For any investor, owning real estate as an investment requires sufficient capital and risk tolerance. However, there are financial vehicles such as REITs and real estate mutual funds that provide Indians with a chance to get exposure to the real estate industry without the requirement of actually owning or operating properties.
Table of contents
What is a REIT?
A real estate investment trust (REIT) is a corporation that invests in potentially income-generating real estate projects like offices, hotels, retail and industrial infrastructure, apartments, and other commercial real estate properties. The primary objective of a REIT is to potentially earn income through rents and interest payments by owning, managing, or financing commercial properties. REITs are mandated to distribute at least 90% of their net distributable cashflows to shareholders in the form of dividends.
Listed on the stock exchange similar to company shares, REITs allow investors to own a fraction of real estate projects and potentially access benefits of potential dividend income along with potential capital appreciation.
Also Read: What is real estate fund?
Types of REITs
Based on features and benefits, REITs can be classified into multiple types. The following categorisation is based on the kind of investments made by REITs:
- Equity REITs - One of the most preferred types of REITs, equity REITs manage income-generating commercial properties and provide a source of fixed income potential to their shareholders through their rentals. These commercial real estate properties include apartments, shopping complexes, hospitals, and offices.
- Mortgage REITs - REITs that invest in mortgages and mortgage-backed securities are called mortgage REITs, or mREITs. Generating income through interest payments, mortgage REITs are said to have lower risk than equity REITs but also come with a lower return potential.
- Hybrid REITs - REITs that invest in a combination of commercial properties as well as mortgages are called hybrid REITs and potentially offer shareholders a diversified mix of rental income as well as interest income.
Based on the accessibility of REITs, they can be categorised into the following.
- Publicly traded REITs - These REITs are listed on the public stock exchange and thus ensure liquidity and transparency.
- Private REITs - Offering higher levels of control, privately traded REITs are generally available only to a certain list of accredited investors. Since they are not publicly traded on the stock exchange, they have a lower level of liquidity.
- Public non-traded REITs - While these REITs are not listed on the public stock exchange, they are registered under regulatory bodies and thus are said to provide higher relative stability than private REITs.
Note: In India, all SEBI approved REITs are publicly traded. Private and public non-traded REITs are currently not allowed under Indian regulations. The global classification exists but only publicly traded REITs are considered relevant to Indian investors.
What is a real estate fund?
A real estate fund is a sectoral mutual fund that invests in companies associated with real estate or in real estate-oriented instruments such as REITs. Similar to other mutual funds, real estate funds are professionally managed by a fund manager who aims to leverage their analysis and industry outlook to generate potential returns.
Difference between REIT and real estate fund
The following can be considered as the prime differences between a real estate fund and a REIT:
- Investment structure - While REITs are trusts that directly own, manage, or finance commercial properties and mortgages, real estate funds are mutual funds that invest in shares of companies that operate in the real estate sector or REITs.
- Returns - REITs can potentially generate value for shareholders through fixed income in the form of rentals and interest payments. REITs may also generate potential returns through potential capital appreciation of the commercial properties. On the other hand, real estate funds may provide value if the stock appreciates, along with potential for dividend income.
- Liquidity - REITs are traded like shares on the stock exchange and are, therefore, highly liquid. On the contrary, real estate funds are not traded like stocks, making them relatively more illiquid than REITs.
- Diversification - Real estate funds allocate their money in multiple companies in the real estate sector, leading to more diversification. Though REITs also provide exposure to multiple income-generating properties, they may potentially face concentration risk due to funds being tied up in properties for longer periods or within certain geographies.
Features and benefits of REITs
- Liquidity - Since they can be directly traded on the stock exchange, they are highly liquid investments.
- Diversification - Investments made in REITs allow exposure to a wide array of commercial properties ranging from industrial to residential.
- Fixed income - 90% of the income generated by REITs from rents and interests is distributed to the shareholders, potentially creating a consistent flow of income.
- Tax breaks - If REITs fulfil certain investment criteria, they can opt for a concessional taxation scheme, potentially benefitting their shareholders.
- Accessibility - Investors of REITs can be fractional owners of commercial properties, allowing participation with a lower entry barrier.
- Expert management - Decisions pertaining to property investment, management, and operations in REITs are handled by professionals from the real estate industry.
- Inflation hedge - Investment in REITs may offer a potential hedge against inflationary forces.
Features and benefits of real estate mutual funds
- Liquidity - Compared to direct investments in real estate, real estate funds offer higher liquidity.
- Diversification - Real estate funds have a diversified portfolio with corpus being allocated across multiple company stocks as well as REITs.
- Investment threshold - Compared to REITs, the minimum amount required to start an investment in a real estate mutual fund is typically low, making it more affordable to enter for more investors.
- Expert management - Portfolios are handled professionally by fund managers, potentially ensuring optimised investment decisions.
- Inflation hedge - Investment in real estate funds might help in outpacing inflation.
Which is better, REITs or real estate mutual funds?
Both REITs and real estate funds have their own set of features and benefits that make them unique. While REITs offer partial ownership to physical properties and provide a relatively stable source of potential income for their investors, real estate funds offer opportunities in the form of potential capital appreciation of stocks of real estate companies. Both these financial instruments differ with respect to the liquidity, accessibility, taxation rules, risk appetite, and investor preferences. What works better for you depends on your financial goals and approach.
Also Read: What is a mutual fund?
Conclusion
Every investor is advised to align their investments based on their financial goals along with other factors such as risk appetite and availability of funds. Since real estate is considered an important part of the Indian economy, instruments like REITs and real estate funds offer one a chance to be a part of this ecosystem with professional risk management and a low entry barrier in terms of initial investment.
FAQs:
What kind of returns do REITs produce?
REITs generate rental income from their owned and managed commercial properties and interest income from mortgages and mortgage-backed debt financing.
Is REIT different from REMF?
Yes. REITs, or real estate investment trusts, directly own and operate income-generating real estate, whereas REMFs, or real estate mutual funds, allocate investor money in a portfolio of stocks that deal in real estate.
How do I start investing in a real estate fund?
Investors may start investing in real estate mutual funds through brokerage platforms and buy or sell funds listed on public exchanges using a demat account.
Are REITs better than physical real estate?
It depends on the investor’s financial objectives as well as other factors such as risk appetite, expertise, availability of capital, and personal preferences. REITs allow investors to get exposed to the real estate market with limited capital.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.
The content herein has been prepared on the basis of publicly available information believed to be reliable. However, Bajaj Finserv Asset Management Ltd. does not guarantee the accuracy of such information, assure its completeness or warrant such information will not be changed.The tax information (if any) in this article is based on current laws and is subject to change. Please consult a tax professional or refer to the latest regulations for up-to-date information.
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