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Are REITs, real estate mutual funds or equity shares?

In its basic structure, a REIT may look like a mutual fund which is also about pooling of assets, but it’s not quite the same. However, given that its listed-on stock exchanges as a share of a company isn’t it more like investing in equity shares?

You may have heard or read about the recent public offer by Mindspace REIT which was highly oversubscribed by individual investors seeking a long-term allocation. 

A REIT or a real estate investment is a company that owns more than one income-generating real estate asset. In other words, it’s a pool of real estate assets or properties which generate income. This pool is then sold to investors who buy a share of the REIT with the objective of earning a steady income. 

In its basic structure, a REIT may look like a mutual fund which is also about the pooling of assets, but it’s not quite the same. However, given that its listed-on stock exchanges as a share of a company, isn’t it more like investing in equity shares? 

It’s really neither and a bit of both.

You are buying a share not a fund unit

REITs are equity shares on listed exchanges, however, the primary objective of investing in a REIT is not capital gain or price rise. The underlying pool of properties is usually income-generating properties, which means that they earn rental income on a regular basis. 

The aggregate rental income from all the properties is then transferred to shareholders in the form of dividends. These properties are commercial buildings leased out as offices to the private and public sector, leases are long term in nature and there is hardly any short-term change or buying and selling of underlying properties.

You can’t transact in REITs other than on stock exchanges and there is no daily net asset value published, hence, despite the structure similarities, it is not a mutual fund. 

Thus, the primary source of income is the dividend from rentals received by the REIT. However, any change in the valuation of the property itself will also get reflected in the price, but given the nature of the underlying property – a large commercial building(s) – this change is unlikely to be significant in short periods. 

The ability to buy and sell a share of the REIT on stock exchanges makes this a unique real estate income-generating equity share. For the purpose of asset allocation though you must look at it as a real estate investment, not equity. 

You can’t transact in REITs other than on stock exchanges and there is no daily net asset value published, hence, despite the structure similarities, it is not a mutual fund. 

Fits in the steady income side of the portfolio

Thanks to the nature of earnings from REITs, the investment is really akin to a steady income-generating asset rather than one where you are seeking growth and long-term wealth creation. The dividend is paid out on a periodic basis and this can then be reinvested or used to supplement your existing income. 

The commercial leases are usually long term in nature themselves, hence it is thought to be a steady income-generating investment. The recent Mindspace REIT, for example, has a weighted average lease expiry of roughly 5.3 years. Which means that at least for this period, rental incomes at the current rate will keep coming in and this ensures steady dividend pay-outs. 

Like for all assets, the risk of quality is there in REITs too. If the quality of tenants and quality of management of properties are poor, your regular income can get impacted negatively. 

It’s a new product for the Indian market, only two exist as of now. Although, it offers an option to diversify your portfolio, be sure you understand the objective behind the investment before deciding to take the plunge.

 

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