Real Estate Investment Trust - Real Estate Investing

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REIT or Real Estate Investment Trust is a company that owns or funds the income producing Real Estate. REIT provides its investors all types of regular income streams, diversification and the long term capital appreciation. It allows every investor the opportunity to invest into large scale income producing Real Estate the way one would invest into stocks, mutual funds or debentures. It provides access to highly capital intensive large scale commercial Real Estate to the average investor.

What are the benefits of REIT fund?

Access to income producing Real Estate at low investment: REIT funds provide common investor an access to income producing large scale Real Estate with very low investment. Typically, if someone has to invest in a small commercial property of 500 sq ft in a city like Bangalore, you would have to make an investment of minimum Rs. 35 – 40 Lac. With REIT fund, you can reap the benefits of higher return on large scale commercial projects at the fractional cost (Rs. 1- 2 Lac)

·        Diversification of your investment portfolio: It provides you an alternative and diversification to your investment portfolio. As mentioned in my earlier post, Real Estate is an important class to be a part of your investment portfolio and investing into REIT funds provide you that diversification. Also returns in REIT have a very low correlation to the Broader markets and thus are very consistent. This also reduces the risk in your investment portfolio

·         Inflation Protection:  REITs provide natural protection against inflation. Real estate rents and values tend to increase when prices do. This supports REIT dividend growth and provides a reliable stream of income even during inflationary periods.

·         Performance: REITs across most of the international markets have delivered better growth and income as compared to most of the asset classes like corporate Bonds etc

·         Liquidity: REITs are listed on the stock exchanges and are trade-able instruments thus providing easy liquidity as compared to the Real Estate investment.

·         Transparency: REITs are professionally managed funds with very strong  corporate governance rules applicable to them. They are traded in open markets and thus are transparent to Markets  as well as there  is transparency in taxes applicable on returns generated through them.

In addition to the investment performance and portfolio diversification benefits available from investing in REITs, REITs offer several advantages not found in companies across other industries. These benefits are part of the reason that REITs have become increasingly popular with investors over the past several decades.

REITs' reliable income is derived from rents paid to the owners of commercial properties whose tenants often sign leases for long periods of time, or from interest payments from the financing of those properties.Most REITs operate along a straightforward and easily understandable business model: By increasing property occupancy rates and rents over time, higher levels of income may be produced. When reporting financial results, REITs, like other public companies, must report earnings per share based on net income as defined by generally accepted accounting principles

Types of REITs:

REITs are classified into 2 broad categories:

Equity REITs:
Equity REITs mostly own and operate income-producing real estate. They increasingly have become real estate operating companies engaged in a wide range of real estate activities, including leasing, maintenance and development of real property and tenant services. One major distinction between Equity REITs and other real estate companies is that a REIT must acquire and develop its properties primarily to operate them as part of its own portfolio rather than to resell them once they are developed.

Mortgage REITs:
Mortgage REITs mostly lend money directly to real estate owners and operators or extend credit indirectly through the acquisition of loans or mortgage-backed securities. Today's Mortgage REITs generally extend mortgage credit only on existing properties. Many mortgage REITs also manage their interest rate and credit risks using securitized mortgage investments, dynamic hedging techniques and other accepted derivative strategies.

The 3^rd category that has started emerging is the Hybrid category that deploys funds in both the above categories i.e. direct investments into properties as well as mortgages.

REITs are strangers to Indian market. SEBI on 26th September 2014 laid the detailed framework for  the registration and regulation of REITs in India. Post that some  of the large Real Estate companies like DLF have started readying for the launch of their REIT funds. This is the asset class that will see a lot of activity in coming 8 to 12 quarters once the economy picks up demand for Real Estate starts picking up.

Do revert with your comments and feedback.

Reverse Mortgage - Real Estate investing

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Reverse Mortgage is one of the investment tools that enable old people to liquidate their investments into homes at older age. Simply put, Reverse Mortgage is opposite of a conventional home loan. It allows the borrower to get a regular monthly income for stipulated time period from the lender against the mortgage of their house.

How does a reverse mortgage work?

When the house is pledged, the lending bank does the monetary evaluation of the property basis the demand for the property, current market price and the condition of the property. Once the financial value is arrived at, the loan as agreed with the borrower is lent in lump sum amount, yearly amount, quarterly or monthly amount as mutually agreed between the lending bank and the borrower.

A reverse mortgage is an ideal option for senior citizens who require regular income, or if the property is of illiquid nature for some reason.

General guidelines for reverse mortgage

The Reserve Bank of India has formulated the following guidelines for a reverse mortgage.

Maximum loan amount would be up to 60% of the value of the residential property.

Maximum tenure of the mortgage is 15 years and minimum is 10 years. Some banks are now also offering a maximum tenure of 20 years.

The re-evaluation pf the property is to be undertaken by the lender once every 5 years. If at such time, the valuation has increased, borrowers have the option of increasing the quantum of the loan. In such a case, they are given the incremental amount in lump-sum.

Amount received through reverse mortgage is a loan and not income. Hence it will not attract any tax. However, a borrower is liable to capital gains tax, at the point of alienation of the mortgaged property by the mortgagee for the purposes of recovering the loan.

Reverse mortgage interest rates could be either fixed or floating and are decided basis prevailing rates in the market.

Eligibility Criteria for reverse mortgage

House owners above the age of 60 years. If spouse is a co-applicant, then she should be above 58 years.

Owners of a self-acquired, self-occupied residential house or flat, located in India. The titles should be clear, indicating the prospective borrower's ownership of the property.

Property should be free from any encumbrances.

The life of the property should be of minimum 20 years and should be the permanent or primary residence of the individuals.

How Reverse Mortgage is settled?

A reverse mortgage loan becomes due when the last surviving borrower dies, or if the borrower chooses to sell the house. The bank first gives an option to the next of kin to settle the loan along with accumulated interest, without sale of property. If the next of kin is unable to settle the loan, the bank then opts to recover the same from the sale proceeds of the property.

Any extra amount, after settlement of the loan with accrued interest and expenses, through the sale of the property, will be passed on to the legal heirs. If the sale proceeds are lower than the accrued principal plus interest amount, the loss is borne by the bank. This loss could happen in cases where the banks original estimation is not in line with the real estate market movement.

Other Factors

Prepayment of loan: Borrowers could prepay the loan at any time during the tenor of the loan, at no prepayment penalty or charges.

Outliving the tenure of the loan: If the borrower outlives the tenure of the loan, he could continue to stay in the house. The lending institution may however cease the monthly payments. Settlement of the loan is done only after the borrower's death.

Death of one of the spouses: If one of the spouses dies, the other can still continue living in the house. Only on death of both, settlement of the loan takes place.

Foreclosure: The loan could be foreclosed by the lender if

The borrower has not stayed in the house for a continuous period of one year.

The borrower has not paid property taxes and fails to insure the home

If the borrower declares himself as bankrupt.

If the mortgaged property is donated or abandoned by the borrower.

If the borrower makes changes in the residential property, that could affect the security of the loan for the lender. This could be renting out part or entire house, addition of a new owner to the house's title or creating further encumbrance on the property.

If the government under statutory provisions, seeks to acquire or condemn the residential property for health or safety reasons.

Drawbacks

Lengthy documentation procedures: Banks require various documents of the property. For a senior citizen this procedure could be tedious, complicated and difficult to understand.

Fixed monthly amounts: The monthly payouts are fixed. There is no provision to increase this amount in case of an emergency or contingency

 Thank you for reading this article. Do revert with your suggestions and feedback.

NCDs as investment opportunity in Real Estate

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NCDs are Non Convertible Debentures, considered one of the best debt options  for the purpose of investments. This is the route highly treaded by the real estate companies to raise money for their capital requirements. 

There are many reasons why people should invest in NCDs:

1. NCDs yield better returns: NCDs offer better returns than Bank FDs and fairly attractive due to advanced returns and lower risk when compared with other investment options. The interest rate and rate of return may vary between 11% to 18% depending on the market conditions and credit profile of the companies offering NCDs.

2. NCDs are not subjected to TDS:  Returns from several venture instruments such as bank fixed deposits and company fixed deposits are subject to tax deduction at source (TDS). But in case of an NCD, as per section 193 of the Income Tax Act, no such taxes on interest earned are applicable when securities are issued by a company in a dematerialized (Demat) form and listed on a stock exchange.  However, taxes are applicable to NCDs if they are in physical form. Also, a Non Resident Indian (NRI) who invests in NCDs is subject to TDS according to section 195 of the IT act.

3. NCDs are safer than other instruments: Not only do NCDs receive good credit rating, but they are also completely protected by the possessions of the company in form of land, earnings, assets etc.. Nevertheless, NCDs are also not completely insulated from market risks, but this risk is much lower in comparison.

4. NCDs can be easily liquidated: In case of NCDs you have an option to either sell on the National Stock Exchange or exercise a put option with regards to a premature exit. Exercising a put option enables the investor to exit the bond in return of the face value on the stipulated date. They have better liquidity due to their NSE listing.

There are a few disadvantages of premature exits such as interest rate risk on exits from the secondary markets.  NCDs from the Real estate companies offer better rates of return though have their fair share of risk attached to such investments.

Factors to consider while selecting an NCD

Credit profile of the company: It is very important to check the credit profile of the company offering NCDs. You would not want the default on payment of your hard earned money and thus do your own due diligence on the financial health of the company before selecting on the particular NCD

Credit rating of the instrument: Next is to check the credit rating of the NCD. There are independent rating companies like CRISIL that rate the individual investment instruments and its worthwhile to check the ratings of the instrument that you wish to invest into.

Usage of the fund: Please ensure to check, where your funds are likely to be invested. Please avoid investments into the funds where the utilization of funds will be for non-core business of the company or any major deviation from the core business of the company.

Liquidity: The NCDs listed on stock exchange are easily liquitable and can be traded into the secondary markets. This provides for an opportunity to exit your investment whenever you may choose to do so. Though there are certain implications on your returns and tax applicable on your investment.

Factor in the post-tax returns: Please read the tax applicable on the NCDs selected. The higher tax may reduce the return in hand (post tax return) and there are better options available that might make your NCD investment less attractive.

Trust this article helps you in making wiser investment decision. Please write back to me with your feedback/suggestions.

Real Estate Investment for Rental Income

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Rental Income

RENTAL INCOME has always been one of the most preferred alternative income considered by the large Indian middle class. It is considered as an aspirational GOLD especially when you look at the salaried class approaching its retirement. One of the best ways to secure your retirement is invest in an additional property that can give you rentals when you retire or build another floor to rent it out and provide you that extra security cover. In this article, I am highlighting the pros and cons of investing in Real Estate for Rental Income.

Typically in India  the rental rates vary between 1.5% - 3% of  the current  market value of your residential property  and 7 – 11% of your commercial property.

Pros:

·         It generates regular income month on month

·         It is protected from inflation as it increases with the rise in overall price index

·         It gets you tax benefits (e.g depreciation benefits)

·         It can cover your incremental mortgage costs

·         Your capital is intact and grows over a period as the price of the property goes up.

Cons:

·         It involves high maintenance cost for  the upkeep of  the property

·         Risk of empty units

·         Dead-beat tenants

·         Typical pitfall of the illiquidity of the asset

·         Loans are not very easy to get by for a commercial property.

If you wish to invest in the rented property, do be cognizant of the above factors apart from the other factors highlighted in my earlier articles before you invest. It is advised to express restrain on investing in rented properties against the bank loans. Also ensure that you keep at least six months' worth of reserves on hand in the event you fail to find a renter.

Thank you again for taking out your time and reading this article. Do write back to me with your feedback and if you found this  article helpful.

Real Estate as a part of your Asset Allocation

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Real  Estate as a part of your Asset Allocation

Before I pen down my ideas on the above subject, let’s understand what asset allocation is.

Asset allocation is an investment strategy that aims to balance your risk and reward by apportioning portfolio’s assets according to individual’s goals, risk tolerance and investment horizon. The main asset classes are:

equities,

fixed-income,

real estate,

gold and cash and cash equivalents;

 Each of these have different levels of risk and return, so each will behave differently over specified time horizon. Allocation of capital to different asset classes is one of the most important decisions in determining the future risk taken and overall returns generated by the total portfolio. The returns are volatile in nature including positive and negative returns and the same hold true for real estate as well.

In my previous article, I had highlighted the importance of having real estate in your investment portfolio. Let me give you some of the pitfalls of investing in real estate and thus we should avoid going overboard on it and have a balanced portfolio.

Pitfalls of Real Estate:

·         There is a general myth that the real estate prices never fall. The reality is that real estate like any other asset tool has its cycle of ups and down when the prices go up based on the demand and goes down when the demand is low. The Real estate prices in NCR region alone have corrected by 25% in last 2 years. As it is a high capital asset class, a correction of such magnitude has a significant impact on our net worth.

·         It gives you steady rental income that grows over time but the rental returns are good in commercial properties (8 -12%) against the residential property that gives you the rental return of 1.5% - 3%.

·         It saves on tax. Actually it is the residential property where you get the tax exemption while there are no tax benefits on the loan against the commercial property. This deduction also is added back to your taxable income if you sell the property within 5 years of taking the possession of the house.

·         As it is a high capital class, the liquidity of the asset is difficult. This asset cannot be used for emergency needs or urgent fund requirements.

Taking all the above factors into consideration, please use your discretion while investing into real estate. Some of the Investment Opportunities that Real estate offers are:

·         Capital Gains

o   while participating at the launch stage of property and taking advantage of value appreciation

o   Participating in auctions of the stressed assets. (Generally for the HNIs)

o   Cyclical or periodic appreciation of the property

·         Rental income The returns on a residential property range anywhere between 1.5% - 3% of the market value of the property while the rental returns on the commercial premises range between 7% - 12% depending on the market demand. The interest on the loan on residential property can be deducted from rental income in the same property and gives added tax benefit.

·         NCD: The real estate sector is still considered amongst the riskiest of the sectors and the developers find it difficult to raise required funds. This opens up the opportunity to invest in high yield debt instruments like NCDs (non-convertible debentures) floated by these developers. The risk of investing in these NCDs is higher than the normal debt and needs to be taken into consideration before investing.

·         Reverse Mortgage: A reverse mortgage is a loan that allows older homeowners to access the equity in their homes. Instead of making a mortgage payment to reduce your debt, you receive money and increase your debt. Reverse mortgages are an option for people who want to turn substantial home equity into cash

·         A REIT, or Real Estate Investment Trust, is a company that owns or finances income-producing real estate. Modeled after mutual funds, REITs provide investors of all types regular income streams, diversification and long-term capital appreciation. REITs typically pay out all of their taxable income as dividends to shareholders. In turn, shareholders pay the income taxes on those dividends.

I will deal with details on all these opportunities in my subsequent posts. Thank you again for taking out your valuable time to read this post. Await your suggestions and inputs.