Real Estate Investment Trust (REIT) – An Idea Whose Time Has Come

The real estate industry has seen many ups and downs. It experienced bull phase in 2002-2007 and then market crashed all over the world. As a result, Indian real estate sector faced one of the worst crises in last few decades.

 

The market suffered in 2008 too but it came back to a respectable level. However, real estate is still languishing. Growth has been disappointing. Interest rate is high and hence borrowers have postponed their purchases. Builders too have been finding it hard to get loan to start new projects or complete the existing ones.

     

Real Estate Investment Trust (REIT)

Real Estate Investment Trusts are like commercial firms that manage properties. They get their income by renting the properties. It is very popular in western countries. However, it is yet to be introduced in India. There has been discussion among regulators, SEBI, and economists on allowing REIT to Indian market. The decision is not yet taken but the industry expects that regulators will decide on REIT very soon.

 

Investors can buy REIT stocks just like mutual funds. When REITs get income by renting properties, the income will be distributed to investors as dividends.

REITs in USA are mandated to invest only on finished properties. They also have to distribute 90% of the income as dividends to investors. Introducing REIT in Indian market will certainly solve some of the problems real estate sector is facing. This will also enable investors earn profit through small investment.

 

REITs are of three types:

Equity REITs: Equity REITs mainly rent properties and get their income by renting. The rent thus collected is distributed as income to the investors.

Mortgage REITs: They earn income by interest received from borrowers. The borrowers take loan from mortgage REITs and pay back interest. This income is then distributed among investors as dividends.

There can be REITs which are mix of the above mentioned two types.

  

REIT – The time is now

This is the right time to introduce REIT in Indian market. As a matter of fact, this has become a necessity for the following reasons –

Because of slowdown in the economy, banks have become very cautious in lending to real estate. Real estate sector runs on debt. Hence this has beaten down the real estate sector.

 

The interest rate is high and it is not going to come down soon. RBI has shown its willingness to go to any extent to control inflation. There is expectation that RBI will raise the interest rates further. This makes borrowing unviable.

 

Banks lent humongous amount of money to borrowers in bull-run by luring the borrowers with teaser rates. Now that the interest rate has risen, liabilities of borrowers have also gone up. There has been at least 25%-50% raise in EMI. RBI has warned banks that they may face larger NPA. Banks have already been facing larger NPA for last few quarters. This has further reduced lending by banks.

 

REIT will enable investors to participate in real estate sector without investing large chunk of money. It will also provide a powerful option for portfolio diversification. Moreover, REITs income is mainly from properties which are on long term lease. Hence it provides cash flow for the long run too.

REIT will also help real estate firms in reducing some of their cash-crunch problems.

 

REITS’ advantage

REIT is attractive to investors who cannot invest big sum of money in real estate. REIT offers them advantage of benefiting from real estate without investing big amount.

 

This is a good source of regular income as REITs distribute major part of their income as dividends and the income is based on long term leases.

Introducing REIT will do wonders for real estate sector. It will reduce problem of financing. It will create a transparent and robust system of valuation and measurement of real estate properties.

 

REITs by Indian firms

Absence of REIT in India has not stopped Indian companies take advantage of listing in foreign shore for raising fund. Indiabulls is in Singapore. ING has mutual funds that invest in REITs. Apart from these cases, there are many, like ICICI, who want to list REIT companies. These companies will bring them as soon as RBI & SEBI clears the REIT proposition.

   

Finally

Real Estate Investment Trust (REIT) must be allowed in Indian market. Even though RBI is concerned over lack of standard mechanism to assess real estate and transparency issue with the sector, REIT is an idea whose time has come. RBI can make stronger laws to handle mismanagement but not allowing it is not the way to go.

   

The author Pankaj Priyadarshi is a financial consultant and can be reached at pankaj@verticalgrass.com. He is B.Tech from IIT, Kharagpur and MBA from ISB, Hyderabad.