How to evaluate the right SM REIT to invest in?

Real estate investment trusts (REITs) have emerged as a popular investment option for people seeking exposure to the commercial real estate market. But with the introduction of small and medium-sized REITs (SM REITs) in India, investors now have a more granular approach to investing in this asset class. Unlike traditional REITs that pool funds to invest in a diversified portfolio of properties, SM REITs allow investors to target specific income-producing real estate assets. This granular approach can be attractive to investors seeking greater control over their real estate investments, similar to owning assets outright.

The rise of small-cap REITs in India

The Securities and Exchange Board of India (SEBI) introduced a consultation paper for small-cap REITs in 2023, which was followed by the issuance of final regulations in March 2024, opening the doors for a wider range of investors to participate in the commercial real estate market. This targeted access to specific assets comes at a much lower minimum investment amount (₹10 lakhs) as compared to direct investments (which typically start from around ₹20-30 crore), making it more accessible to potential investors.

Last week, Property Share (www.propertyshare.in) became the first fractional ownership platform (FOP) to receive the Small and Medium Real Estate Investment Trust (SM REIT) license from SEBI under the name Property Share Investment Trust (PSIT). Property Share will become the investment manager of PSIT.

Factors to consider when evaluating SM REITs

While small-cap REITs open up new investment opportunities, it is important for investors to be diligent about the underlying asset before adding them to their investment portfolio. Below are some of the key parameters:

• Location: It is arguably the most important factor in any real estate investment. Prime locations in major cities with good connectivity and infrastructure are often preferred for commercial assets. Furthermore, the location should have high occupancy rates, indicating strong demand among prospective tenants, should a tenant vacate its premises.
• Supply/demand dynamics: It is important to understand the expected demand and future supply in the location. Compared to demand, if a micromarket sees a much higher future supply, vacancy increases, which puts significant downward pressure on rents as it gives bargaining power to tenants to renegotiate rents. This data is regularly published by research teams at large international real estate consultancies (IPCs) such as JLL, CBRE and Knight Frank, which can serve as a guide for investors.
• Asset quality: Asset quality is extremely important, as the best quality tenants tend to occupy the best quality assets. A-rated properties have impressive double or triple height lobbies, quality amenities, LEED or IGBC certification and are built by A-rated developers. In addition, an investor should physically visit the asset, if possible, to verify both the quality of the asset and the location.
• Tenant Quality: A-grade tenants such as Fortune 1000 or Indian Top 100 companies are always preferred as they make significant investments in their office space (including fit-outs, custom designs, etc.) which increases loyalty. Also, multinational tenants ensure that rent payments are made on time and are therefore quite reliable.
• Lease structure: In a typical commercial lease, the tenant has a tenure for a short period (3-5 years), while the landlord has a tenure for the entire lease term (5-9 years). During the tenure period, the party with a tenure cannot terminate the lease. Investors should look for small-cap REITs where the tenure period is at least 2-3 years or where the residual lease term is medium to long term (5-9 years).
• Property Type: Small-cap REITs can invest in a variety of property types such as offices, retail, hotels, etc. Investors need to understand the economic factors driving each of the asset classes. For example, while the rise of outsourcing has been one of the main drivers of demand for offices in India over the past decade, shopping malls and brick-and-mortar retail stores are primarily driven by growth in domestic consumption.
• Management experience: A strong and experienced management team is essential to the success of any SM REIT. Investors should research the team’s track record and its track record of investing and exiting assets. A strong team with proven capability in investments and asset management bodes well for the success of the SM REIT.

Small-cap REITs offer an attractive opportunity for investors looking to invest in income-producing commercial assets, particularly for those investors who wish to choose the assets and micro-markets in which to invest. By carefully evaluating the factors mentioned above, investors can select small-cap REITs that align with their investment objectives and risk profile.