Can residential REITs succeed in India?

October 8, 2014 / By  

If I say that REITs are currently one of the most discussed topics in India real estate, it will not be an exaggeration. Since July 2014, when the government paved the way for REITs in India, it has had a widespread following, just like the flash sale of Xiaomi mobiles. Out of curiosity and professional interest, I was going through various documents on the topic. While doing some data crunching, one fact I came across was that 16% of equity REITs in the USA are residential REITs. The next moment, a question came to mind – Can residential REITs succeed in India?

I believe the answer is NO, at least for the time being. For any investment option to succeed, it needs to provide returns higher than the opportunity cost. In the USA, residential REITs yielded an average return of 6.4% between 1994 and 2013, which is largely comparable to the return of 6.8% from office/industrial REITs. Further, ten-year US generic bonds have offered returns of 4-4.5% over the same time period, substantially lower than REIT yields, adding to the attractiveness of residential REITs in the USA. India is witnessing a contrasting scenario. While office assets are yielding an average return of 9-10%, residential assets yield 3-4%. The residential returns are considerably lower than even the risk-free 8.5% from ten-year government security bonds, making investment in residential REITs a no gainer.

Then why is the gap between returns from both asset classes in India so large? The answer lies in the ownership pattern. In the case of office assets, as high as 89% of Grade A assets are leased versus only 11% owner-occupied, demonstrating the huge demand for leased assets and hence higher yields. Traditionally, residential assets have carried a high emotional value in India, and hence the majority has preferred to stay in an owned, rather than rented, apartment. In the absence of hard data, I believe more than 90% of residential assets in India would fall under the owned category. This high demand for owned apartments has led to the huge gap between capital values and rental values for residential properties, resulting in lower rental yields.

Does that mean that residential REITs can never see the light in India? The answer is NO. Thanks to the ever-increasing capital values of residential properties in recent years, buyers have started to find owning an apartment less affordable. Further, in search of better job opportunities and lifestyle, the younger generation has become more mobile, and hence demand for rental properties is increasing. The government had started rental housing schemes, but did not meet with the expected success due to various reasons, such as high land cost, taxation policies and distance from business districts. While higher incentives for rental housing development coupled with an incentivised taxation system can take care of supply related bottlenecks, an increase in demand for rental apartments can lead to a reduction in the gap between capital values and rental values, resulting in increasing yields and a stronger case for residential REITs in India. So yes, residential REITs can succeed in India, but the change will be steady and will take at least another 7-10 years.

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