In this week's FinMail we bring to you the overview of Real Estate as an Investment in India and how it is inaccessible to the layman and then an Investment type that is meant to make the entry in Real Estate Affordable or Cheap.
Humans and Land
Our relationship with land goes back to our evolution days. We have been capturing and using lands for centuries and land have been part of our evolution as well. And because of our Survival and Primitive Instincts, we still have the same relationship with our land. Owning it still gives us an immense sense of pride or security because of the same instincts. And because it has been so included in our evolution and growth of the Human Race altogether, we still can't get enough of land or real estate as such. Acquiring and Buying land has become somewhat difficult in India due to the laws surrounding it so we have moved to acquire already developed buildings and estates on these lands. And thus we have kind of developed an inclusive relationship with Real Estate. We just can't get enough of it. And if we talk about Real Estate and India, it is just the same. India and Real Estate
India has had a long history of land disputes throughout the decades and so on and why not? We love the land and owning it or owning a house is still a dream of many. Speak of an Indian guy and buying a house of his own will find a place in his bucket list and even if we talk about our parents or grandparents, it's the same case. You might know other Investment Products or types (thanks to us too ;)) but if you were to ask your parents or grandparents in this case about their preferred Investment or what is the most important asset that one should own? there are high chances of getting to listen to Property or Real Estate because that has been an old and trustworthy source of generating profits or regular income. Real Estate was an Investment Product that was available to the man and the woman, to the salaried and the businessman, to the owner of a shop, or to the king. But why do we say it was and not it is? Ownership of Land - Survival Motive to Profit Motive
While acquiring lands and lands, and buildings and buildings to satisfy the inner un-evolved Human that still needs to be fed a sense of pride and security, we forgot that Land is a scarce resource and not abundantly available. Suddenly the human race was short of land space available to be captured or owned and thus then started the ultimate economic activity of buying and selling of land and buildings. Suddenly there was profit being generated by selling land and building due to the demand being high and the supply being low. And then slowly and steadily prices kept moving up (because of the supply gap) and one day suddenly boom - a common man was not able to afford a house or land of his/her ownership. And the reality is that a common man can't even think of owning a place of his own at a premium place. Reality is harsh, and we know it is even harsh when we learn that we can't afford a place in metro cities via a game. Real Estate and Vyapar - An Analogy
Almost everyone knows and might have played the Business Game also known as Vyapar. It is the Indian Version of the cool board game in the west called - Monopoly. So let us assume everyone has come across this game Vyapar or Monopoly (yeah we know you are cool) or might have played it in childhood. Some of you also might have played it in lockdown after getting tired of Ludo. So as you know the structure of the game, you keep buying places and building houses/hotels, and the one remaining with the highest positive balance wins. So yeah, if you recall, even in the game, Mumbai and Delhi used to be the most premium belt in the game. You just knew that if you were to drop by that place, you were going to be bankrupt if any other player would have previously bought that place and created hotels on it. So yeah from childhood we know that we need to have a huge pocket to be able to afford a place in Mumbai or Delhi or any other sub-metro cities as well like Ahmedabad or Bangalore. Take a look at the following photo to see the price difference between cities: And if we talk about the prices in real-life as well let's take a look at the prices of places. We researched the per sq feet price of the premium places in Mumbai, Delhi, and Ahmedabad with those being BKC Complex, Chanakyapuri, and CG Road respectively. While we found that Real Estate is so unorganized that one is not able to find a precise market price of any locality, with the price being differed from broker to broker and differing between locality as well from factors like building, direction, floor number, and many different factors as well. These were the ranges of prices per sq.ft of the respective areas: Mumbai - Bandra Kurla Complex (BKC) :- ₹39,219 - ₹64,424 per sq.ft Delhi - Chanakyapuri :- ₹38,420 - ₹63,957 per sq.ft Ahmedabad - C.G. Road :- ₹25,180 - ₹33,052 per sq.ft While you can observe that these ranges are widespread even in the niche locality with prices within BKC having a difference of around ₹25,000. Plus even if we consider the lower ranges, it is the price at which a common man loses his/her vision of actually even believing that he/she can own a place at such a premium price. So it basically means that it would cost a person ₹40,000 to lay his/her handkerchief in BKC of Mumbai. This is humorous and sad as well. What if we remove the 'Money' part in the scenario, for a moment let's say money is not the issue (We know it's even tough to imagine!), complications don't end here. Finding a good tenant, broker, maintenance of the Property, legalities, managing property, and many other stressful activities still form a big part of the problem with real estate. And liquidity is a whole another disadvantage with Real Estate and it is just a pain that hits the chest hard. One bad year in the real estate industry and you have to compromise with the selling price or wait for another year or two to get a better price point. And the issue of liquidity in Real Estate is even the disadvantage that is highlighted the most. But if we consider Real Estate as an Investment, Real Estate has been delivering good returns over and above the Inflation rate persistent in the country. Real Estate has been considered as a good hedge against Inflation and it can also form part of your Alternative Investment portion as well. But with Real Estate being out of the hands of the common man, a solution was to be found. So in the budget of 2014, late Shri Arun Jaitley announced REITs to be legally formed as an Investment Vehicle in India. But what is REIT? What is REIT? REITs or Real Estate Investment Trust can be described as a Mutual Fund of Real Estate. It is a kind of Mutual Fund that deals in Real Estate and generates income and dividends for its Investors from the rent or profit by the sale of the Property. REITs can be described as a company that purchases and operates the Real Estate, generates rents from the owned property, and also provides capital appreciation when selling a property. Real Estate Investment Trusts are funds that manage the portfolios of commercial real estate properties. They lease the property they own and collect rent from the tenant, mostly other corporates. The rent which is the income of the trust is then distributed as dividends amongst the shareholders. If we were to simply understand the structure of REIT and how it operates, Let us assume you with your other 9 friends or family members decide to pool money together and invest in commercial property at CG Road in Ahmedabad or let's say in Infinity Mall in Mumbai. So you all pool your money together and buy a property and then give it on lease to a well-established local restaurant for 10 years. The restaurant pays you a rent of ₹1,00,000 every month. Now every month you receive the rent, and distribute 80% of the money to each shareholder as per their share (let's assume everyone holds an equal share of 10% in this property). So each one of you will take home 8,000₹ every month and the remaining 20,000₹ is kept aside for contingencies and for further future investments. And then after 10 years - let's say you decide to sell this property and buy a bigger property or a property at a more prime location to get the benefit of increased rent. Or there is another option underlying which is to sell the current property and distribute the capital gains. This is how REITs work on the base structure. There are legalities around it but this is the base on which it functions i.e. pool of investor's money is created to invest in commercial properties and they generate dividends by earning rent on the owned properties. The sale profit is also distributed to a certain extent to a shareholder. Typically, this structure of REIT enables an Investor, small or big to possess premium price real estate and generate regular income in the form of dividends and then to increase their capital by an increase in the share price. This way it provides an opportunity of generating a regular income and a capital profit at the same time. This is obviously the same case in owning a property on your own. Legalities Surrounding REITs A REIT Company should meet the following requirements to qualify as a REIT that can be publicly traded and available for all investors.
The entity needs to be structured as a business trust or a corporation.
Be managed by a board of directors or trustees
It should extend fully transferable shares.
Must have a minimum of 100 shareholders.
Less than 5 individuals should not have held 50% of their share during each taxable year.
A maximum of 20% of the corporation’s assets comprises stock under taxable REIT subsidiaries.
A minimum of 75% of investment assets must be in real estate.
A minimum of 95% of REIT's total income should be invested.
Is required to pay at least 90% of the taxable income as a dividend.
Accrue a minimum of 75% of gross income from mortgage interest or rents.
80% of the Investments must be made in properties that are capable of generating revenues.
Only 10% of the total investment is allowed in Under Construction Projects.
Advantages of REIT:
A steady source of income along with a chance of Capital Appreciation: REITs provide you with consistent income in the form of dividends. Also, an increase in prices of properties hold by REIT can provide capital gains.
Diversification: REITs could be a good investment for someone who's exploring alternative investments.
Transparency in dealing: Being regulated by the SEBI, REITs are required to file financial reports audited by professionals. It provides investors with an opportunity to avail information on aspects like taxation, ownership, and zoning, hence making the entire process transparent.
Liquidity & Hassle-Free: Since the REITs are traded on SEBI recognized stock exchanges, it doesn't include paperwork while buying or selling which makes it transfer hassle-free.
Low Entry Fee: Unlike Real Estate, REITs have an entry fee much lesser as compared to Real Estate. This allows almost everyone with a Demat Account to access REIT.
Disadvantages of REIT:
Dilution of Control: REIT does give you the benefit of investing in Real Estate but as it functions like Mutual Fund, the right to choose property remains with the fund manager.
Taxation: REITs being the modern substitute for owning an actual real state, it carries the same taxation as levied on Real Estate properties.
Low Growth Prospects: It is mandatory for REIT to distribute 90% of its earnings as dividends to its investors. The remaining 10% does not allow them to quickly accumulate & explore other properties. Hence REITs are supposed to stick with their current portfolio for a long long time.
Less available alternatives: India is a home of only two REITs as of now, of which one has recently issued its IPO. So there's still a lack of good alternatives to REITs to choose from.
Our Perspective on REIT:
We have totally two different perspectives on REIT's future in India as well as its compatibility as an Investment Option for Retail Investors.
Number 1: The Startup Boom
With India on the road to becoming the next Startup Hub, there are increased chances of demand being boomed up for corporate spaces available for rent. With prices of commercial properties reaching the sky, it is impossible for a startup to be able to afford to buy a working space or office for its functioning and thus startups have more tendency towards renting the available spaces as their workplace. And with companies preferring shifting their hub and manufacturing facilities to India from China, there is also another big potential in the Real Estate business in India. There are only 2 public REITs that are available to the masses and with the potential growing up, many more REITs can be seen in the next few years.
Number 2: WFH
Another strong perspective that holds the future of REITs in India is that by the arrival of the pandemic, we made a technological jump. One of the driving factors of India's growth in Information Technology (IT). IT giants kept their workforce on duty by asking them to work from home. As a result, now companies are looking at it as a measure to cut their cost. Not long ago TCS announced that they will allow 75% of its employees to work from home by 2025. The government is supporting the initiative too by allowing & easing the guidelines to make 'Work From Home' a permanent thing. Internet & IT companies occupy a significant number in renting spaces and if they choose to manage their workforce from any location, space won't be a problem.
They would cut their office space in order to cut the cost & this might slow down the pace of growth of REITs in India.
Sources: Groww, Wikipedia, 99 Acres, Magic Bricks, Various
That is it for this week's Newsletter. Thank you, for being with us. We will see you next week.