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A very different Kind Of Fund - REITs

 

A very different Kind Of Fund





REITs are not exactly the real estate equivalent of equity mutual funds. what they are and why they hold the promise of a regular, inflation-adjusted income.

 

After being discussed for a few years, Real Estate Investment Trusts (REITs) are finally getting off the ground. In this year's Budget, Finance Minister Arun Jaitley announced measures to make these tax-efficient for investors. Within a few weeks of the announcement, the Securities and Exchange Board of India (Sebi) came out with detailed regulations to govern the design and operation of REITs.

However, before we get to the regulations, investors should understand exactly what REITs are and what they aren't. In their simplest form, REITs are the real estate equivalent of equity mutual funds. In the latter, the investor can buy into a diversified mutual fund and leave the actual investment management to the fund manager. The fund manager decides which stocks to buy and sell and when to do so.

In the above description, replace `equity' with `real estate' and `stocks' with `properties' and you have a REIT. However, there is a catch. Equity mutual funds operate the way they do because the stocks they invest in are the ones that are traded in an active and liquid market, and high-quality information about the underlying businesses is widely available. However, none of this is true for real estate.

Therein lies the practical difference between the mutual funds you buy into as investors and what you will get when you start investing in REITs. Indians invest in real estate primarily for capital gains. Our standard model of investing is to buy property which we think will appreciate rapidly, and wait, opportunistically looking for good deals as the price rises.

However, Sebi's regulations treat REITs as an income avenue. They will buy commercial property generating rental income.


They will buy a set of such properties and commit to them for 10-15 years, or even longer. All rental income will be distributed to those who have invested in the REIT. The funds will be closed-ended, so that you cannot realise the value by redeeming it from the REIT manager, though they will be listed on the stock markets, where they can be sold to other investors. When the tenure of the fund ends, the REIT will sell its holdings in the underlying property and distribute the proceeds to investors.

Clearly, Sebi's conceptualisation of REITs is that of the property investor who buys and holds, looking for rental income.

Will this model of real estate invest find enough takers? The idea behind find enough takers? The idea behind Indian REITs is not to create something investors are looking for, but to resolve the financing problem faced by real estate developers and the banks that are funding them. The finance minister actually made this clear in his Budget speech. He said that REITs (and equivalent infrastructure investment trusts), ...would reduce the pressure on the banking system, while also making available fresh equity. I am confident these two instruments would attract long-term finance from foreign and domestic sources, including the NRIs.

The vision is that the real estate developers will use their own funds and those of the banks to create earning assets, and then sell them to REITs, thus freeing funds for further projects. That is the need that the government is trying to meet. Do REITs fulfil a valid investment need for individuals? In my view it does, but not that of the property trader. Instead, they hold the promise of generating inflation-adjusted income. Unlike the other types of income generating funds, REITs' rental income should escalate with inflation. This is a unique quality. One would expect that as these trusts take off, a new category of real estate investors will start appreciating this unique quality.

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