Real estate is the preferred asset class of the entire investment community in India. Several among the wealthy have a large percentage of their net worth in physical real estate. If you search for the reason behind this, it will be the long term returns this asset class has offered and the fact that most investors can touch and feel the asset.
But few realize the immense effort, cost and time that physical real estate sucks up. In the last five years due to a spate of new launches that have gone undelivered several people are scared to move forward with physical real estate. Several investors are holding money in fixed deposits just because they could not decide on their investments.
The alternative used in developed market is REITs – Real estate investment trusts. These are listed trusts which hold physical real estate but you buy them like a stock on the stock exchange. They have several advantages a few of which are going to be outlined here.
Reason 1: No stamp duty
When you trade physical real estate you have to pay stamp duty to get the property registered (which could be north of 5% of the property value in most states). In the case that you invest the same amount in a REIT you just trade it like regular stock and negligible stamp duty is charged.
Reason 2: Very low brokerage
A real estate broker typically charges the buyer and the seller over 2% – which means in the end 4% of what you pay goes to just brokers. Compare that will paying 0.1% brokerage on buying the stock of a REIT in your online brokerage account – the advantage is huge.
Reason 3: Much higher liquidity – sell when you want
Typically to sell physical real estate it takes about three to four months to find a buyer and another three to four months to complete the entire transaction. In addition you have to physically go to get to registration done. In the case of a REIT you can sell the REIT stock online from the comfort of your own home in a couple of minutes – yes six months versus two minutes.
Reason 4: No hassle finding renters
A REIT has a management team finding renters for the properties they own at all times. They make sure that the renter is creditworthy, work out the lease to protects the REIT’s interest, collect rent and automatically wire it your account. In the case of physical real estate it can very taxing going through this process of finding a worthy renter and dealing with squatters in case things go sour.
Reason 5: No long term capital gains tax
Long term capital gains tax on REITs is zero versus 20% on real estate. REITs are treated like equity when it comes to taxing long term capital gains. The important point to note here is that long term capital gains is exempt for the individual holding listed units in the REIT but not on the physical real estate traded by the REIT.
Reason 6: Diversification
Currently holding a diversified portfolio of real estate in India requires lots of capital. The reason you want to diversify is to protect yourself from the risk that the individual unit that you own could be inferior without you knowledge at the time of purchase. For example if you bought an apartment that overlooks a field where suddenly construction of a neighboring building starts you could lose versus the side of the build that faces the inner playground.
A REIT will typically own an entire building or even multiple buildings in multiple areas which protects you from this kind of intra-development location risk. Unfortunately there are no listed REITs in India as yet which you can invest in, but a few are expected to be listed very soon. In addition the residential real estate yields are too low for a REIT listing and so you are likely to see either commercial or retail REITs (or mixed use REITs) listed in India first.
Credits India Infoline