Are REITs safe and a substitute for fixed income? Here's what investors should know

Behind this growing investor interest lies a common misconception that REITs are completely safe and can serve as a substitute for traditional fixed income investments.

In reality, while REITs may potentially provide a relatively stable cash flows and regular dividends, they are market-linked instruments, whose prices can fluctuate based on factors such as interest rates, property valuations, occupancy levels and broader market sentiment.

As a result, investors should not view REITs as a direct proxy for fixed income instruments like fixed deposits, bonds, etc. Rather, they should be considered a distinct asset class that combines elements of both equity and income-generating investments.

Radhika Gupta, Edelweiss Mutual Fund's Managing Director and CEO, recently highlighted this misconception around REITs through a post on X.

"Let me bust a REIT myth: REITs are not fixed income. There is a reason SEBI classifies them as equity. Consider the numbers. Equity market volatility in India has typically been around 14–16% (depending on the time period). A pure-play REIT index has exhibited volatility of roughly 10–11%, a shade lower than equities, but nowhere close to fixed income, arbitrage funds or even many hybrid funds," said Gupta.

"Globally too, listed REITs have behaved much more like equities than bonds, with a long-term beta of around 0.6–0.7 versus broad equity markets. The drivers of volatility, however, are different, interest rates, property markets and occupancy, rather than corporate earnings alone. Our proposed fund, in its current construct, has an expected volatility of around 13%, only modestly higher than the REIT index," she added.

How do REITs differ from equities?

According to Gupta, REITs differ from equities in terms of the source of returns.

"A larger share of REIT returns comes from regular income and cash flows, whereas equities rely more heavily on earnings growth. REIT yields are typically around 5–6%, materially higher than the dividend yield of the broader equity market," Gupta said.

How to use REITs?

REITs are essentially an equity asset class with cash flow-generating real estate underneath. They are not a substitute for debt instruments. Investors can have REITs in their portfolios for diversification.

"They provide exposure to cash flow-generating commercial real estate in a liquid, listed format. In that sense, the investment case is similar to adding a Gold ETF or another real asset to a portfolio... it brings exposure to a different underlying asset, not a replacement for bonds," said Gupta.