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Kotak International REIT Fund of Fund review: Should you invest?

Real estate has always been one of the most favoured sectors for Indian investors. And, as with gold, the desire for owning properties in digital form is also gaining ground with the coming of real-estate investment trusts. Now, a new ‘Kotak International REIT FoF,’ has been rolled out. It is the first Real Estate Investment Trust (REIT) focused mutual fund in India. This fund of funds (FOF) scheme will invest its entire corpus in an international scheme that will invest in REITs across the Asia Pacific region (excluding Japan).

What is it about?

Kotak International REIT FoF will invest in ‘SMAM Asia REIT Sub Trust Fund,’ which is managed by Japan-based Sumitomo Mitsui DS Asset Management Company. SMAM Asia REIT Sub Trust Fund is one of Asia Pacific’s largest REITs with exposure to Singapore, Australia and Hong Kong.

Simply put, a REIT is an investment trust or a company that invests in rent-generating properties. Any property developer or a builder that owns a land parcel can roll out a REIT. Now, a REIT can own, operate and lease multiple properties. REITs are listed and traded in the exchanges. Think of it as a property from which you’d like to earn a rental income. Instead, you can invest in a REIT, which itself owns and leases out properties and earns rental income, which it then passes on to you. REITs are a convenient way to hold real estate in your portfolio, without physically owning a property.

According to SEBI regulations, at least 80 percent of the value of REIT assets are to be invested in completed, and rent and/or income-generating real estate. The remaining 20 percent can be deployed in under-construction properties, debt of developers and other instruments as prescribed by the regulator. SEBI also mandates the distribution of a minimum of 90 percent of the net distributable cash flow of a REIT to unitholders. In other words, investors earn income from capital appreciation (REITs are listed on stock exchanges) and dividend income (rents).

Currently, only Embassy Office Parks and Mindspace Business Parks are listed in India.

You can either buy listed REITs directly on the stock exchange or go through a mutual fund that invests in REITs.

What works

A REIT is a good way to diversify in real estate. Typically, returns don’t move much in tandem with equities, so it offers diversification. In 2019, the underlying fund gave 26 percent returns; Nifty 50 delivered 13.5 percent. So far this year, the underlying fund managed 5.5 percent returns, while the Nifty 50 gave 13 percent.

Lakshmi Iyer, President, CIO Debt & Head-Products, Kotak Mahindra AMC says that the fund has gone international due to the lack of opportunities in India. “The Asia Pacific region is expected to see a massive demand in real estate, backed by growth in consumer spending, urbanization and being the epicentre of global trade,” she says.

The underlying fund is also well-diversified and earns rental income from a variety of sectors: healthcare (1.3 percent), industrial (34.3 percent), office (3.9 percent), retail (23.7 percent), diversified (23 percent) and storage (2.2 percent). The portfolio is diversified across sectors that are least impacted by the COVID-19 disruption.

Vinod Jain, Founder-Jain Privy Client says, “Kotak International REIT fund provides access to high yielding real estates and it is suitable for high risk taking investors wanting to diversify out of fixed income, equities and precious metal into another asset class.”

Dividend yields of REITs listed in the Asia Pacific region are higher than those traded in developed markets. According to the AMC’s presentation, dividend yields of REITs in Hong Kong, Singapore and Australia are 5.3 percent, 4.7 percent and 4.3 percent, respectively, which are relatively higher than those in the US (4.4 percent) and UK (2.8 percent). Dividend yield is one of the metrics that the investor should consider while investing in a REIT. So, a REIT with higher dividend yield is desirable. Currently, the dividend yield of the underlying SMAM Asia REIT Sub Trust Fund is 4.3 percent.

International funds are taxed as debt funds. Long-term capital gains tax is applicable at 20 percent with indexation on the profit, if you sell units after 36 months. Capital gains are added to your income and taxed if the holding period is less than 36 months.

What doesn’t

Like any overseas fund, there is currency risk. If the Rupee appreciates against the underlying currencies, you suffer a loss, though the chances are low. Rupee is generally a depreciating entity against major global currencies.

The prospect of capital appreciation is low in REITs, as they distribute as much as 90 percent of their earnings to investors and reinvest the remaining 10 percent into their ventures. A REIT’s price moves depending on how investors perceive rental yields and the quality of the underlying portfolio. An economic recovery and hopes of vaccination spelt good news for REITs in November, as things moving back to normal means office spaces getting occupied again. But to this scheme’s credit, it has diversified across areas that can benefit in pandemic times too, such warehouses, e-commerce and healthcare.

What should you do?

Kotak International REIT FoF is suitable for seasoned investors who have exhausted regular options. If you are beginning to invest in mutual funds, then start by investing in diversified equity and debt schemes, first.

Those with well-established and diversified portfolios can invest up to 5 percent in REIT funds such as this one. Returns would be moderate, but REIT funds can be more volatile than debt schemes.

The new fund offer period closes on December 21, 2020, after which it becomes an open-ended scheme.