Mutual funds can now invest more in REITs—what should small investors do?

This change raises an important question—will this affect how small investors approach REITs? Should they invest directly or via mutual funds?

At first glance, the move seems significant. With the broader allocation limit, hybrid equity funds like balanced advantage funds, flexi-cap funds, and multi-asset allocation funds may increase their REIT exposure. However, experts say that for retail investors, the choice between direct ownership and mutual funds depends on investment goals, tax implications, and ease of access.

Tax efficiency

The reclassification does not fundamentally alter how retail investors should decide between direct REIT investments or mutual funds, said Abhishek Kumar, an investment adviser registered with Sebi and founder of SahajMoney.

The biggest advantage of investing in REITs directly for small investors is the tax-free dividend income. A majority of REIT distributions come in the form of dividends, which are non-taxable in the hands of unit holders.

“This is because corporate tax has already been paid at the special purpose vehicle (SPV) level. This means investors can enjoy a tax-free yield of about 5–7% annually, on top of capital appreciation,” said Kumar.

As of June 2025, the one-year dividend yields for major REITs were: Nexus Select Trust at 6.15%, Embassy REIT at 5.8%, and Brookfield REIT at 6.3%.

In contrast, mutual fund distributions are treated as dividends and taxed at the investor’s slab rate, reducing net returns.

Both routes, however, attract the same capital gains treatment of 20% for short-term gains and 12.5% for long-term gains above ₹1.25 lakh.

Direct vs mutual funds

Niraj Murarka, CIO–real assets, 360 ONE Asset, believes direct participation is the better choice for retail investors.

“If you want meaningful exposure to REITs, you’ll have to invest directly. Mutual funds are expected to allocate only a small portion of their assets and returns will then be subject to market movements,” he said.

Direct investments also offer greater flexibility. Investors can choose which REITs to back, allocate a larger share if desired, and benefit from regular cash flows. Trading REIT units is as simple as buying or selling equity shares.

However, those seeking diversification across multiple REITs and lower entry barriers through systematic investment plans (SIPs) may find mutual funds more suitable, Kumar added.

“While the reclassification mainly benefits mutual fund schemes by allowing higher allocations, it doesn’t materially change the core trade-offs investors face between direct ownership and investing via mutual funds,” Kumar noted.

Challenges of direct REIT investment

The direct route has its downsides. Liquidity and concentration risks are key concerns for REIT investors.

“The Indian REIT market is still small, with limited choices and relatively thin trading volumes,” Kumar pointed out.

Moreover, direct REITs investors need to actively monitor the performance of individual REITs, unlike in mutual funds where professional managers handle this, he added.

Murarka agreed and cautioned that investors need to evaluate the REITs in more detail before investing to understand fair value and sector dynamics.

The mutual fund approach—A wait-and-watch game

Investors choosing the mutual fund route should watch how funds adjust their allocation to REITs. Experts believe the impact of the raised limit will be modest.

“Hardly any fund house exhausted the previous 10% cap covering both REITs and InvITs. Over half the industry had no allocation, and those that did mostly allocated 3–8%,” said an industry expert tracking REITs and InvITs on the condition of anonymity.

“So while fund managers now have more flexibility, it is unlikely to transform their strategies,” he added.

Industry reports suggest that exposure of equity mutual funds, including hybrid funds, in REITs is less than 1% of the total assets under management.