To Invest in REIT, or not to Invest in REIT; that is the Question.

This post has been authored by Priyanka Mulraj Jesrani, Financial Research and Analysis intern at Arthashastra Intelligence

Inflation is a measure of the rate of rising prices of goods and services. It leads to higher prices for basic necessities and can be a serious concern since the money saved today is less valuable tomorrow. The possibilities of third Covid-19 wave and inflation already being a concern, holding a diversified portfolio of investments that provide a good hedge against the rising inflation is a strong need of the hour.

Real Estate Investment Trust (REIT) is a company that owns commercial real estate or related assets. REITs provide a way for individual investors to earn a share of income produced through commercial real estate ownership; without owning one and worrying about the down payment and interest. There are three publicly listed REITs- Embassy office Parks, Mindspace Business Parks and Brookfield India. There are currently no private REITs in India but DLF and Godrej are expected to introduce. Office REITs lease space to multiple tenants and have long leases. The relatively low correlation of listed REIT stock returns with the returns of other equities and fixed income investments also makes REIT a good portfolio diversifier. SEBI has brought down the minimum application value within the range of ₹10,000 – ₹15,000 and revised the trading lot to one unit. The Union Budget 2021 has scrapped the dividend distribution tax (DDT) for companies and shifted the tax burden to investors at slab rates. This can make some investors disinterested in buying REITs. And the advance tax liability on dividend income shall arise only after declaration/payment. The analysis of three REITs based on investment risk, market risk, valuation and sustainability of growth rate for short- and long-term investors is shown below:

Standard Deviation

It is a statistic that measures the volatility of the standalone investment. Using the daily closing price of stocks of each of the trusts from 1 January to 30 August 2021, the calculated standard deviation of the trusts is shown below. Mindspace Business Parks is the most volatile REIT. On the other hand, Brookfield India is the least volatile with standard deviation of 13.7. For risk averse investors, Brookfield India would be a better pick. But higher risk also tantamount to higher expected return.

Beta and Adjusted

Beta measures the systematic risk of security compared to market as whole. Using the S&P BSE Sensex and daily closing price, the calculated beta of REITs from the date the stock has been listed is shown below. Brookfield is the most sensitive to market movements. The Adjusted beta using the Vasceik model to estimate long term market movements of REITs has also been computed. Embassy Office Parks and Brookfield India have an adjusted Beta close to 0.6, which makes it more sensitive to market fluctuations. Therefore, Mindspace business Parks is a good investment if your future market outlook is volatile.

Funds From Operations per share (FFOPS)

FFOPS measures the cash generated by REITs and represents the value of earnings. It is regarded as the best method to determine REITs profitability and earnings growth. FFO is better at determining value of REIT compared to Net Income because depreciation is an acceptable investment cost. Embassy Office Parks has the highest FFOPS which means that it’s also the most profitable REIT. Whereas Brookfield India has lowest FFOPS and currently the least profitable.

Price to Funds from Operations per share (P/FFO)

P/FFO is a good measure to evaluate whether the REIT is under or over- valued compared to its peers. Using the closing price of 30 August, 2021, the average of P/FFO- is 22.9. Mindspace and Embassy Office Parks seem to be relatively undervalued.

Sustainable Growth Rate (SGR)

It is the maximum growth rate that a company can sustain without having to finance the growth with equity or debt. The SGR has been computed using the DuPont decomposition. This allows us to analyse what drives the changes in ROE and isolate effects of operating and financing activities. Using 2020-2021 data, Brookfield India has the highest sustainable growth rate at 1.52%.

Embassy office Parks has the highest tax burden ratio which means they are keeping most of their pre-tax income. They have 100% Interest burden ratio, which means they have no debt in their structure. They also have the highest EBIT margin or the operating performance ratio. And also has the highest financial leverage which makes it the riskiest as most of the assets are financed by equity. Mindspace Business Parks is the most efficient at using their assets to generate revenue with highest Total Asset turnover ratio.

Mindspace Business Parks has been giving the highest dividends whereas Brookfield reinvests all of its dividends.

A diversified portfolio looks different to everyone, depending on your risk preferences and term of investment. If you’re a long-term investor with low-to-high risk affinity then Embassy office Parks should interest you. On the other hand, if you’re a short-term investor and want to take advantage of relatively under-valued, high dividend pay-out and a volatile REIT- Mindspace Business Parks is for you. In conclusion, investments are subject to market risk and cannot be controlled. Please make decisions wisely.

References

http://www.differencebetween.net/science/mathematics-statistics/difference-between-beta-and-standard-deviation/ https://corporatefinanceinstitute.com/resources/knowledge/trading-investing/adjusted-beta/ https://www.investopedia.com/terms/s/sustainablegrowthrate.asp https://www.millionacres.com/real-estate-investing/reits/reit-investing-101/7-valuation-metrics-you-need-to-know/ https://www.etmoney.com/blog/everything-you-need-to-know-about-real-estate-investment-trusts-reits/