Economics Prelims cum Mains

Getting a piece of realty on paper

The news/Topics

  • The initial public offering of Embassy Office Parks REIT, the first-ever public issue of a REIT recently closed with a good response.
  • The article is about understanding a Real Estate Investment Trust (REIT) and its implications.

 

About a Real Estate Investment Trust (REIT)

  • REITs are investment vehicles that own, operate and manage a portfolio of income-generating properties for regular returns.
  • These are usually commercial properties (offices, shopping centres, hotels etc.) that generate rental income.
  • An REIT works very much like a mutual fund.
  • It pools funds from a number of investors and invests them in rent-generating properties.
  • SEBI requires Indian REITs to be listed on exchanges and to make an initial public offer to raise money.
  • The stockholders of a REIT earn a share of the income produced through real estate investment without actually having to do any paper work to buy, manage or finance property.
  • These companies have to meet a number of following requirements to qualify as REITs.
    • Invest at least 75% of its total assets in real estate, cash or government treasuries.
    • Receive at least 75% of its gross income from rents from real property, interest on mortgages financing real property or from sales of real estate.
    • Pay a minimum of 90% percent of its taxable income in the form of shareholder dividends each year.
    • Be an entity that is taxable as a corporation.
    • Be managed by a board of directors or trustees.
    • Have a minimum of 100 shareholders after its first year of existence.
    • Have no more than 50% of its shares held by five or fewer individuals during the last half of the taxable year.

 

Taxation on income from a Real Estate Investment Trust (REIT)

  • Income tax
    • The dividends paid to the unit holders will be added to the overall income of the investor and will be taxed at the applicable rates.
    • It involves a tax deducted at source component that is 10% for resident investors and 40% for non-resident investors.
  • Capital gain tax
    • If a unit holder sells his/her REIT units on the stock exchange platform then capital gains tax would also be applicable based on the period of holding.
    • If the units are sold after three years, then a capital gains tax of 10% along with applicable surcharge and fees would be levied.
    • Selling REIT units within three years would entail short term capital gains tax of 15% plus surcharge and cess.

 

Benefits of a Real Estate Investment Trust (REIT)

  • Ease of investment:The biggest benefit is the ease of investment as investing in REIT can be done through a demat account.
  • Opportunity to earn: It provides the investor an opportunity to invest in commercial properties that will earn higher rental income, as commercial properties usually earn more rent than residential properties.
  • Dividends: REIT regulations mandate the distribution of 90% of the rental income to unit holders, which provides high profit to the investors.
  • Overall capital appreciation: Besides the rental income, any increase in the value of units will also add to overall capital appreciation.
  • Diversifies investment options: Retail investors can diversify their portfolio by investing in high-end commercial properties and earn rental and dividend income.
  • Transparency and liquidityREIT will bring transparency and liquidity in the real estate segment by allowing domestic and global investors to invest in the sector with regulations.
  • Investor’s interest: The response of investors to the first-ever public issue of a REIT shows that there is investor’s interest in REIT.
  • Overall growth: It provide all investors the chance to own valuable real estate, present the opportunity to access dividend-based income and total returns, and help communities grow, thrive and revitalize.

 

Risks involved in a Real Estate Investment Trust (REIT)

  • Downturn or recession: A downturn in the real estate sector would impact rental income and also, capital appreciation, which could negatively impact the investor’s income.
  • Pressure on rentals: They would be under pressure if the real estate inventory is huge due to lack of demand.
  • Actual exposure: The real estate has been a preferred personal investment option since long for Indian investors and the REIT may not serve the purpose of proving exposure to the investors and may not attract much investment.
  • Regulations: REIT in India currently is at a nascent stage but as the segment evolves, the regulatory environment could be tightened.
  • Litigation and compliance: This sector suffers from a host of litigation and compliance issues like title dispute, environment clearance, state & central laws and political interference, etc. that can enhance the investment risks.
  • Tax burden: The taxes applicable in the form of income and capital gain tax reduce the earnings of the investor and hence the post-tax returns and capital appreciation will be deciding factor in the success of REITs.

 

Concluding remarks

  • The government needs to opt for a balanced approach while regulating the REITs.
  • If the post-tax returns and capital appreciation is a major deciding factor in the success of REITs, the government should re-think on this factor for attracting investors.
  • Tough the real estate has been a preferred personal investment option for Indian investors but it requires a huge amount and REITsprovides option to invest with a small amount, which may attract a huge number of small investors.

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