How do REITs work?

In March 2019, the first real estate investment trust, or REIT, came out with an initial public offer (IPO) for Indian investors. This paves the way for Indians to invest in the real estate sector without actually having to buy expensive real estate.

So what are REITs and how do they work? Well, REITs are not all that different from mutual funds, except that instead of investing in equity or debt, they invest in real estate. REITs either purchase property or are involved in property development. They make money in two ways: capital appreciation and rental income, which is then passed on to investors as dividends.

Since they offer investors an opportunity to invest in real estate, it’s important to understand this: how do REITs work? The first step is to come out with an IPO that is open to investors. After the IPO, the shares of the REIT are listed on the stock exchange, where they can be bought and sold freely.

How does a real estate investment trust work to the benefit of investors and the real estate industry? Let’s take a look:

• Easy to invest in real estate: REITs make it much easier for the average investor to put his or her money in real estate. Investing in this sector requires a lot of capital, which many people may not have. REITs enables investors to invest small amounts and reap the benefits of capital appreciation and rental income. It also gives retail investors an opportunity to invest in hitherto inaccessible areas like commercial and office property.

• Diversification: It’s always a good idea to have a diversified portfolio since it allows risks to be spread out over different asset classes. Most investors have found it difficult to include real estate in their investment portfolios because of the high cost involved. REITs offer an excellent way of diversifying your portfolio and investing in real estate without spending large sums.

• Liquidity: Another problem that people face while investing in real state is the lack of liquidity. If you need urgent cash, it’s hard to sell property off quickly, and if you’re in a rush, you may not be able to negotiate the price you want. REITs are listed on the stock exchange so you can sell then whenever you want.

• Boost to real estate: The real estate sector often has trouble getting access to funds. REITs will help broaden the investor base and help the sector get the funds it needs from a large section of the investing public.

• Professional expertise: REITs are run by professional managers who can optimise returns for you. Most people lack the expertise to buy and sell property, and the returns they may be earning may not be optimal. Lay investors also don’t have to play landlord, with all the headaches of recalcitrant and unreliable tenants.

• Inflation protection: Inflation can eat away into your capital each year. REITs offers an excellent way of beating inflation since returns will be far higher than the inflation rate.

• Low volatility: REITs tend to be less volatile than equity, since property values and rentals tend to be more stable than share prices.