Real Estate Investment Trust (REIT)

Introduction

Real Estate Investment Trust or REIT is an investment scheme on similar lines as a Mutual Fund, differing in the types of portfolios held and maintained by them. On one hand, the sphere of investment of a Mutual Fund is directed towards securities listed under some stock exchange, but on the other hand, Real estate investment trusts concentrate their investments on portfolios related to income-generating assets in the real estate sector.^[1] The method of working for both these investment schemes is more or less the same. They pool investments from potential investors who are interested to invest in securities and other portfolios with guaranteed returns with low risk compared to investing in the stock market directly and utilise the collected money to invest in securities in the case of Mutual Funds and real estate assets in case of REITs.

So, Real Estate Investment Trusts are investment schemes specific to the real estate sector in such a manner that a regular income with-profits is ensured along with capital appreciation.^[2] It is different from a listed Real Estate Company which is primarily engaged in the business of developing real estate projects and selling them to the consumers depending on the type of property. Rather, a Real Estate Investment Trust invests its capital into developed properties only to put them on rent to create a permanent source of income. Generally, the portfolios held by Real Estate Investment Trusts are spread across but not limited to office accommodations, residential complexes, shopping malls, hospitality sector like hotels and resorts with some restrictions in place in some countries while a more lenient approach by others. They usually register themselves as a trust with the stock market regulators, which in the case of India is known as the Securities and Exchange Board of India.

Organisational Structure of REITs

Asset Ownership and Management

There are two methods of managing the assets of a Real Estate Investment Trust, viz. direct and indirect approaches. The first approach includes a direct control under which the parent REIT has the ownership rights of the real estate properties and the stakeholders are directly involved in the management process. The second approach includes managing the assets through a subsidiary in the form of a Holding Company or a Special Purpose Vehicle (SPV). The Holding company is a bigger entity as compared to an SPV with control over the SPV. SPV is the last line of control over the assets over which a REIT exercises control directly or through a holding company with majority interest. Their field of operation is restricted to ownership and maintenance of real estate assets held by its parent company.^[3]

People involved with REITs

The stakeholders involved in Real Estate Investment Scheme directly or indirectly are:

1. Sponsor: The feat of setting up a REIT rests in the hands of sponsors. They usually dedicate their properties and assets to the trust for ensuring its survival and initial stability. They play a crucial role in raising funds through REITs.
2. Trustee: He is the person in whose name the assets of a Real estate investment trust are registered. His appointment is decided and overseen by the Sponsor and he represents the unitholders of a REIT.
3. Manager: A manager is a person who shoulders the responsibility of asset management related to a Real estate investment trust. His actions are based on wishes and commands of the sponsors as far as the investment decisions are concerned along with decisions based on personal skills and analysis.
4. Unitholders: They represent the indirect holders who invest their capital into the REITs which then further invest the money collected into some real estate assets. They are the ground level beneficiaries of the Real estate investment trusts functioning as the cash banks for them.^[4]
5. Independent Valuer: This title is held by a third-party valuer assigned with the task to assess the worth of all the assets maintained by the Real estate investment trust. The deciding factor at the time of appointment is the credibility of a valuer.

The list of stakeholders mentioned above is not exhaustive and various other persons of interest are hired by the stakeholders who are entitled to such powers as per the requirements; legal compliance being a shining example at that. For legal compliance, some legal experts or legal firms are employed either full-time or law firms for as long as required by the Real estate investment trusts.^[5] REIT offers a lucrative opportunity for the real estate developers in the form of an alternative to borrowings from the banks, for making arrangements to ensure enough cash flow or liquidity for executing their operations.^[6]

The situation in India

The concept of Real Estate Investment Trusts is quite recent in India, yet to explore its growth potential to the optimum level. Their regulation is governed by the Securities and Exchange Board of India (SEBI). Contrary to some major developed economies, the extent of investment in India is limited to commercial real estate assets especially in the office spaces, offering lucrative dividends to the stakeholders and a hassle-free investment approach by the unitholders without the need for actual sale-purchase, maintenance and direct financing of real estate projects, also keeping in mind the scale of capital available with small investors which are often far too meagre to finance a large real estate project single handedly.

The SEBI has issued guidelines and regulations for the REITs operating in India, assigning some obligations on their part to ensure minimal risk and optimal security for the investors. For assured dividends in the short and long term, REITs are mandated by law to divert at least 80% of their investments in terms of monetary value towards finished real estate projects which are available for end-users to rent or income-generating projects.^[7] There are restrictions in place even for the remaining portion of the investments made by the REITs, which are mentioned below:

1. Shares of a company with more than 3/4^th of its income are derived from investments made in the real estate sector.
2. Government securities, treasury bills, certificates related to deposition of money in the treasury and fiduciary documents.
3. Any ongoing real estate project undergoing construction of non-rent properties with conditions on the duration of operations of the REITs which is set at 3 years.
4. The debt of companies is associated directly with the real estate sector other than its undertakings.
5. Mortgage-Backed Securities (MBS): MBS means that the collective mortgages are sold to investment banks or other entities transferring the rights to the mortgage of property instead of payments and interest.

What does it mean for a layman investor?

The major chunk of opinion building among the investors is done by their outlook towards a particular concept. Weighing the risks involved with the real estate sector during the times of Covid-19 is a game-changing factor. Historically, the real sector has been a safe venue for investment for some while a risky venture for others. The risk appetite of a person is the deciding factor as to choose REIT mode of investment. In listed Real Estate developer companies, there is usually a cash crunch which can create hiccups in the short term, a gap REIT aims to fill with its rich capital resources to contain the volatility of the real estate sector while maintaining a balance between demand and supply, adapting to the evolving scenario owing to pandemic induced work from the home culture which directly affects the domain of operation of REITs in India.^[8]

On the positive side, REITs have shown tremendous potential for growth in the Indian Economy with ensured liquidity inflows and opportunities for the small investors to own a fraction of some real estate project which wasn’t possible earlier.^[9] The investors don’t require the technical know-how as REITs provide professional management of assets ensuring smooth functioning. Currently, there are only three Real Estate Investment Trusts operational in India viz. Embassy Office Parks, Mindspace Business Parks and Brookfield.^[10] They have braved the impacts of COVID-19 and are ready to capture the opportunities as they come.

Conclusion

The aftermath of the pandemic is bound to transform the traditional office space and culture, with the increased focus on health and related aspects. Perhaps the newer version will have more sophisticated expectations from the real estate developers but the demand for office spaces is gradually rising. COVID-19 has slowed down the expansion of REITs into new sectors like residential complexes, shopping avenues and the hospitality sector but as the smoke passes, the untapped segments are likely to see new opportunities squeezed to the full potential.

With pent up demand for office spaces as the pandemic passes and likely revival in the housing as well as retail sector, the investors would feel much more comfortable as the debts of the real estate developers are resolved with fresh capital inflows leading to a boost in confidence and increased volatility. REITs have a bright future in India as the journey proceeds, providing the investors with a lucrative alternative to the usual securities, gold, mutual funds etc. The increased confidence of foreign investors in the Indian market can also lead a long way over time while also boosting the possibilities for REITs.

---

References:

[1]Divakar Vijayasarathy, What Is A REIT And How Does It Work?, Forbes Advisor INDIA (2021), https://www.forbes.com/advisor/in/investing/what-is-a-reit-and-how-does-it-work/ (last visited Dec 12, 2021).

[2]Bavadharini KS, All you wanted to know about REIT, @businessline , https://www.thehindubusinessline.com/opinion/columns/slate/all-you-wanted-to-know-about/article35154455.ece (last visited Dec 12, 2021).

[3]SEBI | Securities and Exchange Board of India (Real Estate Investment Trusts) (Amendment) Regulations, 2021, , https://www.sebi.gov.in/legal/regulations/jul-2021/securities-and-exchange-board-of-india-real-estate-investment-trusts-amendment-regulations-2021_51549.html (last visited Dec 12, 2021).

[4]Prabhat Kumar Tiwary, De-mystifying REIT: Real Estate Investment Trust, BW Businessworld , http://businessworld.inhttps://www.businessworld.in/article/De-mystifying-REIT-Real-Estate-Investment-Trust/24-08-2021-401576 (last visited Dec 12, 2021).

[5] Supra 1.

[6]Sidhharth Maurya, What Are Real Estate Investment Trusts: How REITs Have Performed In 2021, https://www.goodreturns.in/ (2021), https://www.goodreturns.in/classroom/what-are-real-estate-investment-trusts-how-reits-have-performed-in-2021-1231343.html (last visited Dec 12, 2021).

[7]SEBI | SEBI (Real Estate Investment Trusts) Regulations, 2014 (last amended on December 15, 2017), , https://www.sebi.gov.in/legal/regulations/dec-2017/sebi-real-estate-investment-trusts-regulations-2014-last-amended-on-december-15-2017-_38449.html (last visited Dec 12, 2021).

[8]Do You Need REIT Investments For Your Portfolio?, , Moneycontrol , https://www.moneycontrol.com/news/business/personal-finance/do-you-need-reit-investments-for-your-portfolio-7493581.html (last visited Dec 12, 2021).

[9]The future of commercial real estate investment through REITs, , The Financial Express (2021), https://www.financialexpress.com/industry/the-future-of-commercial-real-estate-investment-through-reits/2274119/ (last visited Dec 12, 2021).

[10]De mystifying REIT Real Estate Investment Trust-Prabhat Kumar Tiwary – BW Businessworld, , http://www.businessworld.in/article/De-mystifying-REIT-Real-Estate-Investment-Trust/24-08-2021-401576/ (last visited Dec 12, 2021).