Want to diversify your portfolio? Here’s an alternative

With interest rates at all-time lows and equity prices at all-time highs, REIT can give a retail investor diversification to an alternative asset class

Want to diversify your portfolio? Here's an alternative
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In the last decade, the real estate sector saw a boom like never before and investors were jumping hand over fist to invest in properties. This culminated in irrational exuberance about the sector – in 2011.

I remember visiting a client of mine who would not accept that there was even a possibility of downside in properties. He was convinced that he could make pots of money by buying and flipping multiple properties within a year or two of purchase.

How things have changed from then! The property markets have been through some difficult times over the last decade. But has the sector started to turn around?

Here are three points to consider:

The ecosystem has improved: The government has introduced many new regulations to clean up the sector including the Real Estate Regulation Act. This has gone a long way to ensure that only quality players can survive and do business in the right manner. This is very good for all participants in the ecosystem but particularly so for end-use buyers.

Speculators are out: Demonetisation and COVID have wiped out a lot of the speculative investors in the space and that has meant more room for end users to bargain and get a good price

Affordability is up: With home loan rates at a decadal low and incomes rising, houses have become much more affordable. This is reflected in the Knight Frank Affordability index which tracks the EMI to income ratio in various cities. For example, the EMI to income ratio for Ahmedabad has fallen from 46% in 2010 to 24% in 2020. Barring Mumbai and NCR, most cities have an EMI to income ratio of around 30% or below – a decade low.

Does this mean that we are looking at a new bull market in real estate? Probably not – there still is a lot of inventory in many markets that needs to be cleared out and this should put a cap on prices moving up sharply. However, it does mean that we are starting to see a bottoming out in the sector with end user demand remaining steady.

The commercial real estate sector has mirrored this trend with steady growth in demand and restrained supply over the last few years. One good thing that has developed over the last few years is that the number of options for investors to participate in the growth of the real estate sector have expanded.

One such option is the Real Estate Investment Trust or REIT. Globally, REITs have well-established structures and good participation from investors. There are now three REITs that are listed on the Indian bourses and more to come in the pipeline. The benefit of a REIT is that it allows the retail investor to be able to invest in properties that would otherwise be inaccessible to them.

REITs are setup as trusts that pool together money from investors and invests the money in income producing real estate. Their structure is similar to that of a mutual fund having a sponsor, an asset manager and a trustee. Typically, REITs invest in commercial properties because of their ability to earn regular income from rent.

When compared with traditionally buying a commercial property, a REIT is diversified across multiple properties, has a lower ticket size, better liquidity and doesn’t have the headaches of registration and maintenance because it is professionally managed.

Today, with interest rates at all-time lows and equity prices at all-time highs, REIT can give a retail investor diversification to an alternative asset class. Yields for the REITs are relatively attractive when compared with bond yields and, after the slump in the real estate market over the last decade, capital values in major markets seem to be stabilising. REITs could thus provide effective diversification to the aggressive investor who is already invested in equites and is looking for alternative options.

Of course, this should all be done in line with one’s asset allocation and risk profile and should be thought of as part of the satellite investments in an investor’s portfolio.

(The writer is founder and MD, Kairos Capital. Views expressed are personal)