must be in such assets.
That excludes the speculative dabbling in real estate that is under development.
The underlying idea is that developers will bring up assets using other sources of money, bring them to an income-generating phase, sell them to REITs and then use the funds thus freed up to develop other assets.
It’s a cycle that mostly works well in western markets.
Whether it eventually works as smoothly in India will take years to discover.
But how are REITs different from other types of investments One issue is liquidity.
REITs are to be compulsorily listed on a stock exchange so investors can sell them if needed.
However, no one expects them to be readily saleable at a fair price, or an agreeable price to be discoverable easily.
Another issue is that of taxability of the income.
In mutual funds, income mutates to whatever form the fund distributes it as.
Capital gains or dividends or interest income in the underlying investments can be distributed by the fund companies as capital gains or dividends or bonus in whatever different ratios that is better for investors.
In REITs, no such transformation is allowed.
Rent, income, dividend, whatever the underlying investments generate, will have to be distributed in that form and most importantly, be taxed exactly as that.
This makes REITs distinctly less taxfriendly and less flexible than any other investment.
A REIT can be like a fixed income investment that can additionally generate capital gains when you’d like to exit.
However, these are still operational issues.
As in any new venture, it’s the unknowns that should worry us.
That means that no matter how attractive the sales story sounds, individual investors should be cautious.
Any investment has to be evaluated on returns, liquidity, safety and tax efficiency.
Most importantly, these can only be judged by experience and track record.
In India, that doesn’t yet exist.
This a famously cyclical industry and any part of the story may turn out to be shaky.
There are also too many hidden mechanisms that drive this industry in India.
There are other asset types that can provide a superior combination of returns, liquidity, safety and tax efficiency.
Maybe, retail investors can revisit REITs five or ten years from now, but at this point of time, there is too much that is up in the air.
(The writer is CEO, Value Research)
