REITs Demystified: From Basics to Smart Analysis

What Are REITs?

A Real Estate Investment Trust (REIT) is a company that owns, operates, or finances income-generating real estate. These may include office complexes, shopping malls, warehouses, residential apartments, and hospitality properties. REITs pool funds from numerous investors, enabling them to access high-value commercial real estate assets that would otherwise be unattainable for most individuals.

For example, instead of purchasing an entire commercial office space in a prime location, an investor can gain exposure to such properties through a REIT with a relatively small investment. In return, the investor receives a share of the income generated by the underlying assets.

How Do REITs Generate Returns?

REITs earn revenue primarily through rental income, lease payments, or interest from real estate financing. A significant portion of this income is distributed to investors in the form of dividends.

In India, the Securities and Exchange Board of India (SEBI) mandates that REITs distribute at least 90% of their net distributable cash flows to unitholders. These distributions are typically made on a quarterly basis, offering investors a consistent income stream.

For instance, if a REIT owns a business park leased to corporate tenants, the rental income collected is periodically distributed to investors in proportion to their unit holdings.

Regulatory Oversight and Transparency

REITs are highly regulated investment vehicles. In the United States, they are registered with the Securities and Exchange Commission (SEC), while in India, they operate under SEBI's regulatory framework.

Indian REITs are required to invest at least 80% of their assets in completed and income-generating properties, ensuring greater stability. Additionally, since REITs are listed on stock exchanges, they provide enhanced transparency and liquidity, allowing investors to buy or sell units much like any other listed security.

Types of REITs

REITs are generally classified into three categories:

1. Equity REITs – These directly own and manage income-producing real estate.

2. Mortgage REITs (mREITs) – These provide financing for real estate by purchasing or originating mortgages and mortgage-backed securities.

3. Hybrid REITs – These combine both equity and mortgage investment strategies.

4. Publicly listed REITs – These are publicly listed on exchanges and are regulated by securities regulators. Due to being publicly traded these are highly liquid and available to retail investors.

5. Public Non-Listed REITs (PNLRs) – These REITs are registered with regulators but not traded on stock exchanges. They typically raise capital through intermediaries and are less liquid, often locking in capital for several years.  

6. Private REITs – They are not registered or listed, and are usually offered to institutional or accredited investors. They offer greater flexibility in asset strategy and structure but come with high investment minimums, lower transparency, and higher risk.

In India, Equity REITs are the most prevalent. There are four listed REITs in India which are: Brookfield, Embassy REIT, Mindspace and Nexus select trust.

As provided on IRA (Indian REITs Association)

Risks and Considerations

Despite their benefits, REITs are not without risk. Their market value may fluctuate based on interest rate movements, sector-specific economic trends, and overall market performance. Investors should evaluate a REIT's portfolio composition, dividend history, and regulatory disclosures before investing.

 

Real Estate Investment cycle

I'm sure almost everyone is familiar with the economic cycle. Similarly, there is a cycle specific to real estate prices, which include:

Phase 1: Recovery – The Quiet Rebound

After a downturn, the market enters a recovery phase, often marked by high vacancy rates, little to no new construction, and muted investor interest. In this phase, many of the properties will be undervalued and available at a discounted price.Early signs of improvement include stabilizing rents and falling interest rates. I suggest looking out for the early signs of improvement and investing then, but taking into account one’s cash flows is essential as this phase comes right after a recession.

Phase 2: Expansion – Growth Picks Up

Confidence returns as demand rises, rents increase, and vacancy rates drop. Developers ramp up construction to meet growing demand, and investors feel more optimistic. This is usually the most favorable time for investment, particularly in income-producing properties.

Phase 3: Hyper Supply – When Growth Overshoots

Eventually, new supply catches up and sometimes overshoot the demand. Vacancy rates begin rising again, rent growth slows, and investor sentiment cools. Despite the warning signs, some developers continue building based on earlier projections. It is essential to be cautious in this phase and reallocate or rebalance portfolio into defensive assets like REITs of necessity based properties.

Phase 4: Recession – The Market Contracts

At this point, vacancy rates peak, property values decline, and transactions slow. Overbuilding from the previous phase leads to excess inventory. Many investors face losses, and construction nearly halts. It may seem like the worst time to invest, but this phase often offers long-term value buys, especially for those with liquidity and a high-risk tolerance.

How to Use the Cycle Strategically

Successful real estate investing isn’t just about buying and holding, it’s about understanding the right move at the right time.

● During recovery, consider repositioning or value-add strategies.

● During expansion, look for stable yield-generating assets.

● During hyper supply, reduce exposure to risky sectors or exit selectively.

● During recession, prepare capital to buy when prices bottom out.

This framework applies whether you're investing directly in property, via REITs, or through fractional platforms. For instance, listed REIT markets often move ahead of the physical market, offering early signals of cycle shifts. Keeping track of macro trends such as inflation, interest rate changes, or consumer sentiment can help pinpoint the phase we’re in.

Where Are We Now in the Cycle?

According to CBRE Investment Management and other industry reports, different geographies and sectors are in different phases simultaneously. For example:

● Industrial/logistics real estate in India may still be in an expansionary phase.

● Office real estate in urban centers could be entering a hyper-supply or even recessionary phase due to hybrid work trends.

● Residential markets may be recovering faster due to rising demand in Tier 2/3 cities.

Timing Isn’t Everything, but It’s Close

Understanding the real estate cycle empowers investors to time entries and exits better, manage risk, and allocate capital more wisely. While predicting exact phases isn't foolproof, recognizing the indicators of each phase allows for more informed, data-backed decisions.

So, before jumping into your next property-related investment, ask not just “what” and “where,” but also “when.”

Basic Analysis

REITs are analyzed like other stocks, but the metrics relevant to them are different. Ratios like P/E and EPS are not suitable for comparing REITs.

Why?

This is because REITs are required to distribute 90% or more of their taxable income to shareholders as dividends, resulting in lower reported net income figures. Instead, REITs are evaluated based on the total funds generated through operations, providing a clearer picture of the returns to investors. Metrics like Funds From Operations (FFO) and Adjusted Funds From Operations (AFFO) are more appropriate in this context.

If EPS and P/E do not paint the entire picture then what does?

Funds from Operations (FFO) is a key performance metric used to evaluate the operating performance of Real Estate Investment Trusts (REITs).  

FFO = net income + amortization + depreciation - capital gains from property sales

This adjustment is necessary because depreciation and amortization are non-cash expenses, and gains from property sales are not recurring, making net income a misleading indicator of performance.  

However, FFO does not account for capital expenditures, such as repairs or upgrades, which are critical for maintaining property value and operations. That’s where Adjusted Funds From Operations (AFFO) comes in.  

AFFO = FFO + rent increases - capital expenditures - routine maintenance amounts

AFFO provides a more conservative and realistic estimate of the cash available for distribution to shareholders, as it deducts ongoing capital costs and adjustments needed for long-term property sustainability. It is a widely used metric for assessing a REIT’s ability to sustain and grow its dividend payouts.

Net asset value (NAV) and Debt to equity (D/E) are often used to analyse REIT investment opportunities. NAV estimates the market value for REIT holdings. It is an objective ratio and compared how a REIT is trading compared to private market value of its real estate holdings.

Whereas the D/E for real estate companies ranges from less than 1.0 to more than 8.0 . A ratio of 1.0 indicates an equal amount of debt to equity; less than 1.0 means more equity than debt; more than 1.0 means more debt than equity.