Over the last two years, the Indian financial market has grown and diversified. A greater interest in alternative investment avenues such as REITs and mutual funds is being shown by investors. Both these asset classes offer participants an avenue to take exposure to the larger financial ecosystem without blocking considerable capital. However, their differing liquidity profiles, risk levels, and returns merit consideration. With the changing dynamics in the markets, many investors contemplate if switching over from direct REITs to liquid funds, namely, mutual funds, is now a plausible option.
REITs: High Returns with Lower Liquidity
REITs are investment vehicles that pool resources from the general public to allow individual investors to obtain ownership in commercial income-generating real estate, such as office space, malls, and warehouses. Real Estate Investment Trusts attract investors because they offer predictable rental yields and possible capital appreciation. In the Indian context, direct REIT returns have been between 8% and 10% annually, depending upon portfolio and market conditions.
But REITs also face problems in terms of liquidity: Listed on the exchanges, they generally do not afford the common day-to-day liquidity that one would normally expect from mutual funds. Normally, there are transaction charges if the REIT units are sold, and the prices do not always exactly reflect the prices in the market for real estate. Besides, reliance upon rental yields from commercial properties exposes REITs to economic downturns, like what happened with the COVID-19 pandemic, when vacancies surged and rental incomes plummeted. Additionally, investors should also be aware of the tax on dividend income distributed by REITs, as such earnings are taxable in the hands of the investors, depending on the nature of the distribution and the applicable income tax laws.
Liquid Funds and Mutual Fund Opportunities
Liquid funds are a class of mutual funds that primarily invest in extremely liquid money market instruments such as government securities, treasury bills, and certificates of deposits. Such funds try to preserve the principal with regular returns. On average, liquid funds return between 4-7% per annum in India and are considered comparatively safer than REITs and equity-based mutual fund schemes.
The key selling point here is liquidity. Investors in liquid funds can redeem their investment almost instantly, subject to very small fees, ideal for parking idle cash or any short-term financing requirement. Liquid and equity funds are encapsulated into a varied array of mutual fund options that best suit the investors’ risk tolerance, time horizon, and return expectations.
Besides this, there is also a minimum investment threshold. Typically, direct REITs in India have a minimum threshold investment of at least INR 50,000 or even higher, while mutual fund schemes allow SIPs with as low as INR 500, hence making them more reachable for retail investors.
Liquidity Comparison: REITs vs. Liquid Funds
In turbulent financial markets, investors always prefer liquidity, which is the ease with which any investment is converted into cash swiftly. The trade-offs offered by REITs are less favorable compared to tangible real estate assets because most investors have longer settlement cycles and can have pricing discrepancies in case of a shorter-term outlook. Liquid funds under the mutual funds category allow even single-day withdrawals, thus making them handy in meeting emergency financial requirements.
One is that:
An investor invests INR 40,000 in buying 100 units of REIT at INR 400 per unit and earns an average rental dividend yield of 8% per annum, amounting to INR 3,200. However, this investor decides to sell during the trough of the market. The transaction costs, including broker fees, eat into the returns, while the selling price declines due to market sentiment.
In the same example, an investor invests INR 40,000 in a liquid fund. The returns accrue at 5% per annum and yield INR 2,000. The cost of liquidating the investment in liquid funds is very minimal, thus allowing one to access the full corpus plus returns within days.
Although the long-term earning potentials and stability of portfolios of REITs may overshadow that of liquid funds, liquidity constraints are usually weighed up by investors against financial goals.
Shifting Dynamics in the Indian Market
The Indian market is dynamic and keeps changing. REITs are new, but they offer excellent exposure to the commercial real estate market without actually holding any properties. But with a rising interest rate scenario, growing fears of inflation, and looming uncertainties over economic fundamentals, fixed-income mutual funds like liquid funds have started gaining momentum amongst conservative investors too.
Mutual funds are more diversified and flexible. Investors wary about the extent to which REITs would finally depend upon the collections of rent and the trends in the economy shift to liquid funds for assured returns with lower risk exposure. The introduction of tax-efficient mutual fund tools has made mutual fund tools an even more sought-after option in recent times.
Factors to Consider Before Investment Transition
Risk Profile: While REITs are aligned with the demand for real estate and rental yield, along with economic cycles, liquid funds carry much lesser risk but come with much lower returns.
Investment Horizon: Long-term investors who consolidate a portfolio can find value in REITs, while on the other hand, short-term investors may go for liquid funds.
Liquidity Needs: Liquid funds are the best fit for immediate fund access needs. REITs would not be suitable as an emergency source of liquidity.
Tax Implications: REIT dividends and mutual fund returns attract taxes at prevailing income tax rates.
Transaction Costs: Generally speaking, REITs bear higher transactional costs compared to mutual funds.
Final Thoughts
Whether to switch from direct REITs into mutual funds—liquid funds in particular—depends on an individual’s goals regarding finance, risk tolerance, and understanding of the market conditions. If mutual funds offer more flexibility, liquidation, and diversification, REITs provide realistic exposure to commercial real estate with the possibility of higher returns over longer periods of time. Both the pros and cons of each have to be weighed out, and portfolio allocations have to be pondered upon with the help of a financial advisor before any change in investment is made.
Disclaimer:
All investment products are subject to market risks and economic fluctuations, including REITs and mutual funds. Investors must gauge all the benefits and drawbacks, assess their financial objectives, and consult professionals before making financial decisions in the Indian market environment.
Summary
The Indian financial market offers a broad avenue of opportunities through various means sOver the last two years, the Indian financial market has grown and diversified. A greater interest in alternative investment avenues such as REITs and mutual funds is being shown by investors. Both these asset classes offer participants an avenue to take exposure to the larger financial ecosystem without blocking considerable capital. However, their differing liquidity profiles, risk levels, and returns merit consideration. With the changing dynamics in the markets, many investors contemplate if switching over from direct REITs to liquid funds—namely, mutual funds—is now a plausible option.
