REITs vs. Real Estate Mutual Funds
- Probus Insurance
- January 9, 2024
- 1:27 pm
Real estate investing offers a multitude of strategies and variables, which can sometimes lead to confusion among investors and result in less-than-ideal deals. Seasoned investors, drawing on their experience, possess a clear understanding of these intricacies and know how to leverage opportunities for optimal results.
For newcomers to the real estate investment arena, the choice between real estate mutual funds and Real Estate Investment Trusts (REITs) can be a source of confusion. These investment avenues provide accessible entry points with relatively lower risks, making them attractive options for beginners. Both real estate mutual funds and REITs offer liquidity, adding to their appeal for those new to investing in real estate.
Despite these similarities, there are substantial differences between the two, and navigating these distinctions can be challenging for beginners. Let’s discuss them in detail!
What are Real Estate Mutual Funds (MFs)?
Mutual Funds (REMFs) emerge as an excellent option. These funds belong to the category of Sectoral Mutual Funds, primarily focusing on investments in securities provided by public real estate companies. In terms of asset allocation, a significant portion of these funds is directed towards investments in commercial and corporate properties, undeveloped lands, agricultural areas, and apartment complexes.
Real Estate Mutual Funds may choose to invest directly in real estate companies or opt for exposure through Real Estate Investment Trusts (REITs). The decision between these options is typically made by fund managers, who play a crucial role in determining the fund’s investment strategy.
What are the Features and Benefits of Real Estate MFs?
Real estate is undeniably one of the most popular investment options in India, and Real Estate Mutual Funds (REMFs) fall under the category of highly profitable investment sectors. Here are some of the major features of such mutual funds in India:
Real Estate Mutual Funds provide investors with a diversified approach to the real estate sector. By pooling funds from multiple investors, these funds can invest in a variety of real estate assets, offering diversification that may not be easily achievable through direct property ownership.
- Professional Management
Investors in Real Estate Mutual Funds benefit from the expertise of professional fund managers. These managers make strategic decisions on asset allocation, property selection, and investment timing, leveraging their knowledge to optimize returns for investors.
Compared to direct real estate investments, Real Estate Mutual Funds offer higher liquidity. Investors can buy and sell units of these funds on the stock exchange, providing flexibility and ease of exit when needed.
Real Estate Mutual Funds enable investors to participate in the real estate market with relatively lower capital compared to direct property ownership. This makes real estate investment more accessible to a broader range of investors.
- Risk Mitigation
The diversification and professional management provided by Real Estate Mutual Funds help mitigate certain risks associated with direct real estate investment. Investors share the risks and rewards across a portfolio of properties.
- Investment in Public Securities
These funds typically invest in publicly traded securities of real estate companies or Real Estate Investment Trusts (REITs), allowing investors to indirectly own a stake in various real estate ventures.
What are REITs?
A Real Estate Investment Trust (REIT) is a corporation tasked with managing and owning income-producing commercial real estate properties. There are various types of REITs, each with its specialization. Some may focus on specific product types such as senior housing or multifamily properties, while others may concentrate on specific geographic regions like the southeast.
When an individual decides to invest in a REIT, they purchase shares of the company that owns and manages real estate assets. It’s important to note that they are not directly acquiring physical properties or tangible shares. Instead, it’s akin to buying stocks in companies like Apple or Berkshire Hathaway. Investing in REIT stocks means investing in the company itself, which, in turn, owns and operates a portfolio of real estate assets.
Different Types of REITs: Explained
Broadly speaking, REITs are better categorized due to the kinds of commercial ventures they engage in. The techniques developed for share sales and purchases also aid in the classification of REITs. The following is a list of the different types of REITs.
The type of REIT you are describing falls under the category of one of the most popular ones, known as Equity REIT (Real Estate Investment Trust). These REITs are primarily involved in the ownership, operation, and management of income-generating commercial properties.
Mortgage REITs (mREITs), as they are commonly known, specialize in lending money to property owners and providing mortgage facilities. In addition to direct lending, Mortgage REITs often engage in the acquisition of mortgage-backed securities. These securities represent pools of mortgages that are bundled together and sold to investors.
Investors looking for diversification in their real estate investments often consider a hybrid approach by investing in both Mortgage REITs (mREITs) and Equity REITs. This strategy enables them to balance exposure to different segments of the real estate market.
By incorporating both types of REITs into their portfolio, investors can benefit from diverse income sources. Equity REITs contribute rental income from their owned and managed properties, while Mortgage REITs generate income through interest payments on the loans extended to property owners.
- Private REITs
Private Real Estate Investment Trusts (REITs) operate as private placements, catering to a select list of investors. Unlike publicly traded REITs that are listed on national securities exchanges and subject to regulatory oversight, private REITs are not traded on such exchanges and are not registered with regulatory bodies like the Securities and Exchange Board of India (SEBI).
- Publicly traded REITs
Publicly-traded Real Estate Investment Trusts (REITs) issue shares that are listed on National Securities Exchanges, and their operations are regulated by relevant regulatory bodies such as the Securities and Exchange Board of India (SEBI)
- Public non-traded REITs
Non-listed Real Estate Investment Trusts (REITs) that are registered with SEBI but not traded on the National Stock Exchange fall into the category of private or non-traded REITs. Unlike publicly-traded REITs, these non-listed options do not have their shares listed on the exchange, making them less liquid and not subject to day-to-day market fluctuations.
What are the Features and Benefits of REITs?
The following are some key benefits of investing in REITs:
With REITs, you may diversify your investments by gaining exposure to real estate without having to deal with the annoyances of managing and owning commercial real estate. With the help of this diversification, you may expand your entire asset allocation strategy beyond the traditional asset classes of debt, equity, and gold.
- Small Initial Investment
As was previously noted, one of the main issues with real estate investing is the high initial cost, particularly when it comes to commercial properties. With a much lesser initial investment of approximately Rs. 50,000 REITs offer comparable benefits of portfolio diversification.
- Professional Management
A REIT’s properties are professionally managed. By doing this, you may guarantee seamless operations without having to put in any effort to manage commercial real estate.
- Regular Income Generation
Ninety percent of the rental income that REITs collect is mandatory to be distributed to investors in the form of dividends and interest payments. In this sense, investors receive consistent income from REITs.
- Capital Gains
The price of REITs, which are listed and traded on stock exchanges, is determined by their performance. Thus, a performing REIT may see a rise in value over time and be able to be sold for a profit. The investor benefits from capital gains as a result.
Difference Between REITs and Mutual Funds
|Real Estate Mutual Funds
|Only Demat accounts can be used to transact with REITs, which are listed on the stock exchange.
|Through their website, one can make both online and offline mutual fund investments. Stock exchanges can also be used to invest in mutual funds, however stock exchange liquidity is an issue.
|Approximately 80% of real estate investments are done in rental buildings. Twenty percent of the investments are allocated to properties that are currently under construction.
|Investments in real estate mutual funds are quite liquid. With a few clicks, its units can be redeemed at any time, and funds will be transferred to the specified bank account in two to three business days.
|Investing in REITs exempts you from paying taxes.
|Mutual funds are more advantageous because they are acknowledged as investments that save taxes.
What are the Taxation Rules for REITs?
Taxation Rules for REITs:
Two separate tax laws apply to investors who get distinct kinds of income from REITs: one for capital gains and one for dividend income. Furthermore, when assets are redeemed through an International REITs Fund of Fund, there are additional differences in the tax treatment. The following are the applicable taxation rules:
- Taxation of Dividends
Current regulations state that dividends received by investors from REITs are fully taxed. REIT dividend payments are taxable at the investor’s slab rate for the relevant Financial Year and constitute part of the investor’s yearly income.
- Taxation of Capital Gains
Short Term Capital Gains (STCG) and Long Term Capital Gains (LTCG), which apply to equity investments, cover capital gains from the sale of REIT units. If a unit’s holding duration is one year or less from the date of unit allocation, STCG is applicable. 15% of capital gains on the sale of units is subject to the STCG tax rate. The LTCG taxation regulations are applicable if the holding period is more than a year after the date of unit allocation. 10% of gains over Rs. 1 lakh (across all equity assets for the relevant FY) is the LTCG tax rate; there is no indexation benefit.
- Taxation of Capital Gains for International REIT Fund of Funds
The rules for non-equity capital gains tax apply if proceeds from the sale of units in the International REITs Fund of Funds are received as capital gains. In this instance, if the holding period is three years or less (as determined from the date of unit allocation), then short-term capital gains are applicable. The STCG in this instance is based on the investor’s applicable slab rate for the fiscal year. 20% of indexed capital gains is the LTCG tax, which is levied on units held for more than three years starting on the date of unit allocation. Let’s now examine the process of investing in REITs.
Taxability Of Real Estate Mutual Funds:
The Indian government’s Income Tax Department mandates that investors pay taxes on their gains and income because REITs are financial products that generate money for them. They have, nevertheless, developed some principles for taxing investors in REITs. These are the real estate fund taxability requirements.
- If an investor holds an investment for less than a year, they are subject to a 15% short-term capital gains tax on the proceeds from the sale of the investment.
- If the investments are held for more than 36 months, the investors will be subject to a 10% long-term capital gains tax on the proceeds from the sale of the investments.
- The interest income obtained from the REITs is subject to taxation based on the relevant income tax bracket.
- If the corporation has received a special tax concession, the investors will be responsible for paying taxes on the dividend income.
- The revenue from the amortization of the SPV is not subject to taxation for the REIT investors.
Which is a better option: REITs or Real Estate Mutual Funds?
Depending on your investing objectives, risk tolerance, and unique situation, you should choose between Real Estate Investment Trusts (REITs) and Real Estate Mutual Funds. Although they both expose investors to the real estate market, there are some significant distinctions.
- Investment Structure:Companies that own and manage properties that generate revenue, like retail malls, apartments, and office buildings, are known as REITs. They provide investors with individual shares and are exchanged on stock exchanges. Conversely, real estate mutual funds are investment vehicles that combine the capital of several investors into a diverse portfolio of real estate assets.
- Liquidity:Compared to real estate mutual funds, REITs are typically more liquid. Investors have flexibility as REIT shares are available for purchase and sale on stock exchanges throughout the trading day. However, the pricing of Real Estate Mutual Funds is done once a day following the market close, which can make it more difficult to enter or leave holdings fast.
- Diversification:Since real estate mutual funds invest in a wider variety of real estate assets, they usually provide greater diversification. A combination of commercial, industrial, residential, and other properties might be held by them. Although REITs can also offer diversity, their concentration on particular industries or geographical areas can concentrate risk.
- Management and Expenses:Although professional management is a feature of both alternatives, Real Estate Mutual Funds often have higher expense ratios because of the related costs of active management. Conversely, REITs might incur less in costs, particularly if they are index-based or passively managed.
- Income Distribution:Dividends and capital gains distributions are two ways that investors might receive income from Real Estate Investment Trusts (REITs) and Real Estate Mutual Funds. However, income-oriented investors may find REITs appealing because they are legally obligated to transfer a sizable percentage of their taxable revenue to shareholders.
- Tax Considerations:While capital gains from the sale of REIT shares may be subject to capital gains rates, dividends from REITs are taxed at ordinary income tax rates. Income and capital gains are passed through to investors in real estate mutual funds; investors are then liable for paying taxes on these distributions. Your jurisdiction may have different tax treatment requirements, therefore it’s crucial to speak with a tax adviser.
In the end, your unique investment goals and preferences will determine which choice between REITs and Real Estate Mutual Funds is preferable. When selecting a choice, it’s a good idea to take into account variables including diversification, liquidity requirements, risk tolerance, tax ramifications, and management costs.
Frequently Asked Questions
Typically, dividends, interest payments, and capital gains for investors are how REITs provide returns to their investors.
Yes, REITs are required by SEBI norms to pay dividends to unitholders equal to 90% of their rental income.
Indeed, there are two distinct real estate investment instruments: REITs and REMFs. Mutual funds that invest in shares of real estate businesses are known as REMFs, or real estate mutual funds. Conversely, associations or organizations that purchase real estate are known as REITs (Real Estate Investment Trusts). Similar to stocks, REITs are bought and sold by investors on the stock exchange. Equity REITs, Mortgage REITs, and Hybrid REITs are the three categories of REITs.
Once you have decided which fund to invest in, you have two options: visit the Fund House location that is closest to you or visit their website. Purchase the units of the mutual fund of your choice after presenting the required KYC documentation, address verification, cancelled check, etc.
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As an enthusiast and expert in real estate investments, I bring a wealth of knowledge and experience in navigating the intricate world of real estate mutual funds (REMFs) and Real Estate Investment Trusts (REITs). Having closely followed the evolution of these investment avenues, I am well-versed in the nuances that can often perplex newcomers in the real estate investment arena.
Let's delve into the concepts covered in the article:
Real Estate Mutual Funds (REMFs):
Definition: Real Estate Mutual Funds are sectoral mutual funds focusing on investments in securities provided by public real estate companies. They allocate a significant portion of funds to commercial and corporate properties, undeveloped lands, agricultural areas, and apartment complexes.
Features and Benefits:
- Diversification: Offers a diversified approach to the real estate sector by pooling funds from multiple investors.
- Professional Management: Managed by professional fund managers who make strategic decisions on asset allocation and property selection.
- Liquidity: Higher liquidity compared to direct real estate investments; units can be bought and sold on the stock exchange.
- Affordability: Enables participation in the real estate market with relatively lower capital compared to direct property ownership.
- Risk Mitigation: Diversification and professional management help mitigate risks associated with direct real estate investment.
- Investment in Public Securities: Invests in publicly traded securities of real estate companies or REITs.
Real Estate Investment Trusts (REITs):
Definition: A Real Estate Investment Trust (REIT) is a corporation managing and owning income-producing commercial real estate properties. There are various types, including Equity REITs, Mortgage REITs, Hybrid REITs, Private REITs, Publicly traded REITs, and Public non-traded REITs.
Types of REITs:
- Equity REITs: Own, operate, and manage income-generating commercial properties.
- Mortgage REITs (mREITs): Specialize in lending money to property owners and invest in mortgage-backed securities.
- Hybrid REITs: Combine investments in both Equity REITs and Mortgage REITs for diversification.
Features and Benefits:
- Diversification: Provides exposure to real estate without direct property ownership.
- Small Initial Investment: Allows investment with a lower initial cost compared to direct real estate investment.
- Professional Management: Properties are professionally managed, ensuring seamless operations.
- Regular Income Generation: Mandatory distribution of 90% of rental income to investors.
- Capital Gains: REITs can see a rise in value over time, providing capital gains for investors.
Difference Between REITs and Mutual Funds:
- Investment Areas: REITs transact through Demat accounts on stock exchanges, while real estate mutual funds can be transacted online or offline.
- Investment Portfolio: REITs invest approximately 80% in rental buildings, 20% in properties under construction. Real estate mutual funds are liquid and can be redeemed easily.
- Tax Exemption: Investing in REITs exempts from taxes, while mutual funds are considered tax-saving investments.
Taxation Rules for REITs:
- Taxation of Dividends: Dividends from REITs are fully taxed at the investor's slab rate.
- Taxation of Capital Gains: Short Term Capital Gains (STCG) and Long Term Capital Gains (LTCG) apply, with specific rates for different holding periods.
- Taxation of Capital Gains for International REIT Fund of Funds: Different rules apply for non-equity capital gains tax.
Taxability of Real Estate Mutual Funds:
- Taxation principles for gains and income from Real Estate Mutual Funds, including short-term and long-term capital gains, interest income, and dividend income.
Which is a Better Option: REITs or Real Estate Mutual Funds?
The article emphasizes that the choice depends on individual investing objectives, risk tolerance, and preferences. Factors such as investment structure, liquidity, diversification, management expenses, income distribution, and tax considerations play a crucial role in making the decision.
In conclusion, the expertise and knowledge shared here aim to empower investors with a comprehensive understanding of the intricacies involved in choosing between REITs and Real Estate Mutual Funds for effective wealth growth in the dynamic real estate market.