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REITs: The New Way To Make Less Money Than Inflation, in Real Estate

SEBI, in it’s board meeting, approved regulations for Real Estate Investment Trusts (REITs). These are entities which own property and get rental income and/or income from selling the property. Here’s how the structure will work in India:

The What

Each REIT will have 80% of its assets as owned property. This might consist of property directly owned, or owned through a Special Purpose Vehicle (SPV) in which it owns 50% or more. (An SPV makes sense when the land owners may jointly own the assets with a builder, but the builder holds more than 50%)

This 80% must be completed properties, ready and revenue generating. And right now, only commercial properties. And a minimum of 2 properties, with max 60% in one.

The remaining 20% can be used to buy under-development properties (max 10%), debt to builders or government / money market securities.

This is good regulation – using the money to fund real estate companies through debt would have been a disaster.

REITs can raise funds through an IPO. For this the REIT will have to be at least Rs. 500 cr. in size. (Companies will less can pool together, max 3 in a REIT) It will offer units for sale, and investors can buy a minimum of Rs. 2 lakh worth. The issue should be for 25% public holding at least.

REITs must distribute 90% of the income they get. It can’t be reinvested. Also, if the underlying assets are sold the income generated must be distributed too. 

In Budget 2014 we saw REITs getting a tax-pass-through status. This doesn’t actually mean that much. What it means is:

  • For rental income, the REIT will pay 30% tax, then distribute. Unitholders don’t pay further tax.
  • For interest received, the REIT pays no tax. It’s taxed in the hands of the unit holder. TDS is 5% for foreigners, 10% for Indians.
  • Dividends received by the REIT (from SPVs) are anyhow tax free. (though the SPV will pay dividend distribution tax if it’s a company, or not at all if it’s an LLP). Further distribution of this to unitholders attracts no tax.
  • Capital Gains is taxed at the REIT level (20% LTCG). The post-tax money distributed is not taxed in the hands of the unit holder

Also read this note by Nishith Desai . This really means that the main basis of income for the REIT – rental income – gets taxed at 30%. Which, as we’ll see later, reduces the attractiveness.

NAV Declaration: REITs must get their properties valued every year, and update their Net Asset Value within 15 days.

Skin in the game: The “Sponsors” of the REIT, who are effectively the promoters, will own 25% of the project of 3 years after listing and then on, 15%. They can’t just ditch and run.

Our View

Assume there is a property generating rents. Why will the owner attempt to sell it, and yet, retain 25%? When the price is high, or when it is not apparent that the rental yield will continue to be this high.

Either ways it’s unlikely you get high yield REITs. Most commercial yields are of the order of 2% to 6%, (Note: See Update below) so we can safely assume that companies will put stuff into REITs when the yields are of the order of about 4%. (Remember, there will be a service cost for the REIT to operate – which could take another 1% away from the yield)

A 4% yield is horribly low. However, it is indexed to inflation in many cases – let’s assume a 6% rise in rents each year; how much would that be? Even after 10 years, that’s a yield of 7.16%. Again, way too less to be of consequence.

This does not include property taxes, property upgradation, idle cost (if you aren’t able to find companies that will rent it out, the property maintenance fees have to be paid) and REIT service fees. 

Worse, it doesn’t include income taxes – which as we’ve seen above, are taxed at 30% at the REIT level. A 4% yield is effectively a 2.8% yield.

The bet then is on capital appreciation, which can increase the Net Asset Value and the price in teh market. But don’t bet on money coming in from sales. Because it’s not apparent why any REIT would want to sell. Remember, an REIT collects rents. If it sold properties, it would have to return money to shareholders, and its asset value will drop. It will then have lesser income, and this becomes an existential crisis.

The only time they will sell is if prices are too low and no rents are being realized. Which is not a good bet to take in the first place. So it’s a bet on the greater fool, who bets on the higher “NAV” and a lower yield. (Which in India has been a great bet to take!)

Another risk is that builders will alter the maintenance-rental mix. When you rent from the builder, they put a certain amount as rent, and a certain price per square foot as the maintenance cost. This is unregulated for the most part. So they could charge you Rs. 5 per square foot, or Rs. 15 per square foot. Promoters who are scoundrels can do this – sell the property at a yield of (say) Rs. 100 per square foot to the REIT, and then, after a year, change the maintenance cost to Rs. 40 per square foot, forcing down the rentals to compensate. The builder has thus sold a good portion of the property to the REIT, but makes a higher revenue per square foot on maintenance.

This is not usually done because it invites the wrath of property owners. But here, since the REIT is owned piecemeal, and managed by the builder, the incentives are all for the builder to maximise his own revenue. It’s always dangerous to set up misaligned incentives. (As in, have REITs that are not managed by the builder or anyone related, but that’s not going to fly)

REITs will be marketed with a vengeance. Imagine, you can buy a part of a property and get rentals and own it and have someone else manage it! Our love for property is only next to our love for Gold. So you can bet your left eyeball they will make attractive pitches. But how much it’s useful is largely dependant on pricing, the kind of properties in the pool, related party transactions.

Assuming REITs are a success, the concept is great for real estate folks. But it’s bigger for banks. Banks are up to their eyeballs in lending to commercial real estate. They will be able to get some of their money back. With that exposure cut, they can lend to builders for other kinds of property, or for other reasons.

If you ask me what I would do, the answer is: it depends. What’s the point speculating if you don’t know the price of an REIT, and the specific properties it owns? But yes, marketing teams should dust off their “IPO” presentations, because this could be the next big thing.

Who’ll buy?

  • Domestic Institutions: Perhaps. If the return is decent.
  • Foreign Institutions: Not quite so sure about them as some of their tax situations could get complex. India doesn’t tax certain income from REITs in customers hands but other country’s will. But many countries are lower tax so there’s going to be a lot of interest from them.
  • Individuals: With a 200,000 rupee lower limit, this will be restricted to a few HNIs. But again, post tax yield will determine interest.


Apparently, rental yields for commercial property are 10%+. And price increases are 15% in three years, which is about 4.8% per yea
r. This has come through in a couple of articles. (though I’m not sure where, as yields where I look are lower).

Let’s check this thing out with 11% yield. Taxes take out 3% (30% tax) so you’re left with 8%. A post tax yield of 8%, growing at about 5% a year, isn’t too bad really.

The pain then moves on to: property taxes, idle cost, longer term maintenance and fees. That would probably eat up 1% to 2% or so. So the effective yield would be 6.5% to 7% post tax.

Which is more attractive, I agree, plus the 5% increase each year will take yields higher. (though at this point, even that post-tax yield won’t cover inflation, and tax-free bonds are at 8%)

Like I said, it’s all going to be about yields – so the higher the effective yield and the lower the likelihood of idle costs, the REIT will be more attractive. I just hope the effective return beats inflation!

  • Newbie says:

    So should I invest in Real Estate Stocks (like Prestige Estates, Phoenix Mills, etc) having commercial properties ? Looks like REIT is for them and not for direct REIT investors !

  • Chella says:

    any idea about how these can be bought and sold? will it be listed in secondary market/exchanges similar to ETFs?

  • Px says:

    With the taper in progress and tightening of monetary policy at home
    thanks to unrelenting inflation and poor growth numbers,
    would REITS be a mechanism for bailing out those stuck in the real estate market ?
    People cant afford houses … the lmc pensioner lot getting under Rs 10000 pension is seriously suffering from inflation and life is a lot harder for those with a family earning less than 20000 a month

  • Murthy says:

    Happy (Financial)Independence Day!
    The best thing about the Sprite Ad is about the essence!
    Look at the policies being made. Who makes them? The Politicians. Who backs them? The lobbyists, Industry, and bigwigs.
    Who will pay or it? Obviously the common man.
    Look at Savings limit under Section 80C. All hoopla says one can save upto 35,000, only you can have the benefit of PPF, and nothing else. Returns from this are tax free, but not inflation free.
    Look at the pension scheme, Rs.1000 per month? Living on a Parliament Canteen , of course.
    REITS MY FOOT, WHO CARES? The benefit always goes to the big builder. How to save DLF? how to save Others? After all they gave a good support to the earlier Govt. Golden Geese in deed!
    Oh ! Come on Murthy, the present Government is very strict in taking action on Miners, but no one can ask the Lady’s close links with OMC Reddys. She has to be respected , as an honorable External Affairs Minister. After all, if we do not give respect within our country, who will care out side the country? OK, NO MEDIA SHOULD TOUCH THIS ISSUE.
    But the Big Bro knew where the root of all evil, I mean MONEY,( Sorry All my deer Capitalists), they bugged the entire house before , much before the actual deals made…….SHSSSSSSS,,,,!!! No one shall speak.
    OK, OK, now it almost looks like the same UPA GOVT., so how to divert attention? Ask a new MP to suddenly show some Great concern about Kashmiri Pandits…….her real intention is to show the poor state of Telangana Pandits. Ya, a Non bailable warrant was issued, but wait a minute, after all she is just a new kid on the block, after all she shall be given a few more chances, like Shikar Dhawan! Show would soon be pardoned, why not, when a PAK terrorist who murdered an Indian was left scot free, because of no evidence , soon, her remarks would fade into history. If people still remember, we have NDTV, India. Today, Headline Today, To verify how many times Sachin entered RS or how many of them actually made their presence significant. we all can see how Rekha maintains her looks even at that age, sitting in Rajyasabha, If at all she attends! WHO IS THAT SAYING IT IS PAID NEWS? I will take this as a threat to our Indian Democratic system, an insult to the Parliament, last 10 years it was paid median. This time it is free media. Or else, we will cut off any channel which speaks against us.
    OK, OK,
    Happy Independence Day Again!
    Mera Bharat Mahaaaaaaaaaaaaan!

  • Leo says:

    the thing is it is being launched at a market top… just like dlf IPO on 2007 2008…interesting

  • Murthy says:

    This is for the WRITERS!
    Warren Buffet said: Let Block Heads read what Blockheads wrote!
    Current Trend: Let Bloggers read what Bloggers wrote.
    My intention is something different.
    A man wrote a book after people forgotten all his mis-deeds, and comments on a so called personality in his book.
    Now, it is not the persons who were involved ,instead, their children are speaking::::
    1. My father would have written an auto-biography. after all, he did not get a chance to speak throughout his political career.
    2. My mother would have written her autobiography. She had all the power but could not get it for the third time.
    3. My father should also try his own auto-biography, he was too late to introduce me into his foot steps, in spite of controlling the Country’s finances.
    4. My father would try too, but he was pre-occupied with my now step-mom, as he has a lot to to tell about how the Gen-Sec of the ex-ruling party.
    5. My mother has something to write about, as how successfully she ruled the capital and made me a Mally – mouthed Parliamentarian.
    6. Hey, even my Papa had to write about how he managed the Corporate world, but now into oblivion……..
    7. Actually, it is my dad’s fault, he should have told the truth before making the entire Juduciary a big joke.
    After all, there are a lot of readers who are willing to read.
    This is just for fun, no Capitalism.

  • PSRK says:

    Higher risk and an FD equivalent return. Why bother at all? A 15 year bond gives almost a 7% yield.
    Returns would have to come from capital appreciation on sale.

  • maulik says:

    7% is locked in…. However we are talking about 7% as base which is likely to go up year on year by say 5%.

  • Deepak Bhardwaj says:

    The writer has given a good insight but I think he is assuming that inflation will always remain high and therefore 5 to 7 % can’t be attractive however most of us believes that inflation will settle down between 4 to 5 % moreover he also undermining the fact that going forward if reits r successful in collecting money who knows they might influence the property prices in order to earn a good yeild , reits can also setup bench mark for rental I am sure either rentals will go up or property prices will come down to offer greater yield… I hope reits will buy such properties where yields are good forcing commercial properties to fall down.