XC smallcase Portfolio: REIT
Real Estate Investment Trusts or more commonly known as REITs are “stock market listed investments that allow investors exposure to Real Estate without having to purchase or manage properties by themselves”. REITs are similar to mutual funds in the sense that they allow investors to pool their investments and are managed by an investment professional. However, the difference is that the underlying asset for mutual funds is usually equity, debt, or commodities, or a blend of the three whilst the underlying asset for REITs is real estate holdings.
Traditional real estate has been extremely prevalent in India, with the concept of buying land or a property in the hope of capital appreciation. Despite traditional real estate having its benefits, it does come with its drawbacks. The main issue with traditional real estate is paying a really high price for owning a property or piece of land and the issue that comes with having to manage and maintain the property. This is where REITs come into the picture as investors do not face the same issues that they do when owning and investing in traditional real estate. The concept of REITs in India is in its nascent stages, having been introduced in the last few years. REITs are listed and traded on stock exchanges just like how equity and ETFs are and hence, purchasing REITs via stock exchanges is the easiest way for investors to invest in REITs. Currently, there are five REITs in India: IndiGrid InvIT Fund, Mindspace Business Parks REIT, Embassy Office Parks REIT, Brookfield India Real Estate Trust, and IRB InvIT.
There are several benefits and limitations of investing in REITs. The most obvious benefit is diversification. REITs allow investors to diversify their investment portfolio through exposure to real estate without the hassle of actually owning and managing a physical property. By investing in real estate through REITs, an investor can go beyond the traditional asset classes of equity, debt, and commodities and further enhance their asset allocation strategy. Below is a correlation matrix that has returns of equity, fixed income, commodities, and real estate ETFs. The two real estate ETFs (SCHH and REET) are real estate ETFs of the U.S. REIT and Global REIT market. Due to a lack of data for Indian REITs, their historical data could not be used in the correlation matrix. What we can see above is that REITs have a low correlation with equity (VT, SPY, VEA, VWO, and FM), fixed income (FIXD, VCIT, GOVT, IBND, IGOV, CEMB, EMB), as well as commodities (PDBC, GLD). Hence, we can see above that REITs are a great addition to a portfolio since they have a low correlation with other asset classes and provide diversification benefits. A low correlation amongst two asset classes or investment vehicles means that they tend to move in opposite directions. Hence, the lower the correlation between two instruments (i.e. the closer the value to zero) the better it is from a diversification perspective.
Another really added benefit is that REITs allow investors to make small investments. With traditional real estate, if you want to buy land or a property, you have to buy the whole space and that is very costly. However, with REITs, you can buy units with investments of around Rs. 50,000, significantly lower than traditional real estate investments. Furthermore, since REITs are professionally managed by fund managers, the investor need not worry about anything. Traditional real estate, on the other hand, requires one to manage the property and that leads to additional costs. In addition, REITs generate regular income from rent and as per SEBI guidelines, they are required to pay 90% of this rent as dividends and interest payments to investors.
Despite having several benefits, REITs do have their drawbacks. The first is that there are only a handful of REITs available in India at the moment. As mentioned earlier, there are only five REITs available in India at the moment and the asset class as a whole is in its rudimentary stage. Another issue with REITs is low liquidity. Since the number of market participants is relatively low compared to investments in equity, fixed income, and commodities, investors, especially retail investors can face the risk of low liquidity. Lastly, just like with equity investments, dividends from REITs are also taxed.
There are ample reasons why one could possibly invest in REITs. As discussed earlier, the most important reason is to diversify one’s investment portfolio through exposure to real estate without actually having to face the hassle of owning and managing a property. Other benefits as indicated above involve professional management of the fund (REIT) and a relatively smaller size of the investment compared to traditional real estate investments Despite REITs providing several benefits to investors, they do come up with a few drawbacks. The most essential ones include only a few different REITs, lack of liquidity, and being taxed on dividends received. REITs are still in their early stages in India and the space is only expected to grow as investors get more familiar with them. As an investor, one should consider investing in REITs depending on their current asset allocation across different asset classes such as equity, debt, and commodities and whether the investor is looking to add in another asset class, i.e. real estate to their investment portfolio.
Resources:
https://www.etmoney.com/blog/everything-you-need-to-know-about-real-estate-investment-trusts-reits/
By Arhan Parikh (arhan.parikh@xumitcapital.com)
