REIT or a Real Estate Investment Trust is an entity created with the single purpose of directing investible funds towards operating, financing or owning real estate that can produce income. REITs operate pretty similarly to mutual funds and provide investors with the perfect inroad into the real estate investment space. REIT is a security category that delivers regular income, long-term appreciation and portfolio diversification for all types of investors, no matter how big or small they are. REITs are listed on the stock exchange like any other security.
REITs are over 50 years old and were first devised in 1960 in the United States under the Cigar Excise Tax Extension Act. The first REIT was listed in 1965 on the New York Stock Exchange. In the coming years, similar real estate investment instruments appeared on Japanese, Australian and European stock exchanges. In India, SEBI introduced REITs in 2007, which were finally approved in 2014.
How does a REIT operate?
REITs typically collect money from institutional and retail investors and deploy this money in real estate assets. These real estate assets are those that can generate rental income regularly, such as commercial assets like shopping malls and offices. REITs in India have become exceedingly popular because it is almost a given that real-estate assets will generate income. And with the real estate market on the rise and valuation appreciating, REIT is preferred to investments in other asset classes. There are two categories of REITs – equity and mortgage.
Real Estate Investment Trusts play a key role in fuelling the development of an economy as they enable dormant investable money to be channelled to apartment complexes, schools, hospitals, and other such infrastructure projects.
Pros of investing in REITs
REITs have many pros for interested investors and are, thus, a widespread investment strategy for many individuals and institutional investors. Here is why:
Low Barrier to Entry
Any investor with a brokerage account can invest in a REIT, no matter how small or large they are. They just need to have enough funds to be able to afford one publicly traded REIT share. For investors with limited capital to invest, REITs are the perfect in-road into the real estate market to earn passive returns.
When an investor puts their money in a REIT, it ensures they have a diversified portfolio of real estate assets. REITs help expand the investor portfolio beyond traditional stock markets instruments like ETFs and mutual funds. The REIT asset class itself offers investors diversification options by focusing on specific real estate assets such as healthcare and retail, areas which are not exposed via other investment asset classes.
Like any other real estate investment, REITs assure capital appreciation over time, generating promised returns for shareholders. According to an industry association, Nareit, every REIT in the FTSE Nareit REIT index has given a return of 9.09% YoY from 1972 and 2022.
As per the IRS rules, REITs are obliged to pay at least 90% of their profits and income in the form of dividends. This means that this investment will have high dividend yields compared to other investment types.
No Corporate Tax
If the REITs are in line with IRS rules, they are entitled to claim special tax treatment, which means they are not taxed at the entity level. The profits and income are passed to the shareholders and taxed at an individual level, thereby driving higher returns by preventing double taxation.
REITs are an ideal source of generating passive income for their investors on their investment. After making an initial investment, the investor needn’t do anything to earn a return on their capital. This offsets the need to own, manage and maintain real estate properties that generate income. For instance, if you get an apartment or retail space from a leading real estate developer in Navi Mumbai, you will have to furnish, maintain, and manage it to yield regular rental income. REIT does not require any extra effort from your end.
Cons of investing in REIT
Dividend is taxable
It’s vital to know that REIT dividends are subject to income tax and are taxed like ordinary income. A sizeable investment means high taxes.
REITs raise debt to buy their assets and source the debt from a broad group of lenders. Regarding the debt structure, REIT share prices are susceptible to interest rate fluctuation, especially when they rise.
High Fees and commissions
Investors should know that non-traded REITs can have high sales commissions and up-front fees. Non-traded REITS have annual management fees that put a dent in the final return for the investors.