What Is a REIT? Meaning, Benefits, Risks and Taxation in India

Real estate-based instruments have become more visible in India over the last few years. Although many investors are familiar with direct property investment, a real estate investment trust (REIT) offers a different way to participate in the real estate sector without actually owning physical property. In this article, we will understand the concept of a REIT, how it works, its potential benefits, risks and other important aspects.

What is a real estate investment trust (REIT)?

A real estate investment trust (REIT) is a trust registered with SEBI that raises funds by issuing units to investors and invests primarily in real estate assets. These assets may be held directly or through special purpose vehicles (SPVs) or holding companies. The investors who hold units in a REIT are called unit holders.

REITs generally invest in income-generating real estate assets such as office spaces, shopping malls, warehouses, hotels, hospitals, convention centres and other permitted real estate assets, subject to applicable SEBI regulations.

Unlike traditional real estate companies that focus on building properties for resale, REITs primarily acquire and develop properties to hold them as long-term investments and generate income from them.

How REITs works?

REITs function in a way similar to mutual funds, with a structured framework that includes a sponsor, a manager and a trustee. The trustee holds the real estate assets in trust on behalf of the unit holders and oversees compliance with applicable regulations. The manager is responsible for handling and managing the real estate portfolio. This structure is intended to provide governance and oversight for investors.

REITs generate income mainly through rental earnings from their properties and may also earn gains from selling these assets. Distributions depend on the net distributable cash flows of the REIT and the nature of income received.

Types of real estate investment trusts (REITs)

Here are the different types of REITs that investors may come across, depending on how they invest and how they are structured:

Types of REITs based on investment style

Here are the common types of REITs based on the nature of their underlying investments:

Equity REITs

Equity REITs are a common type. They invest in and own income-generating real estate such as commercial buildings and office spaces. Their income generally comes from rent and, in some cases, gains from property sales.

Mortgage REITs (mREITs)

Mortgage REITs are found in some overseas markets and focus on financing real estate by lending money to property owners or investing in mortgage-backed securities. They earn income through interest payments, which may be passed on to investors. This category should not be treated as a standard Indian REIT type unless a specific non-Indian market context is being discussed.

Hybrid REITs

Hybrid REITs combine the features of both equity and mortgage REITs in some overseas markets. They invest in physical properties as well as real estate debt instruments, offering potential income from both rent and interest. In India, investors should refer to SEBI regulations and the relevant offer documents to understand the structure and asset exposure of a specific REIT.

Types of REITs based on structure

Here are the common REIT structures seen in different markets:

Listed REITs

In India, REITs that are listed and traded on recognised stock exchanges such as the National Stock Exchange (NSE) can be bought and sold through the stock market, subject to liquidity, price movement and market conditions.

Public non-traded REITs

Public non-traded REITs are common in some global markets. They are not listed on stock exchanges and may offer limited liquidity. This category should not be treated as a standard Indian retail REIT category unless the specific jurisdiction and regulatory framework are clearly explained.

Private REITs

Private REITs are also common in some global markets. They are typically available only to select investors and may have lower liquidity compared with listed REITs. This category should not be treated as a standard Indian retail REIT category unless the specific jurisdiction and regulatory framework are clearly explained.

Why investors consider REITs

REITs may allow individual investors to earn potential income from commercial real estate without the need to directly purchase or manage any property. However, returns are not assured and depend on factors such as rental income, occupancy levels, property values, interest rates, liquidity, expenses and market conditions.

How to invest in real estate investment trusts?

Here is a simple way to understand the process of investing in REITs:

1. A demat and trading account is required, as listed REIT units in India are bought and sold on recognised stock exchanges.
2. Investors may check the available listed REITs and review their offer documents, risk factors, disclosures and tax information.
3. REIT units can be purchased through the stock market, subject to availability, price movement and trading volumes.
4. Investors may track the REIT’s performance, as the price of REIT units may fluctuate based on demand and the performance of the underlying assets.
5. Investors may also check whether any mutual fund scheme provides exposure to REITs, depending on the scheme mandate and applicable regulations.

Key considerations in selecting a REIT

Here are key factors that can help investors evaluate a REIT more carefully:

• Check whether the REIT is listed on a recognised stock exchange and whether it has adequate liquidity for buying and selling units.
• Review the quality, location and type of real estate assets held by the REIT.
• Assess occupancy levels and lease terms, as these can influence rental income and cash flows.
• Look at the role and track record of the sponsor, manager and trustee.
• Understand the costs, fees and expenses associated with the REIT.
• Check whether the REIT’s assets are concentrated in a few properties, tenants or locations.
• Review the distribution history, but do not assume that past payouts will continue in the future.
• Consider the tax implications based on the nature of income and the investor’s tax profile.
• Read the risk factors, regulatory disclosures and offer documents before making any investment decision.

Benefits & risks of investing in REITs

Here are the key benefits and risks that investors should understand before considering REITs:

Advantages of investing in REITs

Here are some advantages that REITs may offer as a real estate-linked investment option:

• Diversification: REITs can help diversify a portfolio by adding real estate exposure without the need to directly own or manage property.
• Low initial investment: Compared with traditional real estate, listed REIT units may require a smaller minimum investment, making them more accessible.
• Professional management: Properties are managed by appointed professionals, reducing the need for direct involvement from investors.
• Potential distribution income: REITs are required to distribute at least 90% of their net distributable cash flows, subject to applicable regulations. The amount and nature of distributions are not guaranteed.
• Potential capital gains: Since REITs are market-listed, their value may increase or decrease over time, depending on market and asset-level factors.

Limitations of REITs

Here are some important limitations and risks that investors should consider while evaluating REITs:

• Limited choices: India currently has limited listed REIT options, restricting investor selection.
• Liquidity concerns: Although listed, REITs may have lower trading volumes, making it harder to sell quickly at desired prices.
• Tax on income: Distributions and gains from REIT units may be taxable depending on the nature of income, investor category and applicable tax laws.
• Market and property risks: REIT values may be affected by interest rates, occupancy levels, lease renewals, property valuations, regulation and broader market conditions.

REITS vs. stocks

Here is a quick comparison to understand how REITs differ from stocks:

REITS vs. real estate

Here is a quick comparison to understand how REITs differ from direct real estate investment:

Taxation on REIT

Tax treatment of REITs depends on the nature of the distribution, the investor’s tax status and applicable tax laws. Tax laws may change, and investors should consult a tax adviser for their specific circumstances.

Distribution taxation

Distributions from REITs may include dividend, interest, rental income, repayment of capital or other components. The tax treatment may differ depending on the nature of the distribution and applicable provisions.

Capital gains taxation

For listed REIT units transferred on or after 23 July 2024, Short Term Capital Gains (STCG) may apply if units are held for 12 months or less and may be taxed at 20%, subject to applicable conditions, including STT. Long Term Capital Gains (LTCG) may apply if units are held for more than 12 months and may be taxed at 12.5% on gains exceeding Rs. 1.25 lakh, subject to applicable conditions and without indexation.

The tax information in this article is based on prevailing laws at the time of publishing the article and is subject to change. Please consult a tax professional or refer to the latest regulations for up-to-date information.

Conclusion

A real estate investment trust provides a structured way to invest in income-generating real estate without directly owning property. It combines features of real estate and stock market investments, offering potential liquidity, diversification and distribution income. However, REITs are subject to market, liquidity, property, regulatory and tax risks. Returns and distributions are not guaranteed.

FAQs

What types of properties do REITs own?

REITs typically own or invest in income-generating real estate assets such as office spaces, business parks, shopping malls, warehouses, hotels, hospitals, convention centres and other permitted real estate assets.

How do REITs make money?

REITs primarily make money through rental income from tenants and may also earn gains from the sale of real estate assets, subject to applicable regulations and market conditions.

how does a company qualify as a REIT?

In India, an entity qualifies as a REIT when it is structured as a trust registered with SEBI and complies with the SEBI Real Estate Investment Trust Regulations, including requirements related to the sponsor, trustee, manager and eligible real estate assets.

How have REITs performed in the past?

In India, one publicly available benchmark for listed REITs and InvITs is the Nifty REITs & InvITs Index, but it includes both REITs and Infrastructure Investment Trusts, so it should not be treated as a pure REIT-only index.

What is the management structure of a REIT?

A REIT typically has three key parties: a sponsor who establishes the REIT, a trustee who holds assets in trust and oversees compliance, and a manager who handles operations and investment decisions.