Why investing in REITs makes sense in the current economy

The Real Estate Investment Trust (REIT) is structured like Mutual Funds (MF), in the sense that it allows pooling of investor money to buy a particular asset. Here is how they work and why they offer a number of benefits to investors.

REITs, as the terminology suggests, invest in income-generating real estate assets. The investors benefit by way of dividend-like income and valuations gains in the underlying real estate assets over a period of time. To provide liquidity, REIT units are compulsorily listed on stock exchanges. The two avenues available to investors currently in the listed REITs space are Embassy Office Parks and Mindspace Business Parks.

Embassy Office Parks is India’s first publicly-listed Real Estate Investment Trust (REIT). It owns and operates a 33 million sq ft portfolio of seven Grade A office parks and four city-centre office buildings in Bangalore, Mumbai, Pune and the National Capital Region (NCR). Embassy Office Parks’ portfolio has 26.2 million sq ft completed by area, runs at 92.2 percent occupancy as of June 30, 2020. The portfolio also comprises strategic amenities, including two completed hotels (including the Four Seasons hotel at Embassy One), two under-construction hotels, and a 100MW solar park supplying renewable energy to park tenants.

Mindspace REIT is one of the largest Grade-A office portfolios in India. It has a total leasable area of 29.5 million sq ft out of which 23 million sq ft is completed, with a committed occupancy of 92 percent. The REIT operates five integrated office parks housing 53 buildings in the key areas of Mumbai Region (41.1 percent), Hyderabad (39.3 percent), Pune (16.9 percent) and Chennai (2.7 percent). The REIT enjoys a high-quality tenant base with 85 percent of the rentals generated from MNCs and 39 percent from Fortune 500 companies. It aims at providing integrated office parks by making available amenities such as clubhouse, restaurants, food plazas, outdoor sports arena, etc.

As mentioned earlier, REITs’ main sources of value accretion are mark-to-market (MTM) gains in the underlying real estate assets and the rental income from these assets. The influence of real estate investments on the unit valuation gives it a risk profile similar to the equity asset class and a mandate to make regular payments from the accruals.

The product is not suitable for investors aiming at regular dividend-like income without the accompanying volatility in market prices, owing to the stronger influence of real estate MTM on the valuations. Given the equity-esque risk profile, investors seeking regular income could consider making investments if the correction in valuations push the dividend yield into double digits, where they can also fall-back on the safety net offered by periodic mark-ups in rentals.

At the current juncture, investors intending to take exposure to office real estate space would be advised to do so in a staggered manner. The pandemic related business disruptions can lead to some correction in the real estate valuations and can potentially impact the expected mark-up in lease rentals. The lease rentals could also be potentially negotiated at lower levels that could affect REITs’ periodic pay-outs.

The concerns regarding data security and the efficiencies of working in a close-knit environment should limit the fallout, work-from-home culture by most corporates across industries, on the office real estate over the medium to long term. This, coupled with the limited supply of Grade A offices, should support the two listed REITs. The near-term headwinds, however, warrant a cautious and staggered approach.

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