Real Estate Investment Trusts: Diving deep into how this high dividend paying asset class works

a bridge over a river in a city: The 3 Indian REITs own around 86 msf office space across India’s 640 msf Grade A markets in top metro cities. © Provided by The Financial Express The 3 Indian REITs own around 86 msf office space across India’s 640 msf Grade A markets in top metro cities.

By Mike Holland

REITs or Real Estate Investment Trusts are a $2 trillion mature asset class globally and have been a standard part of investor portfolios worldwide for many years. While in India they are considered a relatively new investment, REITs have been in existence for over 50 years across numerous international markets, providing institutional and retail investors with the opportunity to benefit from the growth in commercial real estate. In India, the REIT regulations were set up in 2014 and Embassy REIT was listed in 2019, followed by the subsequent listing of Mindspace Office Parks and Brookfield Office Parks REIT. The 3 REITs have raised over Rs 16,500 crores as primary equity and since then, have touched a combined market capitalization of Rs 59,000 crores. 

The 3 Indian REITs own around 86 msf office space across India’s 640 msf Grade A markets in top metro cities. According to a recent JLL report, India’s net office absorption stood at 4.39 msf in Q2, showing 32% YoY growth in major cities despite the ongoing pandemic. The momentum is likely to continue in top metro cities driven by very strong hiring announced recently by many players in the IT/ITeS sectors. In the early 2000s, India was known as the leading outsourcing destination however, the scenario has changed from outsourcing to captive offshoring with more mainstream analytical work being executed from India than the traditional back-office work. The availability of STEM talent at scale is the key appeal to international companies which support their global businesses from India. By 2025, the revenue generated through Global Captive Centers (GCCs) is expected to increase around $73 billion from $34 billion in 2020 and this augurs well for commercial office space demand in India.

PURPOSE OF REITs

Investing in commercial real estate has been inaccessible to retail investors due to high-ticket prices, illiquid long-term investments, and difficulties in administering and managing significant assets. 

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With the introduction of REITs in the past couple of years, a more stable way to invest in Indian commercial real estate has emerged. REITs allow investors to invest in small lot sizes with a tax-efficient structure, allowing the common man to invest and profit from the commercial real estate sector.

HOW REITs FUNCTION 

REIT investments are a hybrid between equity and fixed income as they provide regular yield through stable distributions along with the potential for steady capital appreciation via increasing value of the underlying property assets.  REIT assets are secured by long term leases with multinational and Fortune 500 companies, delivering a steady, predictable income flow. REITs generate rental income from underlying real estate assets held in the portfolio and out of the total income, a minimum 90% of the cash flows are required to be distributed to investors as per SEBI mandate. 

REITs provide retail investors with an opportunity to invest in Grade A commercial real estate by offering stable returns as quarterly distributions. Since its listing, Embassy REIT has given a 100% payout for 9 consecutive quarters and distributed over Rs 4,200 crores to its unitholders.

REITs can be owned by a broad range of investors as they provide portfolio diversification to investors along with long-term capital appreciation.  With a strong and organized framework, REITs have emerged as a popular asset class investment vehicle. Being tax-efficient for the private investors; rental income received by REIT and distributed to unitholders is treated as a pass-through flow and not subject to income tax.  With SEBI’s recent decision to reduce the trading lot size of REITs to a single unit, REITs have become even more accessible to small retail investors.

POST COVID OUTLOOK

Indian REITs have performed well for many years and have also demonstrated a resilient performance amidst the pandemic due to the high-quality tenant base and underlying assets. Leasing demand is likely to rebound in 2022, given the growth acceleration from sectors like Tech, E-commerce, financial services, research & analytics while GCCs continue to remain at the heart of office recovery. Property consultants report that the next 12-18 months will be very positive for the sector due to the latent demand from record hiring. As per a latest report, hiring in India has increased by 11% q-o-q in Q2 2021, with standout growth in Information Technology (61%), Financial Services (48%), and BPO/ITeS (47%) as the job market begins showing signs of recovery from the second wave. On the other hand, the supply of Indian office space continues to be impacted with over 25% shrinkage in the two-year forward supply since the start of the COVID-19 pandemic owing to labour, material and supply chain challenges. While hiring and growth prospects of office occupiers remain strong, the deferral of leasing decisions and focus on employee vaccinations is giving way to more conversations on new leasing as we move past the pandemic. RFPs for circa 26 msf continue to remain active in Grade A office markets, indicating demand bounce back over the coming quarters.

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In a post-COVID scenario, commercial office space will focus more on aspects like health & wellness, eco-friendly green spaces, open access areas, touchless sensors, and other such aspects. This shift in focus will benefit high-quality total-business ecosystem products provided by Indian REITs. Further, it is clear that the future of office spaces continues to remain bright despite hurdles from the pandemic, as companies in India have now acknowledged that work from home is not sustainable in the long run and are ramping up their back to office plans. Investor sentiment towards commercial office spaces too remains positive and REITs have consistently recorded stable occupancy levels despite the pandemic setback. Backed by long term pre-existing leases and lease extensions from occupiers, the post pandemic future of REITs looks promising.

(Mike Holland is the Chief Executive Officer at Embassy REIT. Views expressed are the author’s own. Please consult your financial advisor before investing.)

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