Real estate investments for NRIs: Commercial vs. residential properties vs. REITs?

NRI investments in commercial properties has picked-up quite sharply over the last couple of years after the residential property market started generating lower returns.

Nov 29, 2018 05:11 IST India Infoline News Service

Non-resident Indians (NRIs) are allowed to invest in Indian real estate at par with resident Indians. However, there are certain restrictions on NRIs repatriating the proceeds from the sale of a property in India even if said property was purchased out of money generated in India.
 
Broadly, NRIs are permitted to invest in three avenues of Indian real estate specified as under:
  • NRIs are permitted to invest in commercial property, i.e. those purely intended for business purposes. An investment in commercial properties broadly encompasses purchasing factories, office spaces, industrial units, retail complexes, malls, medical centers, hotels, retail outlets, warehouses, and garages, etc. Such investments may either be for the purpose of running a business or for commercial renting.
  • NRIs are also permitted to invest in residential properties, i.e. those purely made for habitation purposes. Such properties can be in the form of villas, gated communities, apartment units, condominiums, units of a cooperative society, etc. Like resident Indians, NRIs can also avail of loans up to 85% of the value of the property to purchase the asset. Such properties can be only used for residential purposes, namely to habitate or as a long-term investment.
  • In addition to these two traditional methods of property investments, NRIs can also invest in real estate funds or REITs, which are essentially a securitized portfolio of commercial and residential properties. Cash flows from these properties in the form of rentals and gains are passed through to the fund holder.
 
NRI investments in residential vs. commercial properties
NRI investments in commercial properties has picked-up quite sharply over the last couple of years after the residential property market started generating lower returns. Also, factors like demonetization and the implementation of the Real Estate (Regulation and Development) Act (RERA) impacted investments in residential properties. As a result, commercial properties have emerged as a preferred investment avenue for NRIs.

There is also a more pragmatic angle to investing in commercial properties. Buying a commercial property makes sense for NRIs. For example, residential properties have a rental yield of around 1.5-2% in larger cities. In contrast, commercial properties offer rental yields in the range of 6-8% of the property value in best case scenarios. This means that the payback period is much quicker for NRIs in the case of commercial property as the internal rate of return (IRR) is higher.

Apart from earning higher rental yields, NRIs investing in commercial real estate also benefit from capital appreciation, which has been better for commercial properties compared to residential properties over the last couple of years. Moreover, the nuances of RERA have also pushed more NRIs towards investing in commercial real estate properties.

Apart from these factors, there has also been a demand push for commercial properties with a large number of players in IT, logistics, e-commerce, banking, NBFCs, and venture firms hungry for office space. In the case of commercial property, the onus of maintenance is on the party renting the said property, which makes it better for NRIs based out of the country.

NRIs can avail loans for purchase of property in India just like resident Indians and also claim benefits under Section 24 and Section 80C of the Income Tax Act. In fact, having bank funding is also a smart way to get your property title papers and link documents evaluated by the bank.
 
Taxation and repatriation of property investments
NRIs are currently permitted to purchase most kinds of properties in India with the exceptions being agricultural land, plantations, and farmhouses. These three investments require a special permission from the RBI while NRIs can buy other properties through the automatic route. Moreover, the sale of property by an NRI is treated at par with resident Indians. If held beyond two years, it is a long-term capital gain (LTCG) that will be taxed at 20% with indexation benefits, while short-term capital gain (STCG) is taxed at the peak income rate applicable.
 
The only difference is that any property sale by an NRI is subject to TDS at the rate of 20% (plus Applicable Surcharge & Cess) in the case of LTCG and 30% (plus Applicable Surcharge & Cess) in case of STCG. Any excess tax paid can be claimed as a refund.
 
Repatriation is slightly more complicated for NRIs. For e.g., NRIs can only repatriate proceeds from the sale of property as long as it does not exceed the price paid. This is only applicable if the payment is made out of an NRE or an FCNR (B) fund. The limit for repatriation is high at $1mn per year if the property was paid for from an NRO account. In the case of residential properties, the NRI can only repatriate proceeds from up to two properties.
 
Investing in REITs
Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs) were thrown open to NRIs a few years ago. While NRI investments in Indian real estate have crossed the $10bn-mark, this is largely in physical property.
 
REITs and InvITs, which are the equivalent of a real estate mutual fund, are just about taking off in India. REITs are not only smaller investment units but also spread your risk across a portfolio of real estate assets. Pass-through benefits to the investors are positive, although it will take more time for this investment avenue to pick up.
 
For now, the big story for NRIs appears to be investing in commercial real estate. With better rental yields and rising demand, it appears to be ‘the place’ for NRIs to be in.

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