REIT – What should small investors look for!

It is strange how investors behave at times. During good times when India’s office market was witnessing one of its strongest growth, the Embassy REIT, listed in March 2019, was oversubscribed by 2.57 times. The recent Mindspace REIT launched amid the ongoing global pandemic last month was oversubscribed almost 13 times. What is pleasantly surprising is that the non-institutional component was oversubscribed by nearly 16 times.

If one were to consider their listing and trading prices, the numbers are even more delightful. Embassy REIT debuted at a 2.7% premium over its issue price of Rs 300 and closed at nearly 5% premium. The Mindspace REIT has had a better opening with a premium of about 11%, interestingly, at very similar pricing to the Embassy REIT debut. The past year’s performance of Embassy REIT showed that it has retained the confidence of the market and never went below its Day 1 listing price. All credit goes to the country’s first REIT as any slip in its performance would have severely damaged investor confidence and possibly the entire market in the following issues. We can expect that the Mindspace REIT will show similar strong performance trends.

The second REIT’s performance shows that Indian investors are growing in confidence with this instrument despite real estate being in a precarious position over the last several years, and more so under the current circumstances. Notwithstanding the tax hitches, the smaller lot sizes in the Mindspace REIT has gone a long way in reducing entry barriers for mid and small investors, i.e. 200 units @ Rs. 275, leading to an investment of only Rs. 55,000. Getting an allotment at the IPO stage has been difficult due to the high oversubscription. This may lead to high trade volumes in the coming months, led by investors who missed out at the IPO stage or got a much lower number of units allotted than desired.

While real estate has always been an attractive asset class, investing in the office market was still daunting for Indian investors. Lack of market knowledge, high entry barriers, managing leases and property, as well as legal complications, were some of the issues that plagued individual investors. For small investors, it was, in fact, an El Dorado – you think you can see the riches but can never grasp them. The REIT market opens the door to a greater promise as they take away almost all the concerns of the commercial market. Nevertheless, one should always be prudent and do some reading before jumping into this seemingly easy instrument.

Here are a few things that the investors need to look at carefully:

1. Geographic spread: Look at which cities the properties are located. Invariably, they will be in the prime centres of economic activity. However, some cities may have a higher weightage in the portfolio – do you see any risks in those cities?

2. Sectoral spread: Study the tenet mix of the properties. Like you would spread your investment portfolio and not bet all your money only in a few sectors, the same is the case with REITs. The present REITs are mainly in the office segment, which means you need to assess the type of tenants they have and note any specific sectors the tenant basket is heavy on. A diversified tenant mix is always better.

3. Vacancy levels: Check vacancy rates. One may think having zero vacancy is good, but my thought is that it is always healthy to have a little vacancy, like below 5%. It opens up the door for letting current tenants expand. If the market is moving upwards, it increases the chances of achieving higher rents – thus increasing portfolio value.

4. Rental value: If the rentals for each property are well above current market levels, it poses a risk as tenants will either renegotiate or exit. A premium rent above market may offer ‘feel good’ factor; in the medium term, it tends to correct.

5. Lease expiries: Know the percentage of the lease expiring in the next two years. Be mindful that an expiring lease not only opens doors for aligning rents to the market but also for exits. It is always better to have a tenant mix where more than 50% of the leases have been signed up in the last five years.

Investing in REITs gives an opportunity for small investors to earn regular dividend as regulations dictate that most of the earning must be distributed to the investors. You can also earn on account of capital appreciation. However, this will be dependent on the long term strategies of your asset manager. REIT operates in the brick and mortar sector, not the click and order game.