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Real Estate Investment Trusts (REITs) Funds: Eligibility, Advantages, Types

Updated on: Jun 28th, 2022


8 min read

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Real Estate Investment Trusts (REITs) are involved in structuring funds that allow investors to invest to earn profits. REITs offer an excellent opportunity to venture into profitable investments.

Understanding REIT’s

At times when the economy is booming, and the government lays greater impetus on the development of infrastructure and real estate, the real estate investment trusts hold a major significance to investors seeking to gain exposure to the real estate sector and reap profits through their investments.

A Real Estate Investment Trust (REIT) is an entity that is created with the main purpose of channelising the funds that could be invested in operational functioning or ownership of the real estate to further generate income for the investors.

A REIT functions in a similar way to mutual funds and offers you an easy way to invest in real estate. It provides the advantage of diversification and long-term capital appreciation. REITs are a great way of investing in the real estate sector as they are listed on the stock exchanges.  

History of REIT’s

REITs structured on the lines of mutual funds were first introduced in the United States of America in the 1960s, through the Cigar Excise Tax Extension Act to boost real estate development by way of existing investments, from investors interested in holding a stake in the real estate sector.

The upsurge in real estate presented the opportunity of reaping huge dividends on the investments made, thereby bringing to effect, the real estate development projects and rewarding the investors financially. REITs were first introduced in India by the Securities and Exchange Board of India (SEBI) in 2007, almost 50 years after they were first incorporated as an investment vehicle.

Subsequently, there were regulations framed to facilitate the operational functions of these investment funds, which were revised and reformed after that. REIT companies listed on the Indian stock exchanges are monitored and regulated by the Securities and Exchange Board of India or SEBI to ensure adherence to industry practices and safeguard the interest of the investors.

Eligibility of REITs

For a company to qualify as a REIT, the following criteria must be satisfied:

  • 90% of the income must be distributed to the investors in the form of dividends
  • 80% of the investment must be made in properties that are capable of generating revenues
  • Only 10% of the total investment must be made in real estate under-construction properties
  • The company must have an asset base of at least Rs 500 crores
  • NAVs must be updated twice in every financial year

How do REIT’s work

  • The REIT industry boasts a diverse profile that offers investors a chance to make investments in real estate-related funds. REIT’s could be classified as Equity REITs and Mortgage REITs.
  • Equity REITs hold properties such as offices, hotels, shopping centres, condominiums and draw most of their revenues through rent from these properties
  • Mortgage REITs look over the financing of the properties that may be residential or commercial, thereby drawing income from interest earned on the investment in mortgages or mortgage-backed securities (MBS).
  • REITs provide quick and easy liquidation of investments in the real estate markets. The growth story of the country depends on infrastructure development which contributes highly to the economy and also the related growth. The idea of REIT backed investments is to ensure the concrete structuring of the real-estate financing industry so that the investments made in the sector are channelised for optimum growth. It is with this purpose that the REIT’s function in India to make industry-backed financing more structured.

REIT funds: Structure Formation and Implementation

The structured formation and implementation of REIT funds, ensure that the investors of all financial capacity get to invest and contribute to the growth and development of the real estate sector. In India, the government is taking necessary steps to ensure the funds reach the real estate sector through citizens’ participation in such funds.

There have been developments in this regard by way of the government passing the Real Estate Regulation Bill. It ensures the rights of the investors investing in real estate development funds. The government also ensured the removal of the Dividend Distribution Tax DDT, associated with the REIT funds which was an obstacle in the implementation of the Real Estate Investment Trusts.

Advantages of Investing in REITs

  • REITs are not as capital intensive as a direct investment in property. Moreover, there are not many profitable investment opportunities left at present.
  • It is easier to invest in real estate using REITs.
  • Compared to direct investment in real estate, REITs have lower liquidity risk.
  • REITs are regulated by SEBI; hence chances of fraud are very rare.
  • These are transparent as they disclose the capital portfolio annually and semi-annually.
  • These offer a relatively higher dividend as approximately 90% of income is paid as a dividend to the REIT investors.

Objectives of REITs

The crux of REITs is to give investors the dividends generated from capital gains that are accrued from the selling of commercial assets. The REIT allocates 90% of its income as dividends to its investor’s. It provides a safe and diversified investment opportunity to get into real estate investments.

  • The REITs are transparent. There is a full valuation of the REIT every year along with a half-yearly audit.
  • Diversification: As per the guidelines, REITs have to invest in at least two projects with the value of one asset comprising 60% of the investment.
  • Low Risk: There is low risk involved in REITs as a minimum of 80% of the assets are invested in revenue-generating projects that are completed. The remaining 20% is allocated to investments in under-construction properties, mortgage-based securities, equity shares deriving at least 75% of income from real estate activities, government securities, money market instruments, cash equivalents, and so on

Types of REITs

Equity REITs

They are owners of real estate properties and lease them to companies or individuals to make money. The income is then distributed among the REIT investors as a dividend.

Mortgage REITs

They are not the owners, but get EMIs against the property from the owners and builders. The earnings are via Net Interest Margin (difference of interest earned on mortgage and cost of funding the loan) which they distribute among the REIT investors as a dividend.

Hybrid REITs

It invests in both Equity and Mortgage REITs.

Difference Between REITs and Real Estate Mutual Funds

REITs and real estate mutual funds are different yet similar as they both offer liquidity and a cheap way to get exposure to diversified and substantial capital real estate assets. Long-term investors have the potential to reap the rewards of dividend income and capital appreciation over a long period. For retail or short-term investors with a low investible surplus, these real estate funds present an opportunity to invest in properties that otherwise may not be feasible to invest in. A real estate fund can invest in a real estate investment trust to offer benefits to investors, making REIT a part of the investment.

  • Real Estate Mutual funds offer wider diversification than the REITs based on the investment strategy and have the benefit of experts and professionals managing their portfolio, unlike the REITs.
  • REITs distribute a higher amount of dividend every year to shareholders or investors than real estate mutual funds.
  • The value of the real estate tends to increase during times of inflation as property prices and rent goes up, thus giving a better return to the REIT investor.
  • REIT or the real estate mutual fund investment should be spread across several real estate categories or funds so as to minimise the risk, and it should not be more than 10% of the portfolio.

The RBI’s proposal to allow banks to invest in REITs will propel a lot of companies to bring in their REITs and get them listed on the stock exchange. REITs have also been approved by SEBI and thus are looked upon as a sure measure by the Indian government to pool in greater investments to India’s realty sector. Once the REITs are up and ready for the investment, we may hope to see an increase in the retail sector participation. 

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