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1.1 What is a REIT?

REITs are companies that collect investments from multiple investors and own income-producing real estate to earn capital appreciation and rental income. REIT act as a tax-efficient mechanism that owns a portfolio of assets. It usually has a specific structure which we will discuss later.

REITs trade in major stock exchanges and they offer a plethora of benefits to their investors and buyers such as instant liquidity, safety, diversification, affordability, etc. They allow anyone from the common crowd to invest and gain benefit from valuable assets, and properties and access dividend-based income and total returns.

Like mutual funds, ETFs, or individual stocks, REITs are a lucrative option for investors to gain benefits. For example, in mutual funds, investors pool money and a fund manager and his team invests in various securities assets and equities to produce a return and in exchange offers the investors a mutual fund unit, REITs also offer a unit but unlike individual shares, REIT units represent ownership of assets/real estate properties.

India had its first REIT in 2019 and now has three famous REITs in the stock market: Mindspace REIT, Brookfield REIT, and Embassy REIT. REITs were first introduced in a minimum lot size of 200 units and were valued at INR 50000 but SEBI then brought down the investment to INR 10,000 – INR 15,000 with a lot size of one. This was done to make them more accessible and increase their liquidity in the market.

1.2 Structure of REIT

The structure of REITs is similar to Mutual Funds. They have a sponsor, a fund management company, and a trustee. The sponsor promotes and markets the funds and the fund management company buys the properties to build the portfolio. They work on an easy business model: by leasing out the properties and collecting the income through rent, the company then gives the dividends to its shareholders.

1.3 SEBI guidelines for REITs

SEBI has set some guidelines for REITs and they need to follow the following to be in accordance. These regulations are under Section 4 of the Regulations.

1. The trust deed is duly registered in India under the provisions of the Registration Act, 1908.

2. The trust deed has its main objective as undertaking activity of REIT in accordance with REIT Regulations.

3. Sponsor, manager, and trustee have been designated and are separate entities.

4. No unit holder enjoys superior rights over another unit holder and there is only a single class of units.

5. The corporation must have a minimum asset base of INR 500 crores.

6. The parties to the REIT are fit and proper persons as per the Schedule II of SEBI (Intermediaries) Regulations, 2008.

7. REITs need to payout 90% distributable cash flows to unit-holders.

8. REITs must have 80% of the total investment in income-generating assets. Only 20% should be made in under-construction assets to decrease the execution risk.

1.4 What you should look for while investing in a REIT?

1) Portfolio Occupancy Ratio
You should check the occupancy ratio, which is the ratio of occupied or rented space to the total available space. A high occupancy rate is an indicator of a good portfolio. This shows consistency in payouts, increased rental, and dividend income. The higher the occupancy, the more stable the cash flows.

2) Weighted Average Lease Expiry (WALE)
WALE is the average lease tenure remaining for the tenants living in the buildings included in the REIT portfolio. It is measured in years and shows the stability of the portfolio. Higher the WALE, the better because of less vacancy risk.

3) Geographical Diversification
REITs which have diversified portfolios across different micro and macro sectors are less prone to having problems with an oversupply of properties in one sector and reduced occupancy rates.

4) Distribution Yield
Distribution yield is the measure of distributable cash flows to the investors. It is not a guaranteed payout and depends on the trust performance. The higher the distribution yield, the better.

5) Sponsor/Developer Name
A reputed sponsor with a good track record and past performance will automatically mean a high-quality portfolio, stability, and asset management. REITs have the Right of first offer (ROFO) on properties that are owned by sponsors.

6) Net Asset Value
NAV is net asset value which is the estimated market value of the properties minus all liabilities divided by the number of shares outstanding. Oftentimes, REITs tend to trade below or above NAV because of the supply and demand of the traded units. But NAV is more accurate to determine the share price of REIT.

1.5 How to Invest?

REITs in India, just like stocks, are first launched through An IPO (Initial Public Offering) and FPO (Follow on Public Offer (FPOs). After the initial offer, REITs trade on the stock exchange where it is listed. You can buy units of REITs through regular trading accounts on BSE and NSE or any other major stock exchange.

Peer Comparison of 3 major REITs

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A GUIDE TO RETURN ON EQUITY (ROE) | ITS USE & CALCULATIONS

ROE Calculation
ROE Example
Return on Equity
Return on Equity Example
Return on Equity Formula
Return on Equity Ratio
Return on Equity Calculator
Return on Equity Video
Return on Equity explanation

Watch Full Video on Youtube

As the name suggests, Return on Equity (ROE) is the efficiency of a company in handling the shareholders’ money. It is calculated by dividing the net income by shareholder equity. It tells us how much return a company is generating on shareholders money. It is expressed in % so if the ROE of some company is 24%, it means on every Rs. 100 invested by a shareholder the company generated ₹24.

Formula

Now let’s understand the components of this formula,
First, Net Income is a firm’s profit after it has paid and accounted for all of the annual liabilities, it is calculated in the P/L account.

Net Income = Gross Income – Expenses

Shareholders’ Equity is the amount that shows a company’s residual assets to pay back to its shareholders. This is the fund that is left for the shareholders after the company has paid back all of its debts. It’s the total value of the firm’s assets minus the liabilities and is one of the three basic components of a balance sheet.

Shareholders’ Equity = Share Capital + Retained Earnings – Treasury Stock

Putting Values into the formula for calculating the ROE of a company XYZ Ltd.

Return On Equity (ROE) = 404/1699 = 0.2377 =23.77%

So, the ROE came out to be 0.2377 or 23.77% (after multiplying by 100)

This means that for every rupee invested in XYZ Ltd., its shareholders earn 0.25 rupees.

Return on Equity is used by potential buyers, lenders, and management to gauge past and future performance. Generally, a higher ROE is better, but sometimes, a high ROE can also mean an increasing debt or liabilities. So, a rule of thumb is an increasing ROE indicates a good company that generates value for its shareholders by reinvesting its earnings wisely. A declining ROE over time means a company has poor management and makes unseemly investment decisions.

Advantages of Return on Equity

– Determining a company’s growth sustainability: ROE ratio helps in determining the growth sustainability of a company. Investors and lenders use this financial ratio to identify and find stocks that are more vulnerable to market risks and instability.

– ROE can be used to estimate a company’s dividend growth. A more accurate approximation can be calculated by multiplying the company’s ROE with its payout ratio. The higher or lower the company’s dividend growth rate to the sustainable growth rate, the higher or lower the chances of operational mishaps.

– Calculating problems with the net income: a very high ROE ratio may signal a hidden issue with the company. These may relate to the net income. For example, if the company’s net income is considerably more than its equity then, a high return on investment (ROI) is great but if the equity is less than the net income then, it might indicate a hidden issue.

Disadvantages of Return on Equity

– Share buybacks can affect the return on equity ratio. This is because the number of outstanding shares is lowered when the company repurchases its shares from the market. As the denominator decreases, ROE increases.

– A negative ROE that comes from a company’s net loss or negative shareholders’ equity is unusable to compare with its previous years or to be compared with the industry or competitors with positive ROEs.

– Another drawback is that some ROE ratios disregard intangible assets when calculating the shareholder’s equity. Goodwill, trademarks, copyrights, and patents are examples of intangible assets. This leads to difficulty in drawing comparisons with other companies that opt to include intangible assets.

DuPont Formula

DuPont Corporation created a model called Dupont Analysis for analyzing a company’s profitability. This is a tool that helps to discard unnecessary false assumptions about a company’s profitability.

The DuPont method divides ROE into three parts:
The product of a company’s net profit margin, asset turnover, and financial leverage is called the Return on Equity (ROE) according to the DuPont Analysis.

Formula

ROE = Net Profit Margin X Asset turnover X Financial Leverage

ROE = Net Income/Sales X Sales/Total Asset X Total Assets/Shareholder’s Equity

If the net profit margin rises in due time it means that the company controls its operating and financial costs, and the ROE should increase. When the asset turnover ratio rises, it indicates that the company is making better use of its assets which is generating greater sales per rupee invested. And lastly, as the company’s financial leverage rises, it can use debt money to increase returns.

Conclusions

The Return on Equity ratio is a financial metric used to assess a company’s financial health and its capacity to create profitable returns for its shareholders over a specific time period. However, it cannot be the only criterion used to make investment decisions since it does carry its drawbacks. Other than ROE, investors can also calculate the return efficiency of a company by calculating its return on capital employed (ROCE) and return on operating capital (ROOC) to paint a complete picture.

The DuPont Analysis can be employed to get a more thorough understanding of the company and make a better investment decision.

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