On 12 September the Securities and Exchange Board of India (Sebi) allowed REITs, earlier considered hybrid instruments, to be classified as equity instruments by mutual funds. The move is aimed at deepening the market and aligning it with global standards. It is expected to increase the demand for REITs – both from active equity funds and from passive funds as REITs become part of benchmark equity indices.
REITs are gaining traction in the mutual fund industry for their ability to provide regular cash flows. “We invest in REITs primarily due to their ability to generate consistent operational cash flows through rental income. These rental agreements have built-in contractual escalations, which help mitigate inflation,” said Raj Mehta, executive vice president and fund manager, equity, PPFAS Mutual Fund.
This, combined with their potential for capital gains, make REITs a tempting investment. However, it’s important to understand that while the financialisation of real estate makes it more convenient for investors, the underlying asset is still real estate, so proper asset allocation is needed.
Kalpesh Ashar, a certified financial planner, said, “I don’t recommend allocation to real estate as part of an investment portfolio. But if someone wants exposure to real estate, REITs can be a good option. One way to do this is to invest in multi-asset allocation funds that invest in REITs.”
Read on to know more.
What is a REIT?
Think of a REIT as a mutual fund, but one that invests in real estate rather than stocks or bonds. At least 80% of the real estate it invests in must be rent-generating. Most REITs in India primarily own grade-A office spaces, with the exception of Nexus Select Trust, which mainly owns shopping malls.
After deducting expenses from the total rent collected, a REIT must distribute at least 90% of that amount, called the net distributable cash flow, to unitholders. All REITs in India do this every quarter. REITs are regulated by Sebi, and you can buy units just as you buy stocks – via your trading account.
How have Indian REITs performed so far?
REITs, which are relatively new in India, have offered regular albeit varying periodic income to their unitholders and have already seen some ups and downs.
The period immediately after covid saw uncertain demand for office spaces, affecting REIT prices negatively. India’s first REIT, the Embassy Office Parks REIT, was launched in March 2019 and saw its price fall 29% from 1 March 2020 to 1 March 2021.The price of Mindspace Business Parks REIT (Mindspace REIT), which was listed in August 2020, had shed 6% by the end of first year. But REITs have more than recovered (see graphic for returns data) since then as people have gradually returned to offices and interest rates have fallen.
Based on FY25 numbers, REITs have provided pre-tax distribution yields (distribution per unit divided by the current market price) of 4.7% to 5.5%. Note that REIT prices shot up 6-13% after Sebi’s 12 September decision to classify them as equity instruments, which impacted yields. But distribution isn’t the only thing that matters. Movements in REIT prices, as with stocks, can result in capital gains or loss for investors. Data from Sanctum Wealth shows that all REITs in India have offered compound annual total returns (distributions plus capital gains) of 16.7% to 24% over the past two years. But the golden rule of stock investing applies to REITs as well – the past is no predictor of future returns.
Because of this, Mehta said, investors eyeing REITs must have an investment horizon of at least 3 to 5 years. “For capital gains to play out, investors need at least a five-year horizon,” added Alekh Yadav, head of investment products at Sanctum Wealth.
Do REITs have a place in your portfolio?
Yadav said REITs can be considered as an alternative to yield-generating products. “In a low-yield environment, the demand for REITs goes up. They may be a better option than bonds and debt funds on a post-tax basis, with slightly higher volatility,” he added.
How much should investors allocate to REITs? Yadav suggested a 5% share for do-it-yourself investors and 10% for those who rely on financial advisors. Vaibhav Porwal, co-founder at Dezerv, a wealth management firm, recommended a 15-20% allocation to REITs within an investor’s debt portfolio.
You can invest in REITs directly or via mutual funds. If you wish to have a small exposure, the mutual fund route is better.
What are the tax implications?
REITs score over debt products such as bonds and debt funds on a post-tax basis. Interest income from bonds is taxed at your income tax slab rate. Following a change in their taxation, any capital gain on debt funds bought on or after 1 April 2023 are also taxed at your slab rate.
Taxation of REIT distribution, on the other hand, depends upon its nature – whether it was received in the form of dividend, interest, or repayment of debt. All REITs disclose this breakup on their websites.
While the interest is taxed at the unitholder’s slab rate, dividends are tax-exempt if the tax has been paid at the special purpose vehicle (SPV) level, which is a common practice currently. The repayment of debt is taxed as capital gains when you sell REIT units. Capital gains from REITs are taxed as equity (see graphic for tax details). An SPV is a separate legal entity, typically a company, created by the REIT to own and manage the actual income-generating real estate assets, allowing for risk isolation and specific tax treatments.
So, should you invest?
Porwal said the performance of REITs is deeply linked with interest-rate and economic cycles, so if investors invest at the wrong end of the cycle, they may face capital depreciation and lower distributions.
But today, there are some positives for REITs. “Many companies are setting up data centres. With US President Donald Trump’s protectionist behaviour resulting in more offshoring, the demand for GCCs (global capability centres) is expected to increase further. These are very strong tailwinds for REITs,” said Porwal.
There is a also significant negative, though. “About 70-80% of the occupants of REIT properties are IT/tech companies. The broader slowdown in the IT sector is therefore a risk,” Porwal added.
For now, it may be best to stick with your existing allocation, given the recent run-up in REIT prices. If you’re hell-bent on them, it’s best to start small.