REITs: A lucrative addition to an investment portfolio

Real estate investment trusts (REITs) are a key consideration when formulating any equity or fixed-income portfolio. Let us understand why they provide greater diversification, potentially higher total returns and small overall risk.

A 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. REITs, as the terminology suggests, invest in income-generating real estate assets. The investors benefit by way of dividend-like income and also by valuations in the underlying real estate assets over a while. 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. 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 Delhi NCR. Embassy Office Parks’ portfolio with a 26.2 million sq ft completed area, runs at 92.2 per cent 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 100 MW 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 per cent. The REIT operates five integrated office parks housing 53 buildings in the key areas of Mumbai Metropolitan Region (41.1 per cent), Hyderabad (39.3 per cent), Pune (16.9 per cent) and Chennai (2.7 per cent). The REIT enjoys a high-quality tenant base with 85 per cent of the rentals generated from MNCs and 39 per cent 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’ primary 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 also has the 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 higher influence of real estate MTM on the valuations. Given the equity-like risk profile, investors seeking regular income could consider making investments if the correction in valuations pushes the dividend yield into double digits, where they can also be fallback 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 also has the potential to impact the expected mark-up in lease rentals. The lease rentals could also be potentially negotiated at lower levels that could affect the periodic pay-outs done by REITs. The concerns regarding data security and the efficiencies of working in a close-knit environment should limit the fallout, of work-from-home culture by the majority of the 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 be supportive of the two listed REITs. The near-term headwinds, however, warrant a cautious and staggered approach

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