Limit Your Small and Medium Reit Exposure to 5% Until They Prove Themselves
Two players, Propertyshare and Rudrabhishek Enterprises, have secured licences from the Securities and Exchange Board of India (Sebi) to launch Small and Medium Real Estate Investment Trusts (SM Reits). The first SM Reits could make their debut as early a
Real EstateInvestmentSm ReitsPropertyTaxReal EstateOct 18, 2024
Key Features of SM ReitsEach SM Reit can offer multiple investment schemes. According to Kunal Motkan, Director of Propertyshare Investment Trust, investors can directly inspect the properties and choose to invest if they find them appealing. This level of choice is not available in traditional Reits, where the investment team selects multiple properties. Shobhit Agarwal, Managing Director and CEO of Anarock Capital, points out that SM Reits provide a broader investment base by investing in both commercial and residential properties, thereby reducing concentration risk.
Promoter Investment and Yield PotentialPromoters are required to invest 5% of the capital, aligning their interests with those of the investors. Commercial properties typically offer rental yields of 8% and above, along with potential annualized capital gains of 5-6% on sale. This makes SM Reits an attractive option for investors looking for regular income and long-term appreciation.
Risks and ConsiderationsOne of the primary risks associated with SM Reits is re-leasing risk. Motkan explains that while the building must be leased at the time of investment, there is a chance that the tenant may vacate once the lock-in period, usually three years, ends. This can make it challenging for the investment manager to find a new tenant. Additionally, fluctuations in property values could impact the Reit’s share price. Given that SM Reits are a relatively new asset class, their long-term performance is yet to be observed.
Tax ImplicationsAn SM Reit’s quarterly payout consists of 20% interest and 80% return of capital. The interest is taxed at the marginal tax rate, while there is no tax on the return of capital. Selling units after one year results in long-term capital gains, taxed at 12.5%, while short-term capital gains (on units sold within a year) are taxed at 20%.
Who Should Invest?SM Reits are suitable for investors looking to diversify their portfolios. Agarwal advises that investors with a long-term investment horizon and the ability to tolerate fluctuations in property values may find SM Reits a viable option. Many investors are familiar with fractional ownership platforms, and becoming regulated entities can enhance their appeal. Vishal Dhawan, Chief Financial Planner at Plan Ahead Wealth Advisors, suggests that SM Reits are ideal for investors who cannot conduct thorough due diligence on a property themselves.
Evaluation and MonitoringWhen considering an SM Reit, investors should evaluate the property’s location, building quality, tenant profile, and rental rates. If the rent is significantly above market rates, there is a higher risk that the tenant may vacate. Future supply in the area can also affect tenant turnover. Checking for upcoming infrastructure projects that could drive rental growth is crucial. Assessing the experience and track record of the investment team is also important. Agarwal recommends monitoring the Reit’s performance and the broader commercial and residential rental market.
Advice for Retail InvestorsMost retail investors are advised to stick to mainboard Reits for now. Dhawan suggests waiting until SM Reits have established a track record and demonstrated liquidity. For those who decide to invest, limiting exposure to 5% of net worth (excluding the primary residence) and entering with a minimum 10-year horizon is recommended.
Frequently Asked Questions
What are Small and Medium Real Estate Investment Trusts (SM Reits)?
SM Reits are investment vehicles that can invest in both commercial and residential properties that generate rental income. Investors receive quarterly rental income and potential capital appreciation when the properties are sold after 4-6 years. Their units are listed on stock exchanges, providing an exit avenue for investors.
What are the key features of SM Reits?
Key features of SM Reits include the ability for investors to inspect and choose properties, a broader investment base in both commercial and residential properties, and a requirement for promoters to invest 5% of the capital, aligning their interests with investors.
What are the risks associated with SM Reits?
Major risks include re-leasing risk, where tenants may vacate after the lock-in period, and fluctuations in property values that can impact the Reit’s share price. SM Reits are a relatively new asset class, and their long-term performance is yet to be seen.
What are the tax implications of investing in SM Reits?
An SM Reit’s quarterly payout consists of 20% interest and 80% return of capital. The interest is taxed at the marginal tax rate, while there is no tax on the return of capital. Selling units after one year results in long-term capital gains taxed at 12.5%, and short-term capital gains are taxed at 20%.
Who should consider investing in SM Reits?
SM Reits are suitable for investors with a long-term investment horizon and the ability to tolerate fluctuations in property values. They are also ideal for investors who cannot conduct thorough due diligence on a property themselves and are seeking a regulated investment platform.
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