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Income from office property through REIT written by ET Bureau, published in The Economic Times. June 6, 2019

1. What is REIT?

 

A real estate investment trust (REIT) is an entity that owns income producing real estate assets. It can be a private entity or publicly traded. The unitholders of REITs modelled as mutual funds receive a share of the rental income. The income earned from REITs has two components: half is received as interest, while the remaining will be in the form of dividend. The inflows for investors come through different channels to make REIT more tax efficient. The value of the REIT unit traded on secondary market potentially can appreciate depending on profits of the REIT known as net operating income (NOI).

 

2. What kind of investors should look at investing in REIT?

 

REIT offers a return of 8-13 per cent annually.

 

Therefore investors who are looking for stable returns in the medium-to-long term may invest. It offers an important bridge in portfolio allocation for investors to participate in a medium-risk portfolio of commercial real estate, which has a longterm lease agreement with a contractual escalation in place. Longterm revenue visibility and the large ticket sizes have resulted in higher participation from pension funds and also a small percentage in the portfolio allocation of high net-worth individuals. The return of REITs in the US has outperformed that of S&P 500 by a wide margin over the past 20 years.

 

3. What is the most pivotal parameter to evaluate the performance of the REIT?

 

The net profit is not the right measure for the REITs to evaluate financial performance as it includes depreciation, which is typically loss of value of assets such as plants and machinery in the case of manufacturing companies.

 

On the other hand, the value may appreciate when it comes to real estate assets. Therefore, funds from operations (FFOs) is often used to evaluate REITs. FFO is arrived at by adding depreciation back to net income and subtracting the gains on sales. REIT companies often provide three years of financial forecasts, which gives projected profit and FFO.

 

Another parameter is the capitalisation rate or cap rate. It is calculated by dividing FFO with the current market value of the REIT. The cap rate in India is 7.5-8.5 per cent, which is 175-575 basis points higher than Grade A office assets in other global cities.

 

Globally, the spread between the rental yield of REIT and government bond interest rate is keenly watched by investors. The higher spread generates higher investors&rsquo participation.

 

4. What are the investment guidelines for REITs in India?

 

Under Indian regulations, REITs need to invest 80 per cent or more of the total value of assets in completed and rental yield assets. The remaining 20 per cent can be invested in under construction properties, completed but not rent-generating properties, listed or unlisted debt of companies in the real estate sector including unlisted equity shares of companies deriving not less than 75 per cent of their operating income from real estate activity.