What is REIT?
A well-diversified portfolio is important to achieve optimal returns on your investments and also minimize the overall risk of your investments. To create a balanced portfolio, it is important to invest in various asset classes that have a lower correlation to each other. A majority of investors today have a healthy mix of stocks, bonds, and gold in their portfolio for the same reason. Real estate, too, is an important asset class for a well-diversified portfolio as it has a very low correlation to stocks and bonds. However, even though, investing in real estate can be rewarding, not many investors have exposure in real estate primarily because real estate investments, especially, commercial real estate require huge capital that is financially out of reach for retail investors. REIT investments provide the perfect opportunity for such investors to diversify real estate and create an additional avenue of growth and income from their portfolio without actually owning any real estate properties.
What is REIT?
REIT or real estate investment trusts are securities that trade in real estate properties. REITs are companies that own, manage or operate income-generating real estate properties and provide investors with the opportunity to invest in these real estate assets that are otherwise out of their financial reach. REITs invest in commercial spaces like offices, shopping complexes, multiplexes, hotels, etc. and create a steady source of rental income through these investments.
In a simple definition, REITs can be considered as a mutual fund of real estate, wherein investors buy shares of REIT and contribute money to a pool of funds that are professionally managed and invest the money in income-generating properties. Just like mutual funds REITs have a three-tier structure of having a sponsor- who has the onus to set up the REIT, a fund management company for selecting and operating the properties and a trustee to safeguard the interest of the unitholders. REIT investing provides an opportunity for investors to earn regular returns from the rentals and leasing income of the trust and also long-term gains by way of capital appreciation of the underlying real estate.
How does a company become eligible for REIT?
A company is not eligible as REIT only because it owns some real estate. Here are some specific requirements which it needs to fulfil to become eligible for REIT-:
- REITs must have an asset base of Rs 500 crores
- REITs must distribute 90% of their profits as dividends to the unitholders
- REITs must invest 80% of the funds in real estate that is generating income, and only 20% can be invested in under-construction properties
- REITs must update their NAV twice in a year
How does real estate investment trust work?
The real estate sector has immense potential in India and as the government is continuously working towards creating world-class infrastructure and development of the real estate. As quality properties are high on investment so they are potentially out of reach for the common man. However, investments in REIT funds enable investors of varying financial capacity to invest in the real estate sector and participate in the growth and development of the real estate and earn profits from their investment. REIT funds are the perfect gateway for investors to invest in high-quality real estate assets by making them affordable and within their reach.
Broadly speaking there are three types of REITs which currently operate in India
- Equity REITs- These REITs own large real estate properties like shopping malls, business centres, hotels, residential townships and make money by giving properties either on rent or lease agreements. The rental income earned is distributed as dividends to the unitholders
- Mortgage REITs- These REITs are not owners but provide finance to real estate projects of developers, builders, owners, etc. and earn income in the form of EMI and the Net Interest Margin is distributed as profits among the unitholders
- Hybrid REITs- These are companies which have both Equity and Mortgage REITs
What are the advantages to investors investing REIT?
- REIT investing is the simplest and least capital intensive way of investing in real estate making it affording for an average investor to invest in them
- REIT, even though, are securities but represent real-estate, that is a separate asset class, thus diversifying your portfolio which has a low correlation to stocks
- As most of the investments in REITs are in steady income-generating properties by way of rentals, they are a reliable source of income for investors looking for a steady income. Moreover, they provide the opportunity of capital appreciation over the long-term as the value of the property goes up
- Strict regulations and norms of SEBI ensure transparency in operations and decrease the chances of fraud
What are the risks of investing in REIT?
Real estate is a great asset class for long-term investment purpose, and REIT provides a great alternative for retail investors to invest in real estate directly, as in investor you should be aware of certain REIT risks associated with your investment-
- The minimum investment amount of REIT is Rs 2 lakh, which is small when compared to directly investing in real estate but still a sizeable chunk of investible surplus for many investors
- Mortgage REITs are debts used to finance debts and subject to interest rate risk and default risk of the debtors
- REITs are required to pay 90% of their income as dividends, thus leaving very little capital for the trust to acquire newer properties
- REITs invest in high investment assets and hence trading in and out of REITs involves high transaction costs
The regulatory framework for REIT in India is very stringent, and SEBI guidelines and norms for REITs ensure that the interest of investors is safeguarded at all times when it comes to REIT investments. If you are looking out for exposure in quality real estate, then REITs may be the perfect investment option for you. Reach out to our experts at IndiaNivesh, who can guide you with the ins and outs of REIT investment in India best suited for you.
Disclaimer: Investment in securities market / Mutual Funds are subject to market risks, read all the related documents carefully before investing.
Internal Rate of Return (IRR) – Meaning, Calculation & Advantages
In the world of finance and investments, very often you hear the term IRR or internal rate of return. Many a time, company officials make announcements of going ahead with a project because it is financially viable. A company uses a variety of financial tools and metrics to evaluate the commercial attractiveness of a project to make its operating and investing decision. One of such vital parameters to determine the attractiveness of the project and whether or not a company should invest its resources in it is by calculating the internal rate of return, or IRR of the project. What is the Internal Rate of Return (IRR)? Internal rate of return (IRR) is a capital budgeting technique to gauge the performance of an investment and the help determine its profitability. IRR is expressed as a percentage, and it is the discount rate at which the net present value of an investment or project becomes zero. IRR takes into account the time value of money and capital inflows and outflows over the life of the investment. As the full form of IRR suggests, it is the internal rate of return and does not take into account external factors like inflation, state of the economy, etc. at the time of calculating returns. In simple terms, IRR is the breakeven rate of a project. If the IRR of a project is high and exceeds the required rate of return, then the company will go ahead and invest in the project, but if the IRR is low and below the required rate of return, then the company will not go ahead with it. It also helps analyze and compare between different projects and how to prioritize projects based on their IRR. How is IRR calculated? Calculating the IRR of a project is not a straightforward calculation. It requires trial and error as we try to arrive at a percentage wherein the net present value of the investment will become zero. IRR of a project can be easily calculated through financial calculators or using the IRR function in excel. The formula for IRR is 0= P0 P1(1 IRR) P2/(1 RR)2 P3/(1 IRR)3 P4/(1 IRR)4 ... Pn/(1 IRR)n Where P0, P1 ... Pn are the cash flows in the period 1, 2, .., n, respectively and IRR is the internal rate of return of the investment. Here is an example to show how to calculate IRR- A company is considering the purchase of machinery to increase its sales, whose cost is Rs 3,00,000. This new machinery has a life of three years, and it will help the company generate an additional profit of Rs 1,50,000 per annum in the three years, and the scrap value, in the end, is Rs 10000. The company’s rate of return from investing the cash in other investments will fetch a return of 15%. Now, if we want to find out if buying the machinery is a better option or not, we have to calculate IRR. 0 = -Rs 300,000 (Rs150, 000)/(1 .243) (Rs150,000)/(1 .2431)2 (Rs 150,000)/(1 .2431)3 Rs10,000/(1 .2431)4 The net present value of the investment becomes zero when the IRR assumed is 24.31% which is much higher than the required rate of return of 15%. Thus, the company must purchase the machinery. What are the advantages of using IRR in investments? There are many advantages of using IRR technique at the time of analyzing investments and include- Time Value of Money is considered One of the significant benefits of using the IRR technique is that it takes into account the time value of money at the time of calculating the returns from an investment. This makes IRR credible and accurate to determine the future earning potential of the money A simple technique for analysis Using the IRR technique to assess the profitability of the project is straightforward. If the project IRR is higher than the cost of capital or required rate of return, then it is advisable to go ahead otherwise not. Helps rank and compare projects from an investment perspective When you have to make a comparison between two or more projects, IRR is useful in comparing and ranking projects depending on the yield. The project with a higher IRR is preferred. Limitations of IRR technique Even though IRR is an important financial metric in capital budgeting, it has its limitations. The major drawbacks of using IRR technique are- Project duration, size, etc. not considered One of the most significant disadvantages of IRR is that it does not take into account important aspects such as the scale of the project, time taken for completion, etc. into account at the time of comparing projects, which can be misleading. The assumption about the reinvestment rate Another limitation of using the IRR technique is that it assumes the same reinvestment rate for all the future cash flows throughout the tenure of the project, which is not practical as not all the future cash flows may have the same reinvestment opportunity. One of the best ways to overcome the limitations of IRR is that one should not use IRR in isolation but use the NPV method and IRR together in capital budgeting to understand the profitability of the project. Another option is to use the MIRR, which is the modified internal rate of return, which helps overcome the assumption of reinvestment at the same rate. Conclusion IRR plays an important role in determining the return from your investments, and if you want to use IRR in practice, then open a Demat account with IndiaNivesh and get the correct guidance from our experts to get desirable returns on your investments. Disclaimer: Investment in securities market / Mutual Funds are subject to market risks, read all the related documents carefully before investing.
What is Side Pocketing and How it affects Mutual Funds
What is Side Pocketing, and How it affects Mutual Funds? The mutual fund industry in India is growing at an exponential pace, and as an industry, it is continuously widening its investor base and also increasing its geographical spread. The market regulator SEBI plays an important role in the regulation of the mutual fund industry, protecting the interest of investors at all times and taking adequate measures as and when needed to boost investor confidence in both equity and debt mutual fund schemes. Side pocketing in mutual funds is one such measure taken by SEBI to protect the interest of investors in debt mutual fund schemes in case of troublesome debt in the portfolio of the scheme. What is side pocketing in mutual funds? Side pocketing in mutual funds is the creation of a separate portfolio within the fund’s portfolio for assets that are illiquid, risky or distressed at the moment and have been downgraded by rating agencies below investment grade. Such assets are ring-fenced from the other high quality, liquid assets in the portfolio to protect and treated differently for investment and redemption to safeguard the interest of old as well as new investors in the scheme. Side pocketing was introduced by SEBI in December 2018 after the IL&FS fiasco, where it failed to meet its debt obligations and repay its lenders and creditors. This, in turn, put significant pressure on various mutual fund schemes that had IL&FS papers as a part of its holdings. The complete mayhem resulted in substantial volatility in the debt and money market instruments resulting in redemption pressure in mutual fund schemes. High-quality, liquid assets in the schemes were sold by the funds to meet redemption requests resulting in increasing the exposure of remaining investors in the illiquid assets. Side pocketing mechanism is allowed only in debt mutual fund schemes. How does it side pocketing work? Whenever a debt instrument is downgraded by credit rating agency from an investment grade to a non- investment grade, the mutual funds have an option for creating a side pocket and segregating illiquid assets from the high-quality liquid assets. The existing investors are allotted units in the leading portfolio and segregated portfolio on a pro-rata basis. No redemption and subscription are allowed in the segregated portfolio. Moreover, SEBI makes it mandatory for the fund to list the segregated portfolio on the stock exchange within 10 days to provide an exit window to the existing unitholders. Depending upon their outlook, investors can either continue to hold their investment in the segregated portfolio or choose to exit at the prevailing rate. Any future recovery from the illiquid assets is credited in the side pocket portfolio and paid to the unit holder in proportion to his holdings. Side pocketing impact on mutual funds and AMCs Side pocketing aids mutual fund schemes from selling quality assets in its portfolio to meet sudden redemption pressure in a panic situation. Creation of side pockets help insulate the remaining portfolio from troublesome debt To ensure that mutual funds do not misuse side pocketing, SEBI also suggests a list of safeguards that AMCs may implement. Benefits of side pocketing in mutual funds Over the last few months, many debt mutual fund schemes have side pocketing a portion of its portfolio if the ratings of the investment paper in its holdings have been downgraded by the credit rating agency. Side pocketing is important to protect the interest of retail investors in case of illiquid assets because credit defaults accompanied by information asymmetry, results in institutional investors taking advantage of the situation. The benefits of side pocketing in mutual funds include- It is an important mechanism to ensure stability and reduce volatility in the debt market by addressing the issue of redemption pressure in case of troubled assets It prevents distressed assets from hampering the returns generated by high quality, liquid assets At the time of selling the segregated assets, only those investors who have units in segregated assets on the record date are entitled to the proceeds, thus ensuring a fair treatment To avoid unfair advantage of lower valuation, fresh inflows are allowed only in the non-side pocketed portfolio As side-pocketing helps curb redemptions, it helps in stabilizing the net asset value (NAV) of the scheme In case of a situation arising due to sudden illiquidity, it provides cushioning to the portfolio. The most significant benefit of side pocketing is that all investors, retail or institutional are treated at par CONCLUSION Globally, side pocketing is one of the best mechanisms to protect the interest of investors, and SEBI as a regulator ensures that it takes timely measures and imposes adequate regulations for the AMCs to safeguard the interest of investors at large. If you have any specific query or doubt about side pocketing in mutual funds schemes, contact our experts at IndiaNivesh for guidance. Disclaimer: Investment in securities market / Mutual Funds are subject to market risks, read all the related documents carefully before investing.
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