Last week, we have learned about REITs, its type and structure. Click here to read it.
Now, let us look at advantages and disadvantages of REITS before recommending it to your clients.
Advantages
Dividend income: REITs have to pay at least 90% of net earnings to unitholders as dividend. Hence, most of the gains generated through rental income and capital gains are distributed among investors giving them regular flow of income.
Transparent: Like public listed companies, REITs must disclose financial information to investors, report on material business developments and risks on a timely basis. Since REITs distribute most of earnings, they frequently seek funding from capital markets, which require them to make additional disclosure and justify plans for using such funds.
Also, since REITs are listed on stock exchanges, investors can seek performance history and get all the necessary details to make investments.
Diversification: REITs help investors diversify portfolio, as they have low correlation to equity, debt and other assets class.
Disadvantages
Limited growth: REITs exhibit limited growth, as they have to distribute 90% of income. Thus, REITs can reinvest 10% of its income indicating lower compounding effect.
Tax on dividend: Earnings from REITs are taxed at the marginal rate of taxation making it less attractive.
Investment risks: Do your due diligence before recommending REITs. Look at the trends in real estate market such as property values, interest rates on loans, location and tax laws.
High expenses: At times, REITs charge high management and transaction fees. Look at terms and conditions in the fine print of scheme information document. There are instances where REITs have put a limit on redemption.
Keep in mind these tips before recommending REITs
Understand the types of properties you are recommending: Most REITs specialize in a certain segment, which you can find in the fund summary. Understand the risks of each sector. For example, REITs holding undeveloped land carry more risk than REITs investing in high-end apartments in a major metropolis.
Look at the numbers: REITs should pay dividend from operations. At times, REITs use additional capital to fund dividends due to stressed assets.
Timing matters: Timing the investment in real estate is the key to make money. If REIT was created after a housing market recession; it could own and buy valuable properties at low prices.
Chanchal Wankhade works with a large AMC. He has authored two books ‘Mutual Funds For All’ and ‘Health Insurance For All’. The views expressed in this article are solely of the author and do not necessarily reflect the views of Cafemutual.