Saturday, August 23, 2014

HOW CAN YOU BUY PROPERTY FOR Rs 2 LAKH ? REITs TO HELP INVESTORS

Coutresy : Economic Times




If you have Rs 2 lakh to invest, your bank may roll out a red carpet, your stock broker may inundate you with hot tips and the friendly neighbourhood jeweller may even offer a discount on making charges. However, you will probably get laughed out of the estate agent's office. Not anymore. With Sebi issuing final guidelines for real estate investment trusts (REITs), you will soon be able to get a piece of the action in the property market with as little as Rs 2 lakh.

REITs are just like mutual funds, but instead of using the money collected from investors to buy stocks and bonds, they invest in property. After more than a decade of discussions, this unique form of mutual fund is finally taking shape in India. Last month, the Union Budget removed an important hurdle by giving pass-through taxation status to REITs.
Last fortnight, market regulator Sebi issued final guidelines for REITs, settling several of the concerns raised by the real estate industry. Industry watchers claim that the launch of REITs will increase the flow of funds to the cash-starved real estate industry. "Even if half of the currently available Grade A office space gets converted to REIT and is listed in the next 2-3 years, it can mean an inflow of Rs 60,000-72,000 crore," says Anuj Puri, chairman and country head, JLL India.

High entry barrier

The problem with real estate as an investment is that it either occupies no place or a lot of it in a portfolio. Whether you invest in a residential property or commercial space in a metro or tier I city, the minimum investment is normally upwards of Rs 30-40 lakh. Sebi's guidelines for REITs have pegged the minimum investment at Rs 2 lakh, which will allow retail investors to participate in the real estate market. In the secondary market, the minimum holding could be even lower at Rs 1 lakh. "REITs allow even middle income individuals to invest in real estate. Without this, they can't participate in real estate because of the huge entry barrier," says Keki Mistry, vice-chairman and CEO, HDFC. The low ticket size means that investors can diversify their portfolios by including real estate without investing huge amounts in the asset class.
The high entry barrier is not the only problem with investments in real estate. With no real estate regulator in place, individual investors are at the mercy of politically connected builders in India. If, however, they invest in a REIT, they will be able to join hands and get bargaining power against the real estate developers.
The other benefit that REITs offer is diversification. When one invests in a real estate project, the returns are dependent on how well that project is received in the market and the rental income it is able to command. On the other hand, REITs invest in several projects and, therefore, provide the benefit of diversification to the investor. With a low entry barrier of Rs 1 lakh in the secondary market when units are listed, an investor can spread his investment across 3-4 REITs launchThe liquidity offered by REITs is another positive feature of this mode. Real estate is an illiquid asset, and selling a property can take weeks, even months, but REITs will inject liquidity into the investment by listing the units on the stock exchanges. The day is not far when one will be able to buy and sell property at the click of the mouse.

REITs also generate a regular flow of income which could move up in tandem with inflation. This explains why REITs are a hit in most developed markets. "Around 40% of the global alternative investment assets is through REITs," says Anshu Kapoor, head of Global Wealth Management, Edelweiss.

How attractive is the investment?

While Sebi has given the go-ahead to REITs, right now they can invest only in commercial real estate. This narrows the scope considerably because most of the action in the sector is in residential real estate. Even in commercial projects, 80% of the investment must be in rent-earning projects. The balance 20% can be in other assets, including projects under construction (restricted to 10% of the total REIT assets), listed or unlisted  debt of real estate companies, equity shares of real estate companies having 75% income from realty activities, government securities and money market instruments.

Though some may see this as an unnecessary restriction (investors should have the freedom to select the place where they want to invest), the straitjacket of rental yielding projects is actually a blessing in disguise. First, there is major difference between rental yield from commercial and residential properties in India now. "While the rental yield on commercial property is slightly lower than the interest rate, the one on residential property is very low. So REITs will not work in the residential market now," says Mistry.

If the rental yield from commercial projects is less than the prevailing interest rate, why should one consider investing in REITs? "The rental yield is not very attractive now, but is expected to rise in the future," says Ujwala Rao, national director, capital markets, JLL. Besides, there is always the possibility of capital appreciation that will push up the NAV. "REIT will not only provide opportunity to earn regular rental income but also capital appreciation on such assets along with liquididity of listed market," says Sharad Mittal, director & head, real estate fund, Motilal Oswal Real Estate.
Bottom of the cycle

Still, there are several factors that investors need to keep in mind. As of now, the commercial real estate market is in doldrums. "In several pockets, the price of commercial real estate is around 30% cheaper compared to residential real estate," says Kapoor. Though there is an escalation clause in most commercial real estate projects, it is a users' market and, therefore, they are able to renegotiate the rents downwards.
This also means that commercial real estate is reasonably priced right now. There is a greater scope for appreciation. As the economy picks up momentum and commercial activity increases, things are likely to improve in the coming years. "This is the time to get into commercial real estate because it is at the bottom of the cycle," says Kapoor. Other experts join the chorus of optimism. "For the REIT to work, you need a buoyant real estate market. Nothing much had been happening in the past 3-4  years, but things have started picking up now," says Mistry.

"Commercial real estate is linked to economic recovery. Rentals may remain under pressure for the next 12-18 months given the oversupply, but with the speed of supply moderating in the coming years, the situation should improve if we get back to the economic recovery mode," says Mittal. The huge commercial real estate projects that were launched between 2005 and 2008 are being delivered now. With the builders facing financial stress, the supply of fresh real estate has moderated in recent years.
Taxation of REIT income

This was the biggest bone of contention for REITs. The recent budget offered some relief when the finance minister announced that REITs will be a pass-through vehicle. In the earlier structure, both the trust as well as the investors had to pay tax. Now, the trust will not pay tax on income. Only the investor will be taxed when he gets the income or sells the units. However, experts warn that this passthrough benefit is not applicable to all types of incomes from the REIT (see table) "The pass-through benefit is only for interest income earned by the REIT from its special purpose vehicle (SPV). As of now, there is no pass-through for rent or other income received by the REIT from property directly held by it," says Sriram Govind, core member of the international tax team, Nishith Desai Associates. He says the REIT has to pay corporate tax on such income earned by the SPV. Similarly, the REIT will also have to pay capital gains tax on sale of shares of the SPV. There is also no relaxation on the dividend distribution tax on payouts by the SPV to the REIT," says Govind. Though the dividend received from the SPV is tax-free for the REIT as well as the investor, the SPV would have already paid corporate tax and dividend distribution tax on such income. Factor this tax into the calculation of returns from REITs.
Though the dividend distribution tax is a prickly problem, what more than makes up for it is the treatment of capital gains from the REIT. Since there is a securities transaction tax (STT) on the listed REITs, the longterm capital gains will be tax-free while short-term capital gains will be taxed at a concessional rate of 15%.

However, you need to hold the REIT units for at least three years to qualify for longterm capital gains. In addition, the investor has to pay tax on part of the  income received during the period. "The listed pass-through vehicles are at a tax disadvantage," says Feroze Azeez, director, Investment Products, Anand Rathi Private Wealth Management.
Since some of the income from the REIT will be tax-free and some other will be taxable, the big question is, how will investors know the difference? "There will be some reporting mechanism and the break-up will come at the time of income distribution from the REIT," says Rao of JLL.

Interestingly, REITs offer a better deal to NRIs on the tax front. The withholding tax for them is only 5% compared to 10% for resident Indians. And the amount received may be tax-free for them, at least in  most countries, while the Indian investors have to pay tax based on their slab rates. If the NRI has to pay tax on the income in the country of residence, he can claim this 5% as a rebate.

What are the risks?

The biggest risk can come in the form of developers keeping their prime rent-earning properties and dumping their not-so-good assets on REITs. Though there will be professional valuers, the real estate market is notorious for its opacity. It is still a builder's market and the investors don't have any access to the valuation process. Though the introduction of REITs is expected to improve the situation, the lack of transparency and the black money component in the real estate deals is another possible risk. Finally, there may be stable regular income, but the capital appreciation or depreciation depends on the market price of commercial real estate and, therefore, will be volatile.

Sebi's guidelines for REITs is only the first step. There are bound to be teething problems when the market starts functioning. However, this has paved the way for a more vibrant market for real estate. If you want to invest in real estate but don't have deep pockets, you can consider REITs as the vehicle that can take you there.

40 comments :

  1. Dear vp
    Thanks a lot for a great insight on reits ...

    ReplyDelete
    Replies
    1. I just reproduced it , credit goes to the original author and the publisher ET

      Delete
  2. Dear VP Sir,
    Very Good Morning, i have gone through above article of yours and apparently i found it quite interesting and will be full of roller coaster at initial stage of it. Thanks a lot for adducing such a infallible guidance and i express my gratitude for the same.
    Sir i always consider your valuable picks and do invest in it, but i have two stock Va Tech Wabag and Shanti gear, can you please give your perspective on this stocks.

    Rgds,
    Ajay Singh.
    Mob.No.9909978100

    ReplyDelete
  3. Dear VP,
    Recently, I glanced this article in Ecomonic Times and not getting convinced about this investment.The same article is verified by you and posted here. It means there is value in REITs. Can you please provide your views and suggestion on this article. After seeing this article at this blog, I am under impression that there is potential value at REITs.
    Veera Brahmam

    ReplyDelete
    Replies
    1. Since this is a new instrument ,just posted it to get a basic awareness to my readers

      Delete
  4. Just got link to your blog.....great posts...thank you very much..

    ReplyDelete
  5. Dear VP,
    Thank you for sharing the information.

    Sir, I would like to have your views on Snowman Logistics IPO.

    ReplyDelete
    Replies
    1. I wonder how many times people ask the same question repeatedly!!! Can you not check the comments of the recent posts?

      Delete
  6. Asian granito stock reached 52 high and is rocking.. thank you for all your insights.... am still holding on to it.. As you mentioned its a dark horse for sure......

    ReplyDelete
  7. Sir, whats your view on IFGL Refractories.. Whether it will be multi bagger and can one enter at CMP.?

    ReplyDelete
    Replies
    1. Already turned as a four bagger for my old readers .This stock recommended @ Rs.49 in the below link. At CMP neutral on it

      http://value-picks.blogspot.in/2013/11/ifgl-refractories-ltd-improving-business.html

      Delete
  8. Thanks for the info....

    ReplyDelete
  9. Dear VP ji, i bought RS software and it is up by about 50% from then. Should i exit now..?

    ReplyDelete
  10. Hi there is a news from RBI that plastic notes will be introduced from 2015......will it help Bilcare...kindly advice.

    ReplyDelete
    Replies
    1. Earlier company officials met RBi officials to use its non clonable ID technology to prevent fake notes .Let us wait and see.

      Delete
  11. Dear sir, please share your views on premier explosives and Anant Raj
    pls......

    ReplyDelete
    Replies
    1. Not tracking Anant Raj

      Premier Explo already gained 100 % from recommended level , now neutral on it

      http://value-picks.blogspot.in/2012/07/premier-explosives-ltd-buy.html

      Delete
  12. Dear VP,
    GAP recently announced that it's foraying in Indian market with Arvind Mills. Also Arvind Mills recently re-stratized its approach by coming up with its own e-commerce platform and also new brick and mortar stores....given the fact that it already owns many Intl brands in India and now these new initiatives, woukd like to have your views on it. Please do respond.

    Thanks,
    Rc

    ReplyDelete
    Replies
    1. If promoters are ready to give some consideration to the minority share holders too , it is Ok

      Delete
  13. Dear Vp, wats your take on Responsive Industries (in case tracking) & can you through some light on company's decline in share price 24th june onwards..

    ReplyDelete
    Replies
    1. Not tracking this stock

      I prefer Mayur Uniquoters from related industry.

      Delete
  14. What is your view on Kesar Terminals and Infrastructures?

    ReplyDelete
  15. I like to subscribe value picks . Pls send detail to my mail id - selvamsathiya@gmail.com

    ReplyDelete
    Replies
    1. Not providing any personalised service.

      Delete
  16. Sir,....waiting for your weekend recommendation..

    ReplyDelete
    Replies
    1. Updating on First and Third Saturday's

      Delete
  17. Dear VP, Please share you view on Innoventive industries in case you track the same? CRISIL had a fair value of Rs 29 in Aug-2013 report but they seems to be tracking it any more. It was in Forbes 200 best company list a year ago. But company had been posting loss for couple of quarters and many resignations in director board. Are they into good business?

    Also please tell us your view on Radico Khaitan? Is it having multibagger potential (given liqour business is tabboo in india) for next 5-10 years?

    ReplyDelete
    Replies
    1. Performance of Innoventive Ind is very poor in recent times.

      Not tracking Radico Khaitan

      Delete
  18. Please share your view on agree rayalasema high strenth hypo I think huge growth prospects are three

    ReplyDelete
    Replies
    1. It is in a cyclical industry, so entry and exit time is very important.

      Delete
  19. pls share your view on sequent scientific at current level

    ReplyDelete
  20. Dear vp sir your view on jenburkt pharma

    ReplyDelete
    Replies
    1. This stock already recommended @ Rs.83 , which is currently trading around Rs.250 . At CMP ,neutral on it..

      http://value-picks.blogspot.in/2010/10/jenburkt-pharmaceuticals-ltd-buy.html

      Delete
  21. Dear VP,
    Your views on HSIL HIL and Meghmani Organics - if u r tracking it.

    ReplyDelete
    Replies
    1. Positive on HSIL ,not tracking others

      Delete
  22. *
    Please if you could throw some light on the land bank of control print and its valuation and how it can change the future valuations of the company..moreover what is your future outlook and fair value for the company based on its distinguished position in the industry.

    ReplyDelete
  23. Hello VPji,
    What is your take on Jyothy lab

    ReplyDelete

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