A month after Finance Minister Arun Jaitley in his budget speech 2014-15 announced that the government would provide the necessary tax incentives to Real Estate Investment Trusts (REITs), the board of the Securities and Exchange Board of India on Sunday cleared the final guidelines for setting up REITs and Infrastructure Investment Trusts (InvITs) and thereby laid the roadmap for introduction of a new investment avenue for investors in the Indian markets. On Sunday by announcing the final guidelines Sebi set the ball rolling for product manufacturers to launch their product to be subscribed by investors with a minimum investment of Rs 2 lakh to own a piece of a high end real estate property.
While the concept of REITs been in existence in developed markets for several years now, it is a new concept in India and investors need to know what it is and how it works before they put in their hard-earned money to invest in them.
What are REITs
They are investment trusts that operate much like the mutual funds except for the fact that they invest in income generating real estate assets — commercial, residential etc and thereby look to generate return for the investors within the fund. While mutual funds invest in equities, REITs invest in real estate and make it possible for even the smaller investors to invest in real estate.
For investors it is a good option to invest in real estate as you can own a piece of a prime property for a modest sum which otherwise is impossible for small investors. It is also a less risky real estate investment mode as the investors takes a position in a developed property that provides regular income.
“For retail investors, they provide an avenue to such investors in properties which they otherwise would not have been able to take an exposure. REITs are also a popular investment option for long term pools of capital such as pension funds and insurance companies primarily since the regular stream of income helps them in managing regular outflow to their investors,” said a consultative paper on draft Sebi REITs Regulations.
The Proposed Framework in regulations
In India REIT will be set up as a Trust and will have parties such as trustee (registered with SEBI), sponsor, manager and principal valuer with specific responsibilities.
After the registration, the REIT would raise funds through an initial offer from investors and get listed. The minimum issue size of the initial offer has been specified at Rs 250 crore and the regulator has specified that the size of assets under the REITs should not be less than Rs 500 crore.
The regulator has said that till the market develops, the units of REITs may be offered only to HNIs/institutions and therefore, the minimum subscription size has been kept at Rs 2 lakh and the unit size is proposed at Rs 1 lakh.
In India the REIT will invest in commercial real estate assets, either directly or through SPVs. In such SPVs a REIT shall hold or proposes to hold controlling interest and not less than 50 per cent of the equity share capital or interest.
As per the final guidelines REITs shall invest in at least two projects with not more than 60 per cent of value of assets invested in one project. It has also been proposed that at least 90 per cent of the distributable post tax income of the REIT should be distributed among the investors on a half yearly basis so that there is regular income for them.
Also not less than 80 per cent of the value of the REIT assets shall be in completed and revenue generating properties and not more than 20 per cent of the value of REIT assets shall be invested in developmental properties and mortgage backed securities, equities, government securities and money market instruments.
CB Richard Ellis (CBRE), a real estate consulting firm, feels that the composition, distribution and volume of investment grade office stock in India has risen from a little over 90 million sq ft in 2005 to more than 400 million sq ft today but the sector continues to lack large scale institutional funding.
Critical factors listed by CBRE for successful implementation of REITs:
* Lengthy registration processes and burdensome stamp duties could hinder the establishment of I-REITs. In India, the transaction cost for physical assets typically ranges between 5-12 per cent as against 4-6 per cent in Singapore. This could act as a barrier to acquisitions by I-REITs and hamper growth.
* The success of I-REITs hinges on the returns being offered to investors, which should ideally score well above other instruments available in the market. A negative yield spread over stable investment instruments such as the 10-year Government Securities or the AAA rated corporate bonds could reduce I-REITs’ appeal to investors.
* Supply of high quality en-bloc investible assets available for injection into I-REITs is limited. Developers preferring ownership and stable income returns will hold on to quality assets rather than sell them to I-REITS, thereby preventing stabilised properties from entering the I-REIT market. Recent entrance of foreign investors such as Blackstone, Brookfield and APG in Indian real estate market may help shape and increase the future stock of institutional grade real estate assets in the market.
* International institutional investors generally have mandates to invest only in developed markets, even if they are permitted to invest in emerging markets, there exist regulatory restriction on foreign stock ownership in India. As a work around, I-REITs or trusts packaged with Indian properties could list in developed markets such as Singapore in order to increase their accessibility to FIIs, although challenges related to the remittance of funds would remain.
* In mature economies there is large pool of long-term investors such as pension and insurance funds, however, investor preferences in developing economies could be different. Many buyers place an emphasis on the upside of capital values and are willing to take on risks in development projects.
“The I-REIT market needs to be perceived as more attractive for pricing and asset quality, as compared to the direct real estate market and other investment asset classes, for it to become a success,” said Anshuman Magazine, Chairman & MD, CBRE South Asia.