A better way to add rental income to your portfolio💰

Hong Kong skyline from Victoria Peak
Hong Kong skyline from Victoria Peak

Rental income has become the holy grail for a passive income source in the gig economy. And now there is an easy route…read on🚧.

What are the options ?

Subletting an apartment is not permitted by most landlords and hence to earn rental income you need to have ownership. You can buy a property in an all cash deal; as per the popular advice, to save on cash, you buy a run down property, fix it up and then rent it out – requires a lot of time, effort and money. Not feasible…next please🙄.

The most followed alternative path is to take loan and unless you limit the loan amount, such that the rental income is more than the EMI, there is no income generation happening. Worse, if the rent received is less than the EMI, it takes money out from your pocket. In India currently this is the case as the rental yields (i.e rent / cost of property) are in the range of 3%-4% per annum while the home loan rates are at 8.5% per annum😣. 

Then there is the REIT way😘 – avoid property ownership, instead buy the shares or units of  a REIT and you get the rent generated by the properties owned and managed by the REIT in proportion to the number of units you own.

What are REITs?

The concept of Real Estate Investment Trusts (REITs) originated in US which is also currently the largest market for REITs in the world. In India, the first and only REIT so far, was launched by the Embassy group; the IPO hit the market in March 2019, listing price was Rs. 300/- and rose to a high of Rs. 450/- and the current market price (CMP) is Rs. 392.39/- as on 8 Nov 2019 on NSE.  

REIT units are shares linked to the underlying real estate owned by the trust and are traded on stock exchanges. The concept is similar to a mutual fund, with the difference that the REIT units are held in your demat account like shares. 

The source of income is the rent received from the underlying real estate – in the case of Embassy Office Parks REIT – the underlying real estate is the office spaces they own and manage. The rent collected by the REIT is distributed to the unit holders. In addition to the rental income there is also the capital appreciation of the REIT units just like shares.

Though the income is not guaranteed, the REITs have to mandatorily invest 80% of their portfolio is income generating assets.

How are REITs better?

[1] Debt free way to invest in real estate

Initially the minimum lot size was 400 units, it’s now been reduced to 200 units. At CMP of Rs. 392.29/-, the minimum investible amount required is Rs. 78,458/-.

[2] Quarterly income payouts

SEBI has mandated that REITs payout 90% of the income generated and at least twice a year; the current trend is a quarterly payout. For the first quarter ended in Jun 19, Embassy paid a total distribution of Rs 5.4/- per unit.

[3] Income distributed has tax advantages

REIT income is divided into – dividends, interest (or rental income) and principal. The interest or rental income is taxable for the individual. Tax is deducted by REIT (10% for resident individuals) and TDS certificates (Form 16A) issued to the unit holders. The dividends and principal components are not taxed.

[4] Hassle free buying and selling through the stock exchanges 

The shares of REIT are traded on the stock exchanges and hence they can be bought and sold easily; however the minimum lot size has to be met.

[4] Inflation protection

US is the largest market fo REIT in the world, one of the reason being that they are steady and predictable source of income and second all rental agreements have pre-set periodic increase in rent which provides some inflation protection to the investors. 

[5] Access to commercial real estate meaning higher rental yields for individuals

Individuals have little access to commercial real estate; one way is to own the shares of the real estate companies, but they do not have the tax benefits enjoyed by REITs and hence their dividend payouts are relatively low. Commercial real estate also provides higher rental yields between 8% -10% per annum or even higher. 

For the first quarter since listing, Embassy REIT has paid out Rs. 5.40/- per unit to the investors. Their second quarter results are awaited on 11 Nov 2019.

Though they provide income from real estate without the hassles of physical ownership, REITs have the volatility of equity – the unit price listing at was Rs 300/-, seeing highs of Rs 450/- and currently at Rs. 392/- and hence carry the risk of loss of capital.

Till next post, take care!!

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