Recently, Mindspace Business Parks REIT’s initial public offering (IPO) was overall subscribed 13 times. Within that, the other investor category, including corporates, individual investors, non-resident Indians and Hindu Undivided Family, was subscribed 16 times. The issue was received well even though the outlook for commercial properties is not bright. Companies have put expansion on hold, many are laying off employees and most of the staff are expected to continue working from home (WFH) given the covid-19 threat. Tinesh Bhasin spoke to experts to find out if investing in REITs make sense currently
Take exposure when outlook for commercial realty improves
REITs allow investment in commercial real estate with a relatively smaller sum. In addition, they make the process of investing in real estate convenient and more scientific as experts make the decisions on behalf of investors. Investors who took direct exposure to real estate now have an option to diversify their funds into professionally-run commercial space through REITs.
Whether a retail investor should take exposure to REITs or not depends on several factors. An investment should follow a sound asset allocation strategy based on risk profile and investment horizon. It’s prudent to involve REITs in a portfolio along with allocation to traditional forms of investing like equity, debt and gold.
There is this risk with REITs right now that the current occupancy could fall. Retail investors could, therefore, take exposure to REITs later when they are comfortable with the commercial real estate outlook. On the flip side, they may lose yields if the unit price goes up in the meanwhile. But that would also mitigate the risk.
Listing makes REITs liquid and accessible to retail investors
Combining the stability of debt and upside of equity, REITs provide the opportunity to invest in a pool of rent yielding properties and earn a return of 12-15%. Of this, 6-7.5% is fixed (based on rental income) and the balance accrues through escalations.
The listing of REIT makes it liquid and accessible to investors at a small ticket size starting at ₹50,000. Tax exemption on dividend distributions by REITs also makes them attractive. Globally, REIT returns over 10-15 years have been commensurate with equity returns, with significantly less volatility.
Over the last few months, WFH and potential economic impact due to covid-19 have weakened the sentiment around commercial real estate. Despite that, REITs have found favour. Embassy Office Parks REIT as well as Mindspace Business Park have shown strong rental collections in the last quarter. Even as escalations may be questioned, REITs provide a stable 7% post-tax return.
With the collapse in debt returns, REITs provide attractive returns from an asset-backed investment.
The situation is challenging, so retail investors should wait
One of the biggest consumers of office spaces are IT and ITeS companies. They have implemented WFH, which could put pressure on rent. As of now, it doesn’t seem there will be a treatment for covid-19 anytime soon. Corporates are, therefore, going to continue with WFH. Allowing employees to WFH also allows businesses to save cost on office rentals.
Commercial real estate prices are also expected to soften due to lack of demand. No one would be buying or investing in properties and compromising their cash flows in the current situation.
If you look at the typical REIT model, it starts with a limited number of properties. Based on demand, the trust adds more space. It’s when the new properties are constructed and leased out that the real jump in revenues happen. This may not be possible in the current situation.
It’s best for retail investor to wait for some time before including REITs in their portfolio. REIT is a listed product and can be bought any time. Who knows there could be more options available later.
Be selective about location of investment, mind the risks
Retail investors can look at REITs at present and invest up to 10% of their portfolios in it. But they also need to diversify, restricting their exposure to 5% to a single REIT.
This asset class is particularly suitable for investors looking at regular income but there are some things that need to be considered.
However, investors need to be selective about the location of properties in which REITs invest. It is expected that US firms will come to India after the restrictions on H-1B visa, leading to higher demand for office space. They are likely to look for offices in Bengaluru and Hyderabad. So investors need to be mindful of the location.
There is the risk that these could get delayed due to the pandemic. Investors need to see the trade-off. If they enter in REITs at the current prices, they may get a higher yield. Later, the yields may fall if the unit price of REITs rises. At present, REITs are likely to offer around 7.5% returns.
Be mindful of the risk before investing. Anything that gives higher returns than a bank fixed deposit comes with higher risk.
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