Reit-oriented funds: should you invest?

Summary

Reit-oriented funds offer an easy way into real estate trusts, but with only a handful of listed Reits, their portfolios are not pure Reit plays yet.

A growing number of mutual fund houses are launching funds focused on real estate investment trusts (Reits), following regulatory changes that have classified Reits as equities and allowed them to be included in market indices. But while these funds offer a simpler way to access the asset class, their portfolios may not provide pure Reit exposure, and their tax treatment differs from direct investments.

Reits pool investors' money to own income-generating commercial real estate. They can add diversification and rental-income exposure to a portfolio, but investing directly involves selecting trusts and navigating the tax treatment of different payouts. Should investors take the mutual fund route instead?

How they work

Four of the five Reit-oriented funds launched so far are passively managed, with almost all tracking the Nifty Reits & Realty Index. The index currently requires a minimum 60% allocation to Reits, with the balance invested in listed real estate companies. This allocation could rise as more Reits become available.

"There are only six Reits available in the listed space as of now. Hence, the index allocation is right now at 60%," said Radhika Gupta, managing director and chief executive officer of Edelweiss Mutual Fund.

The balance 40% will be allocated to stocks of real estate companies listed on the exchanges, as per the index rules.

The index selects up to 15 Reits based on their six-month average free-float market capitalization. If fewer than 15 are available, the remaining constituents are selected from eligible stocks in the realty sector using the same market-cap criterion. As the listed Reit universe expands, the index can gradually move towards a 100% Reit allocation.

"As and when more Reits get available, the fund and index can gradually increase Reit exposure," Gupta added.

WhiteOak Capital Mutual Fund has taken a different route, launching an actively managed Reit-oriented offering through its Dividend Yield Fund. Its Reit allocation currently stands at 57%.

"As more Reit get listed the fund can theoretically go up to 100% Reit as it is allowed by its mandate, i.e. invest in dividend-yielding securities and Reits are classified as equity for investment universe of equity funds," said Aashish Somaiyaa, executive director and chief executive officer of WhiteOak Capital Mutual Fund.

"We felt the dividend yield category is most suitable for a product like Reit and InvIT (infrastructure investment trusts). Dividend-yielding investments essentially means buying equities with income character. While Reit is a hybrid product, but it fits this definition perfectly as it offers growth through rental escalations and by law Reits are required to distribute 90% of their cash flows," Somaiyaa explained.

The fund can allocate up to 10% to InvITs. Around 30% is held in arbitrage and liquid debt securities, while traditional dividend-yielding equities are restricted to about 5% to control volatility. The strategy aims to keep the fund's risk relatively low through its Reit, InvIT and arbitrage exposure.

Reit funds or direct Reits

Investors can access Reits either through these funds or by buying listed units directly. Funds offer a diversified portfolio without requiring investors to choose individual trusts.

"When you are investing in a Reit-oriented fund, you don't have to worry about deciding which Reit to invest in and which to avoid, as you get a diversified portfolio of Reits in a fund wrapper," said Shravan Sreenivasula, head of investment solutions at Avendus Wealth Management.

"But at the same time, the funds' Reit exposure at least as of now is limited to around 60%. So, you are not getting a 100%-Reit portfolio," he added.

Tax treatment is another distinction. Direct Reit investors may receive distributions classified as dividends, repayment of capital, interest or rental income, each with different tax implications.

Dividend income is tax-free in the hands of investors. "After enactment of the Taxation and Other Laws (Amendment) Act, 2026, dividend is exempt in the hands of unit holders regardless of the taxation regime opted by SPV (special purpose vehicle," SR Patnaik, partner (head - taxation), Cyril Amarchand Mangaldas.

Repayment of capital is not taxed when received but reduces the investor's cost of acquisition, increasing the capital gain when the units are eventually sold. Once cumulative repayments exceed the unit's issue price, the excess is taxed as income from other sources in the year it is received.

For instance, if you buy a Reit unit at an issue price of ₹100 and receive ₹15 as repayment of capital over a few years, the payout is not taxed immediately, but your acquisition cost falls to ₹85. If you sell the unit for ₹120, capital gains tax applies to ₹35 rather than ₹20. If cumulative repayments reach ₹103, the excess ₹3 is taxed at your slab rate.

A Reit may also earn interest through debt instruments or loans. Distributed interest is taxable at the investor's income-tax slab rate, with 10% tax deducted at source (TDS). Where a Reit owns properties directly rather than through special purpose vehicles (SPVs), distributions may also include rental income, taxable at the investor's slab rate with 10% TDS.

In a Reit-oriented mutual fund, distributions received from investee Reits are reflected in the fund's net asset value (NAV). Investors pay capital gains tax when they redeem their units. These funds attract a 12.5% long-term capital gains tax after a holding period of two years, compared with one year for equity funds. Short-term gains are taxed at the investor's slab rate.

Direct investors must retain the original nature of Reit distributions while filing their returns. The more tax-efficient route will depend on an investor's tax slab and the nature of income received. Funds simplify the tax treatment, but also charge a fund management fee.

What investors should do

Whether investing directly or through a fund, investors should understand what drives Reit returns. Higher interest rates increase borrowing costs, leaving less cash available for distribution. They also make bonds more attractive and can weigh on Reit valuations and unit prices, although rental growth may partly offset the impact.

The underlying property market matters, too. Office demand is linked to hiring by information technology firms and global capability centres, while mall rentals depend on consumer spending. "Occupancy is the other key factor, as vacant space earns no rent and cuts payouts," said Deepak Chhabria, chief executive officer and director at Axiom Financial Services.

Financial advisors do not see the current crop of Reit-oriented funds as a replacement for direct investments. "Combining Reits with real estate stocks, which are volatile and not dividend candidates, is sub-optimal and dilutes the purpose of owning Reits, which is mainly to receive rising income," said Aarati Krishnan, head of advisory at PrimeInvestor Financial Research.

Others consider these funds closer to sectoral or thematic offerings. "The index funds combine Reits and real estate stocks. So there is potential of equity upside, but that also comes with volatility. Given its sectoral-bias, it is more suitable for satellite allocation, rather than core at this point," said Vishal Dhawan, founder of Plan Ahead Wealth Advisors.

WhiteOak's Dividend Yield Fund seeks to limit volatility through arbitrage, liquid debt instruments and InvITs, but investors may want to wait for a track record.

As more Reits get listed, funds could offer greater Reit exposure and diversification. Investors comfortable assessing individual trusts, or working with investment and tax advisors, can consider direct Reit investments for their cash-flow needs