Indian REITs are primarily skewed toward IT-occupied assets. As the government prepares to disinvest in different classes of assets, these funds would gain more traction and REITs can become more broad-based, finds E Jayashree Kurup. Premium A grade commercial space has become a tradable asset, thanks to three successful REITs operating in the country. These work in IT-driven economies such as Bengaluru, Mumbai, Pune, Hyderabad, Chennai, Gurugram, Noida and Kolkata. With the IT sector hiring double the workforce in the past year as compared to the last five years, the sector seems poised to grow further. Currently, all three REITs are operating at over 90% occupancy with regular lease rentals coming in and keeping the returns steady. Most of the property are in secondary business districts (SBDs) with lease values in the Rs 35-50 per sq ft range, in large format integrated tech parks. As a result of the introduction of this asset class, a large number of premium A grade assets across cities, populated largely by multinational corporations from the IT sector, have been aggregated into portfolios of income generating assets. This has translated into three REITs so far - The Blackstone-Embassy REIT which has 80% assets in Bengaluru and others in Mumbai, Pune and Noida; the K Raheja-sponsored Mindspace REIT which has properties in, besides Mumbai, also in Pune, Chennai and Hyderabad; the latest entrant, Brookfield India REIT, whose properties are in Gurugram, Noida, Mumbai and Kolkata. Mindspace and Brookfield - These aggregate mostly completed assets with well tenanted space that yield regular monthly rental income from clients who are locked in for the long term.They are mostly in locations which are most suited to the IT sector where tenants know that if they vacate, they may not be able to find a similar space, if any at all. They are mostly 85-95% tenanted and even during the pandemic there were no significant exits from these properties. “Since most of these are integrated complexes, the F&B outlets, food courts and hotels in the complexes also contribute to the monthly income,” says Michael Holland, CEO, Embassy REIT.  With 86 million sq ft under management by the three AAA-rated REITs in India and a combined market capitalisation of Rs 580 billion, it seems a winning proposition. Since 2019 they have raised Rs 167 billion in primary equity and distributed Rs 53 billion. Any domestic, foreign, retail or institutional investor can purchase REIT units. They are listed on the stock exchanges and investors can buy shares of REITs like any other shares on the stock exchange, through demat accounts, with no minimum trading requirement. They can be bought and sold on NSE or BSE, either online or through a registered broker or in a REIT IPO, upon listing. REITs are highly regulated and must pay out at least 90% of the Net Distributed Cash Flows semi-annually. They are a hybrid product between yield-oriented fixed income generating assets and capital appreciation-oriented equity products.With this type of portfolio, the REIT earnings are from rental income generated by the underlying assets in the portfolio. The asset quality is high-quality institutional grade commercial properties in key metro cities that attract premium rentals. Indian REITs are primarily skewed toward IT-occupied assets. This is backed by the projection that the Indian digital economy has grown from $200 billion in 2017-18 to an estimated $1 trillion in 2025. Digital services as a percentage of all services is estimated by Nasscom to grow from 29% in 2020 to 58% in 2025. This is reflected in the 82% growth in the number of employees from 2020 to 2022. As the three REITs pick up large-format, AAA rated integrated tech parks, parallelly, there is another class of investment option in commercial real estate by retail investors that is rapidly opening up. This is fractional ownership - the underlying principle of REITs. Large commercial owners such as Morphogenesis, which has been designing and constructing IT spaces across cities, have invested into the property they have constructed, again primarily for the IT sector. But to expand this business, they have invested in funds in private equity format. The starting investment benchmark is Rs 25 lakh. They function as Private Equity fund formats but do not report to either SEBI or RBI as a regulator. Commercial real estate is a hard asset and provides lucrative returns, says Aryaman Vir, Founder and CEO, MYRE Capital. Vir’s venture is supported by Morphogenesis, which invests alongside other fractional ownership investors, to the tune of 12.5-35% of the stock. Since it already has premium AAA rated stock in its portfolio, it has the confidence to mix assets of lower grade in the portfolio, for higher returns. Unlike REITs, Myre Capital chooses property largely for its future value. “It depends on the micro market, the quality of the building and the vacancy rates in the micro market,” says Vir. “In a mature micromarket like the Bandra Kurla Complex (BKC) in Mumbai, the risk is much lower than buying an office building in the suburbs. So, for a B grade building in the suburbs, which has significant risk, the investors would ask for a return of say 11%. With a very strong asset like maybe a Deloitte as an anchor tenant, the sellers may ask for as low as 7%. Value depends on the amount of risk you are taking. As a ballpark figure, across A grade assets, returns are about 8-9%, sometimes even 9-10% - it all depends on the risk as perceived by the seller.” Vir is in the business of identifying and aggregating commercial real estate with a potential of high returns. He has recently picked up the commercial RE portfolio of Magarpatta City. While Morphogenesis backs MYRE with funds, the bulk of the investment comes from investors, including funds and HNIs. They get fractional ownership and monthly returns of 8-10%. “Commercial real estate is a very lucrative asset class,” says Vir. “By allowing retail investors to own fractions of it, it becomes affordable to each owner and it helps mobilise money from many retail investors.” By collateralising these hard assets, agencies like MYRE are making it a competitive asset with equity as well. “Real estate appreciates over time as well. Our business is more in line with equity but the risk profile is more in line with debt.” Since the investment required is upwards of Rs 30-40 crores, fractional ownership seems the way forward. So why not just start another REIT? Vir believes that unlike REITs, which are strictly monitored, aggregators like him have the freedom to scout for B or even C grade properties in premium markets, which may be smaller in size than tech parks. “So, in a B grade building in the suburbs, which has significant risk, investors would ask for a return of say 11%.” Unlike REITs, which are relatively insulated from risk, fractional ownership offers a higher rate of return for a higher risk appetite. Vir tries to understand the dynamics of that micromarket. The underlying aim is the same - that investor should have stable and long-term returns. As an integrated township, Magarpatta was a great development with a walk to work concept. It is an insulated micro market with vacancy under 2%. Even during Covid, there was not a single drop in rental values. The tenant knows that if they vacate, it would be very difficult to get space again. But these players also pick up C and B grade properties in an A+ grade micro market and convert them to paying assets. “We also look for B grade buildings with low rentals. We then focus on the dynamics of the micro market and enhance the property to make it competitive. But Brookfield and Blackstone don’t look for properties with development or construction risks. They come at the final process stage, when they can invest the capital, they raise at 4% to get a return of 8-9%.” “Brookfield, Blackstone and Hines Capital are picking up the most flagship developments in the country. Rental yield is inversely proportional to the price. When the rental yield comes down, the price of the property goes up,” Vir says. As the government started facilitating foreign funds, prices did go up. In most developed countries, the cost of capital is 4-5%. They are deploying it in CRE with a return of 12-13%. REITs have increased prices but also increased the quality of real estate and made the segment more organised.So what is the significance of all this fractional and REITs ownership and aggregation of commercial real estate? The market has started consolidating. In a market where structured funds were in short supply, good property or real estate with future potential has institutional buyers. Developers can exit the management role and focus on building better after meticulous micro market research. Also, as the government prepares to disinvest in different classes of assets, these funds would gain more traction and REITs can become more broad-based as it is in the global markets. Warehousing, healthcare and even institutional residential assets may come into the REITs fold. E Jayashree Kurup is Director, Wordmeister Real Estate & Cities. She is a property writer and researcher. She can be contacted at jkurup@Asapmedia.com