Retirement planning these days doesn’t simply involve putting your money in fixed deposits (FDs) or increasing the share in retirement funds like provident fund (PF), National Pension System (NPS), etc. Nowadays, investing methods have expanded, and so have your options. One option that is gaining traction is the Small and Medium Real Estate Investment Trusts (SM REITs). These investments can offer unique benefits but come with their own set of risks. Here’s a look at whether SM REITs should be a part of your retirement portfolio.

Benefits and Risks Associated With SM REITs

SM REITs are a new asset class introduced by the Securities and Exchange Board of India (Sebi) in March 2024. They allow investors to invest in commercial real estate.

Kunal Moktan, CEO and co-founder of Property Share, a technology platform that provides access to institutional and leased commercial properties, says SM REITs have the following benefits and risks.

Benefits of Investing In SM REITs

Higher Yield: With SM REITs, investors can enjoy higher post-tax yields than regular REITs and other investment options like FDs. Additionally, with foreseeable quarterly distributions, investors can use this product effectively for passive returns.

Investment Decision: REITs are pooled vehicles with large portfolios. Their investment decisions are made by corresponding investment committees, which expose investors to corporate governance issues. “SM REITs will allow investors to pick and choose their investments, allowing them to enter into specific assets as per their risk profile,” says Moktan.

Capital Appreciation: As SM REITs allow investors to invest in individual assets, they can enjoy capital appreciation in the form of an increase in the SM REIT unit price as the rentals increase.

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Risks of Investing In SM REITs

Higher Tenancy Risk: Investors must be cautious of SM REITs compared to regular REITs, as there is a higher tenancy risk given that an SM REIT will typically have a small (1 or low single digits) number of tenants. “However, investors can invest in multiple SM REITs in different geographies and with differing tenant portfolios to reduce this risk,” informs Moktan.

Lower Liquidity: “SM REITs will have lower liquidity on the stock market than regular REITs since the ticket size is larger at Rs 10 lakh and because it is a new product and will take some time for investors to warm up to. Hence, investors should only invest with a 3-5 years horizon,” Moktan suggests.

Would SM REITs Be A Good Fit For A Retirement Portfolio? 

SM REITs or a portfolio of SM REITs can be a good fit for an individual’s retirement portfolio. Moktan lists the following reasons why investors can invest in them for their long-term goals:

Income Generation: Retirees can enjoy quarterly income distributions with good visibility over 3-5 years. Most commercial leases have a lock-in period of 3+ years. Investors should look for the remaining lock-in period before investing in an SM REIT.

Inflation Hedge: Commercial leases have contracted rental escalation obligation (typically at 5 per cent annually or 15 per cent every three years). This ensures the returns from SM REIT will be protected from inflation. This becomes especially important since India doesn’t have products like inflation-linked bonds, which are prevalent in developed markets like the US and Europe.

Diversification: SM REITs offer investors an opportunity to diversify into commercial real estate, an asset class typically not in any retiree’s portfolio. Not only this, SM REITs allow investors to invest in different geographies and commercial real estate of their choice, like office, retail, or hospitality.

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How Resilient Are SM REITs Than Other Investments?

During an economic downturn, SM REITs will be more resilient than other investments as the underlying real estate is generally more resilient. Some factors contributing to the resilience are:

Tenant Quality: Grade “A” assets are typically leased by multi-national companies (MNCs) and large Indian companies, which usually have high “stickiness”. Hence, SM REITs with underlying Grade A assets will remain more resilient even during an economic downturn.

Lock-in Period: Most commercial leases have a lock-in period during which the tenant cannot vacate the premises until the lease expires. This means that even in a poor economic market, investors have visibility into their returns, making SM REITs an attractive investment class.

Completed Tangible Asset: The underlying real estate in an SM REIT is a completed pre-leased asset. In an economic downturn, a well-chosen Grade A asset in a low vacancy micro-market, investors’ downside is fairly protected. It is because, even if the tenant occupying the asset vacates the premises, the asset can be released at a similar or slightly lower rental.

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How Do SM REITs Compare With Other Real Estate Investment Options?

Higher Yields: Compared to regular REITs, SM REITs offer higher yields, making them more attractive for investors.

Ease of Holding: SM REITs typically have an asset management team that manages the asset. Directly holding real estate is cumbersome for most investors as managing the asset is time-consuming and requires technical expertise. 

Tax Benefits: SM REITs are allowed to structure their investment as a blend of dividend, interest, and repayment of shareholder loans. This provides an opportunity to reduce tax burdens compared to directly investing in commercial real estate, where returns would be taxed at the slab rate.

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Common Mistakes Investors Should Avoid In SM REITs

According to Moktan, investors should be thorough with their research on the underlying asset, the micro-market, the tenant, and the lease structure before investing in SM REITs. Additionally, they should invest in multiple SM REITs to minimise risk, thereby creating a diverse portfolio. 

Also, investors should invest with an outlook of at least 3-5 years, Moktan adds.