This is for education purpose and the story is made up to simplify the concept, don’t take it at face value.
Lets say I am a Real Estate developer, K Raheja. I like a land in Mumbai & Hyderabad for some commercial development. I decide to buy it. Where will I get the funds to buy & construct it?
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Self
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Bank, NBFC, MF – Debt
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Partner – someone else investing as Equity
So I invest some funds, got some from banks & MF’s & I also got Blackrock to invest to buy the land & make the business park called Mindspace. I constructed around 23-mn sq ft with multiple building & I started leasing them out to companies who wanted rented office premises.
There comes a point where I needed more funds to build new building (6.4 mn sq ft), pay off the loans etc., where do I get the funds? So I decide to do an IPO. Not of the entire company K Raheja but only this project called Mindspace. So I formed a trust or corporation.
I committed to payout 90% of my rent income to the shareholders proportionately as dividends & I will use this money to invest a minimum 80% in completed real estate, which is generating rent and will use 20% in constructing new Real Estate.
Is the IPO a win-win?
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K Raheja gets more money 2 pay off debt, investment in more commercial real estate.
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Investors will receive dividends semi annually (from the rent income) which is tax free + as its listed on the exchange the stock prices can go up.
Why will the stock price go up?
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Rents increase year after year
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The value of the land increases
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New construction means more business.
Why invest in a REIT?
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G-Sec is at 6% and the rent yield in commercial RE is 7.5%-8%
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Diversification – It’s a combination of Debt (rent income) & Equity (listed so prices can move)
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Investment in RE with just 50K.
Tax Structure?
There are 3 types of income,
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Rent–Tax-free
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Interest – REIT’s can also loan money to another developer (maximum 20%) & receive interest. If you receive interest from the REIT, It will be taxed at the slab rate. Practically this is very less or zero.
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Capital Gain on the stock exchange – 15% Short Term Capital Gains Tax if you sell the REIT before 3 years and 10% Long Term Capital Gains Tax if you sell the REIT units after 3 years.
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Capital Gain on the stock exchange – 15% Short Term Capital Gains Tax if you sell the REIT before 3 years and 10% Long Term Capital Gains Tax if you sell the REIT units after 3 years.
What to look for before investing in a REIT?
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Weighted Average Lease Expiry – Higher the better
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Vacancy Rate – Lower the better
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Concentration of top 10 tenants – Lower the better
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Sector Concentration – Lower the better.
REITs operate exactly like MF’s
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Sponsor – K Raheja and Blackstone
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Manager – K Raheja (receives AMC fees for managing the properties)
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Trustee
But
REITs and real estate mutual funds are not the same.
Disclaimer: This is not investment advice.
Source: Kirtan A Shah, you can reach him on his twitter handle @kirtan0810