Can Real-estate bring returns to your portfolio? (REITs)

The market of real estate is expected to contribute 13% of India’s 2025 GDP where most of the economies develop with infrastructure as a stimulus. As a habit of being desi, people celebrate buying new ones or erecting homes themselves. The upcoming generation is parting away from the conventional practice of being together. The lack of togetherness did rise nuclear families in the residential sector and the commercial big blocks are supported by tech firms. Is it a wise decision to buy or rent a house? Let’s not get bothered about this and we proceed with you are holding on to buy a new property for consumption or for renting gains.

Sector info

First and foremost school of thought is, buy a house when you need it. Being in a rental is absolutely fine. Some debate renting is same as paying interest, that kind of point is valid when the payments are the same. Taxes, maintenance and other unforeseeable costs will eat up your money lessening return on capital. Another thing to be taken care is the non-cash charge, depreciation during the loan tenure, say 20 years. The capital appreciation is Nil to less and the banks realized this after the real estate bubble of 2008 where the financing on homes were seamless assuming the value would grow forever.

Valuing real estate:

Real estate valuation is quite simple if the influencing parameters are well known. Since every property has a guideline value set by the government, which is now-a-days half of the market value. Even after considering all the parameters and not sure of arriving at a price that is not foolproof. The real estate market has always been in the dark where the price is known to everyone and to none, whom will you point for a perfect price?

If the property is left out, the cash flows are already known, rent is the only inflow from a working estate. Similar to valuing a business cash flow might help you in valuing the asset. One way to predict the price or rent is by assessing the quality of life, income of the individual in the locality, easy access to daily needs and infrequent exceptional wants etc., the list is full of intangibles were the collective of assumptions will always be a prediction. Not moving into the specifics of valuation just add cash flows and buy them at a discount price. This seems to be a time, work demanding for a different domain worker, leave this to a broker. Even after too much research the present value will still be an arbitrary price. This sector is under-regulated with regard to pricing.

Comparative pricing is one way of knowing the real value of the estate. Seeking out for a property with same specifics and altering around the price according to our needs is a sure way of getting a reasonable price.

Down sides of investing in real estate:

  • As already said, the capital appreciation is near to zero and the words “hedge against inflation” are diminishing.
  • When seeking for a second home, borrowing to invest is of no value, hardly ever the rent pays the loan and several months the house would be of zero occupancy. Investing is parking excess money and to make them perform better than inflation.
  • Risk of renting.
  • Holds a large portion of the portfolio dragging the overall returns.
  • Leasing is not a preferable option unless the property is bought in full cash or the owner is in need of bulk amount for contingencies.

Another way to invest in real estate is by opting for Real estate investment trusts (REITs) which are analogous to ETFs traded on the stock exchanges. India is still nascent for REITs, the tender stocks been in listing for the least 2 years and the record of dividends don’t play up to investment standards. REITs should have to breath on its own for some years to attain investment grades.

Price fluctuations of Properties

The spike dropping from the left is the dust settling from the 2008 real estate bubble.

Who all qualify for REITs:

  • 90% of the income must be distributed as dividends.
  • 80% of the investments should be made on revenue generating properties.
  • Only 10% of the funds go to financing under construction properties.
  • Asset base of 500 crore INR.
  • The whole system is under the direct surveillance of SEBI which ensures the investor, of narrow gap for frauds to occur.

‘These entities are created with the main purpose of channelling the funds that are operational, or ownership of the estate to produce investment returns. Maily invented to escape double taxation of LLP and JV of early real estate financing.

How to buy REIT:

  • Since the business is well-known to everyone and REITs themselves are transparent in nature, complexity prevails in discovering the management’s efficiency. As already specified about the equivalence of REITs to ETFs, the NAV of the fund is disclosed often.
  • The trait of REIT is paying out 90% for the half year or financial year, along with the dividend payment, check for capital appreciation too. As specified in the Dividend portfolio.
  • Apart from expenditure, the assets depreciate which is uncontrollable. Stepping into the premises of real estate depreciation to be added to the revenues that gives a true picture about the performance, called the fund from operation (FFO).

Even though this number seems to be meaningful, the maintenance charges should be taken care by the estate owner which is not accounted in FFO. Adjusted FFO accommodates by subtracting the FFO with capital expenditure.

  • The occupancy rate of the left out properties which solely contribute to revenue never be overlooked. In the long haul, maintaining high rate is a supporting factor. A low rate indicates non performing assets are owned by them, directly affects the efficiency of the management.
  • Instead of constructing a new building, buying a below par estate and upgrading them would cost less.
  • Since the business is always short of cash, restructuring of properties would be possible by selling the mediocre and buying the stellar performer.

As far as India is in focus it has only three REITs on a roll:

  1. Mind space Business park REITs,
  2. Brookfield India Real estate trusts,
  3. Embassy office park REITs.
CompanyCash flowCap. AppreciationGrowth (CAGR)Debt/EquityArea Mn. sq. feet Dividend payment
Mind Space Business Park REITNegative-4.6%20%2.729.5Nil
Brookfield India Real Estate TrustPositive-6.14%12.2%-332Nil
Embassy Office Park REITPositive-0.37%8.2%1.3442.4*Since 2019
*This was before the Blackstone real estate bought Embassy Industrial of 22 million sq. feet for 5250 crore INR

Real estate in 2021:

Life can easily be bifurcated as before corona and after corona, the unprecedented hit shook the world resulting in frenetic business failures. Surge in Covid-19 cases derailed real estate from the recovery path, but the sales were/are still positive. Repo rates stay unchanged made lenders to offer cheap loans in 6.7% to 7% bracket to stimulate the recovery.

House affordability has started increasing, price travels sideways due to the flattening demand. Residential plots are performing no so well because of people migrating to their native where the expenses are low that goes in hand with the reduced income. Commercial blocks are struggling to breath, nevertheless the companies prefer employees to work from home, they achieve same results and perform more than the forecasts. The profit margin has widened due to reduced expenses in accommodation and maintenance. Corporate parting away from physical work spaces has disrupted the revenue stream for more sectors like restaurants, Taxi services, Hostel etc.

Both boon and bane for home buyers. Comfortable for those who work for the same pay as before who are planning for a house.

Stocks Vs Real estate investing:

StocksReal Estate
Ease of liquidityHighly illiquid
Price movements are visible, instant changes are available publicly.Similar to a dark market, prices aren’t available to everyone and no one knows what’s the right amount.
Ease of tradeInvolves physical work. Availing a brokerage service. He then finds a buyer.
Easy to diversifyDiversification in barely possible.
Low transaction fee.Brokerage charges are hefty. 1% to 3% is handful of money.

Both might ride sideways, longer than you remain solvent. Patience is important to book profits and perfect price capturing is impossible in both the investments. Potential for emotion-driven investing prevails in all kinds of investments apart from compulsory lock in featured products.

Real estateStocks
Less volatile in nature, might stay the same for a quarter.More volatile, may miss prices in seconds of delay.
Risks are known.Markets are influenced by numerous factors.
Ability to leverage.No leverage available.
Tax advantagesOn the occasion of exiting, taxes significantly affect returns.

Alternatives for real estate investing:

  • If the assumption of 3%-5% still holds, India’s 10 year bond will approximately yield 6.22% with a 1.5% swing. Unlike other securities, Treasury bills will also do the needed work with absolutely no risk.
  • Investment in gold detains the top position of hedge against inflation. The value of gold never deteriorates as no substitute is found to dethrone.
  • Bank FD’s would comfortably beat returns from real estate, where the loss of capital happens only when the bank fails, it never happened in the history. RBI steps in to bail them out with peer acquisitions or external funding with corrective actions.

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