Investing in Indian REITs: A Comprehensive Guide

Are you curious about how to start investing in Real Estate Investment Trusts (REITs) in India? REITs are a popular investment avenue, combining the benefits of real estate investment with the liquidity of stocks. This article will provide you with all the information you need to understand REITs and how to invest in them.

What are REITs?

REITs, or Real Estate Investment Trusts, are investment funds that pool money from investors to invest in commercial properties like offices, hotels, malls, and more. They are similar to mutual funds in that they offer investors access to a diversified portfolio of real estate assets. However, there are specific rules regarding where REITs can invest.

Investment Rules for REITs in India

In India, a REIT must invest at least 80% of its corpus in commercial properties that can be rented out to generate income. The remaining 20% can be invested in financial instruments such as stocks, bonds, cash, or under-construction commercial properties. These rules ensure that REITs provide a steady income stream for investors through the rental income from their properties.

How to Make Gains from Investing in REITs

There are two primary ways to make gains from investing in REITs:

Trading REIT units on stock exchanges, such as the BSE and NSE.

Receiving dividends, interests, and other distributions of the cash flow generated by the REITs.

Furthermore, REITs are required to distribute at least 90% of their cash flow. The cash flow of REITs is not limited to rental income and can also come from other sources such as interest earned from investments in deposits, income from asset sales, and payments from special purpose vehicles (SPVs).

Understanding SPVs and Cash Flow Distribution

The majority of REITs do not own properties directly but instead do so through SPVs, which are like subsidiaries of the REIT. When SPVs earn rental or other income, they pass it to the REIT. This process can also involve the REIT giving loans to SPVs and receiving interest income in return.

Embassy Office Parks REIT Case Study

Let's look at an example using Embassy Office Parks REIT. The trust distributes its cash flow into three main components:

Interest payments

Dividend payments

Amortization of SPV level debt: Loan repayment by SPVs to the parent company.

If we analyze the payout from Embassy Office Parks REIT in the last financial year, we can see that the total payout was Rs 21.76 per unit, which includes Rs 5.26, Rs 5.20, and Rs 5.66 for interest payments, dividend payments, and SPV level debt amortization, respectively.

Calculating Yields and NAVs

To calculate the yield of each unit of REIT, you need to divide the total distribution by the unit price. For instance, if you invested in one unit of Embassy Office Park REIT on April 1, 2021, at Rs 325.30, the gross distribution yield would be 6.69%. If you bought the unit on April 19, 2021, at Rs 304.57, the yield would be 7.14%.

Understanding the Net Asset Value (NAV) of the REIT is also crucial. Unlike mutual funds, REITs do not calculate NAVs daily. Instead, they declare the NAVs every six months, which can be found in their investor presentations. As of October 4, 2023, the NAV for Embassy Office Parks REIT was Rs 393.90, while the current unit price was around Rs 345, indicating a significant discount.

Pros and Cons of Investing in REITs

REITs are promising investments due to their potential for regular income through dividends and capital appreciation from property price increases and new asset additions. Additionally, they provide diversification opportunities for investors, especially in the real estate sector.

However, it's important to keep in mind that commercial properties are not completely insulated from economic problems such as recessions and lockdowns. Negative economic conditions can adversely impact REITs, affecting their performance.

Conclusion

Investing in REITs in India can be a wise decision, but it's essential to understand the structures and the risks involved. By carefully analyzing the NAVs and yields, you can make informed decisions about your investment in REITs.

Now that you have a better understanding of how to invest in REITs in India, take the next step and explore your investment options. Happy investing!