REIT vs Physical Real Estate: Which one is a better investment option for you?

REITs (Real Estate Investment Trusts) are modeled after mutual funds. They collect or rather pool investments from retail and institutional investors and use them to hold and operate income-generating commercial assets. REITs are required to distribute 90% of the taxable income to their investors, either in the form of dividends or interest, or both. REITs are mandated by SEBI to invest 80% of their fund into income-generating assets.

In the past, higher ticket sizes have stymied investments from smaller retail investors into commercial assets. Meanwhile, REITs can systematically dismantle the disparity and enable smaller investors to get exposure to income-generating commercial asset classes such as Grade-A office spaces, retail properties, etc. There are presently three listed REITs in India and a few are in the pipeline.

REITs vs Real Estate: Risk Assessment

REITs are emerging as an alternate investment platform for real estate. They are gaining popularity and are touted as a step towards democratizing commercial real estate investment. However, believing that one day they will replace actual real estate might be far-fetched.
No matter, how much some real estate & financial market pundits claim REITs to be risk-averse, the ground realities are contradictory. REITs contain a definite amount of market as well as operational risks. There is an inherent risk of late operationalization of REIT assets due to legal hurdles. Similarly, there is a possible risk of slow offtake or low occupancy that can soften the potential returns.

Also, one has to factor in the pandemic, before evaluating the future of REITs, which mostly invest in commercial assets. In the wake of the Covid-triggered crisis, most of the large enterprises are operating from home, which may affect occupancy in near future.

Elevated Yields in Commercial Realty Investment

REITs generally give returns in the range of 5-6% and are a seemingly better alternative to invest than residential properties. In India, rental yields from housing are low and are pegged at around 2-3%. However, there are special real estate options that can give much higher ROI, roughly in the range of 8-11%, outflanking REITs in terms of income generation.

Research suggests numerous commercial assets such as prime office locations, co-living properties, and co-working properties can give ROI to the tune of 6-11%. Likewise, with the demand for retirement and rental homes soaring after the pandemic, such assets are also becoming very lucrative.

Moreover, while owning property directly, one is better equipped to make capital gains. If the intent is not to make quick returns and one can hold the property for a long haul, the chances of appreciation are tremendous. REITs also have capital gain options. However, since there is no direct control over the property, it is limited.

Real Estate has Edge Over REITs

There is a visible growth in REIT’s popularity over the past few quarters. With a few more REITs set to join soon, it might emerge as a popular alternative asset class, drawing retail and institutional investors alike.

Nevertheless, the perspective that it is a more prudent investment option than directly buying real estate might be flawed. In India, ~ 84% of household income is invested in real estate (RBI research) and their dominant position will largely remain uncontested. (Gold is a distant second with 7% investments, while financial markets receive around 5%.)

Smart investments in real estate backed by solid research can help in mitigating risk alongside posting higher ROIs than REITs. Moreover, there are numerous other benefits to real estate such as tax exemptions and using it for collateral.

Real estate is a physical asset and hence is less volatile. It gives a certain degree of stability that REITs can’t match. Likewise, when required, they can also be used for personal purposes, something which is not possible with REITs.\

(By Atul Goel, MD, Goel Ganga Group)