A Real Estate Investment Trust (REIT) is a company that owns or finances income producing assets such as commercial, industrial, residential and hotels properties. REITs are similar to mutual funds. While mutual funds provide for an opportunity to invest in equity stocks, REITs allow investors to invest in income generating real estate assets.
History of REITs
REITs were created in the United States after President Dwight D. Eisenhower signed Public Law 86-779, sometimes called the Cigar Excise Tax Extension of 1960. The law was enacted to give all investors the opportunity to invest in large-scale, diversified portfolios of income-producing real estate in the same way they typically invest in other asset classes – through the purchase and sale of liquid securities.
The first REIT was American Realty Trust founded by Thomas J. Boyhill, cousin of Virginia U.S. Congressmen Joel Broyhill in 1961. Since then more than 35 countries around the world have adopted REIT legislation and over 1000 REITs worth $1 Trillion are listed on global stock exchanges.
How does REIT Work
REITs raise funds from a wide pool of investors and directly invest them in acquiring or constructing income generating real estate properties such as offices buildings, residential apartments, shopping centres, hotels and warehouses. REITs are listed in stock exchanges so that investors can buy units in the trust. Rental income generated from REITs real estate assets are distributed to investors of REITs as dividends.
Below image will help you understand the industry cycle of REIT.
In India a REIT must:
- Be registered as a Trust under the provisions of the Indian Trusts Act, 1882 and managed by a board of trustees.
- Is publicly listed on a major stock exchange.
- Invest atleast 80% of its total assets in completed real estate.
- Derive at least 90% of its gross income from rents from real property, interest on mortgages backed securities or from sales of real estate. (Didn’t find a clarity on this from SEBI draft 2016)
- Distribute at least 90% of its taxable income in the form of shareholder dividends each year.
Types of REITs
There are two primary types of REITs: Equity REITs and Mortgage REITs.
(1) Equity REITs: They are real estate companies that acquire commercial properties and lease the space in the structures to tenants. (As per the SEBI draft, it is mandated to have at least 80% of the value of the REIT assets in completed revenue generating properties. Balance 20% can be in under-construction assets or mortgage backed securities.)
(2) Mortgage REITs: They invest in real estate mortgages or mortgage-backed securities, earning income from the interest on these investments, as well as from the sales of mortgages. (This type of REIT is not allowed in India by SEBI.)
Benefits of Investing in REITs
REITs are probably the safest and most lucrative alternate investment class for investors. It allows investors to invest in rent yielding high quality commercial assets which is usually very expensive and beyond the reach of retail investors. The minimum investment required in a REIT is Rs. 2 Lakh compared to few crores if you have to buy similar high grade real estate. On top of it, unlike investment in physical real estate, investment in REIT is as liquid as that of in stocks!
Source: National Association of Real Estate Investment Trusts (NAREIT)
Taxation in REIT
- Dividend Distribution Tax (DDT): The Finance Budget of 2016 proposes that any distribution made out of income of SPV to REITs and infrastructure investment trusts having specified shareholding will not be subjected to any DDT. It is exempted for unit holders and REIT.
- Capital Gains Tax: (a) Capital Gains earned by REITs on the sale of shares of SPV are taxable for REITs as per the applicable capital gains tax rates; (b) Long Term Capital Gains earned by unit holders on the sale of units of REITs is exempt for the unit holders. Short Term Capital Gains is taxable at the rate of 15%; (c) Capital Gains earned by sponsors on the sale of units of REITs/ swap of SPV shares with REIT units is exempted.
- Interest from SPV: The Interest amount is exempted from tax for REITs and is taxable as income for unit holders.
- Other income: Any other income is taxed at maximum marginal rate for REITs and is exempted for the unit holders.
SEBI REITs Guidelines
You can read about the proposed structure of REIT by SEBI here.