REITs bring new hope for realty sector

K Ramanathan

Is it a new dawn for the real estate sector in India? The struggling construction industry and its offshoot realty sector have got a new reprieve recently when the country’s top market regulator Securities and Exchange Board of India (SEBI), ending a seven-year-long hiatus, approved the rules and regulations to be followed for RealEstate Investment Trusts (REITs). Infrastructure Investment Trusts were also included by SEBI.

Once the REITs become a reality, investors can buy small virtual units of the commercial establishments and part their profits. Though approval has been granted to only for commercial real estate, where the income generation is likely to be more, real estate experts and builders suggest that such option should be available for residential side too.

With over 300 million sq ft of prime commercial space being available across India, the real estate sector would look for a whooping $6-7 billon inflow of funds in the next two to three years, feel realty pundits.

If all goes well with REITs, India will have more commercial complexes and malls across the nation, with tier II and tier III cities too vying for spaces to have their own multi-storey commercial complexes or multiplexes.

Will REITs really make a paradigm shift in the otherwise lackluster real estate market in India? What are the benefits and precautions to be followed to safeguard medium to small investors and also the taxation policy? We asked a few real estate experts and leading builders their opinion on the viability of such trusts in India.

What are REITs?

Realestate investment trusts (REITs) allow individuals to invest in income-generating real estate assets. These may include shopping malls, office buildings, multiplexes, mixed-use developments, self-storage facilities, hotels, resorts and warehouses. Unlike other real estate companies, REITs do not develop real estate properties to resell them. Instead, REITs buy and develop properties primarily to operate them as part of its own investment portfolio.

So, how does it work?  REITs provide a way for individual investors to earn a share of the income produced through commercial real estate ownership – without actually having to go out and buy a property. For example, if one wants to construct a mega commercial complex or mall, he or she can float a trust on its name and get it listed on leading stock exchanges subject to fulfillment of certain pre-requisite conditions laid down by SEBI and finance ministry.

If the cost of construction comes to about Rs 2000 crores, then the REIT would, through Initial Public Offer (IPO) call for investors to invest in the project with each one of them being offered minimum of one unit whose basic cost would be decided by SEBI. Once the construction of commercial complex is completed and let out to tenants or occupants, the income generated will be shared among shareholders by way of dividends.  The rule states that REITs should distribute not less than 90 per cent of their net distributable cash flows to investors at least once in every six months to benefit the tax pass through.

For making an IPO, the value of assets owned or proposed to be owned by REITs should be worth at least Rs 500 crore. The minimum issue size for the initial offer has been fixed at Rs 250 crore. The minimum subscription size for the units of REITs will be Rs 2 lakh.

A welcome trend

Anuj Puri

Commenting on the approval of rules by SEBI for REITs in India, Anuj Puri, Chairman and Country Head, JLL India, said, “With the stamp of approval, REITs are finally a formalized concept in India. This is a big change from the uncertainty and ambiguity that prevailed about this very important instrument for the last few years. It is gratifying to note that SEBI fully intends to deliver on its assurances of bringing better and faster funding into Indian real estate.”

Pressing for more clarity on taxation eligibility norms before the first listing, he said this would increase the interest of foreign investors.

Currently, Grade A office space across major Indian cities amounts to about 376 million square feet, and approximately 50% of this space would likely to get listed in the next 2–3 years. The valuation of these assets is around $10-12 billion, and this accounts for a fairly massive influx of funding waiting in the wings to hit the Indian real estate market via REITs, says Puri.

Industry experts welcomed the rules formulated by SEBI, saying that realty and infrastructure trusts will provide a new source of funding for investors and developers in infrastructure projects.

Calling it as a good step that will bring in organised funding and transparency to the sector, T Chitty Babu, Executive Committee Member, CREDAI and Chairman & CEO of Akshaya Pvt Ltd, however, 

wants the current proposal to have REITs for commercial sector should be extended to the residential sector too. “But the point is that we had to make a beginning somewhere and this is a good way to set the ball rolling. As with every new initiative, this will also go through the learning curve to refine the policy, regulation and implementation processes as we go along.”

T Chitty Babu

“To the developer it means that he can plan large integrated, commercially viable projects that can attract quality funds. Though in the initial phase we expect only a few large developers to launch REIT’s, three years down the line, more quality assets will be created. Also, the government’s commitment to boost manufacturing sector and also to create100 smart cities will make REITs playing a big role to achieve these target,” Chitty Babu said.

The Associated Chamber of Commerce and Industry of India (ASSOCHAM) too welcomed the introduction of Real Estate Investment Trust (REIT's) which would eliminate the double taxation of built assets with an established rental yield.

“REITs have the potential to attract $15bn to $20bn to finance established assets, which will free up capital for new developments”, said D S Rawat, Secretary General ASSOCHAM, adding, “REITs are important sources of funding across world and there is potential of raising about US$15 billion through this”.

He also emphasized the importance of having clarity over taxation such as stamp duty, VAT etc before the first listing. Suggesting that the ratio of completed property and under construction needs to be modified from 90:10 to 70:30, he said if any project which is about to complete within a year of floating REITs and income generation starts within 12 months should be included.

Under the rules, at least 80% of the value of REIT's assets must be in properties that are completed and generating revenue. A REIT can invest only 10% of the value of its assets in properties that are under construction. It can also invest a small portion in other securities like mortgage-backed securities and money market funds.

Benefits and risks of REITs

Though they are new to Indian investors, REITs are prevalent in USA since 1960, and now successfully functioning in about 20 countries including Australia, UK, France, Singapore, Japan, to name a few.

D S Rawat

It has its own advantages and disadvantages. Apart from providing investment portfolio and offering high dividend compared to other investment options, there are some risks, especially with non-exchange traded REITs.

Though SEBI has set the guidelines on how REIT should be regulated, it is too early to predict its success. As we go along, there will be clarity on many issues like taxation, property valuation, listing price, etc. We need to go through the learning curve, and since RIET is being allowed in commercial sector and that too only for large sized assets, we will see an initial spurt and with that the policy and regulation will get refined and fine-tuned. One can expect the flow of funds at around $10 billion every year for commercial space. Considering the fact that this is only from commercial space, one can understand the potential of REITs when it is introduced to residential and retail sectors, says Chitty Babu.  

Also, most REITs will focus on particular types of commercial development, such as apartments or office buildings. This concentration leaves them vulnerable to a downturn in this particular section of real estate.  Investors should also examine where the REITs projects are located. A high concentration of development in one community or geographic region may leave it vulnerable to a downturn or saturation in that area’s economy.   

Realty experts suggest that one should invest in more than one REIT (from different geographic locations) and choose absolutely different real estate sectors.

Hoping that RIETs will be more of custodians and value creators for investors, ChittyBabu said, “Realty did have any investment option to small retail investors with surplus funds. They had an option to buy residential property for investment purposes and sell it once their capital investments go up to certain percentage. REIT will be able to channelise all these retail investors who were avoiding the realty sector due to lack of a regulatory norms and clarity. One can invest in REIT with as minimum as Rs 2 lakh. The model works well for investors who will earn from long term lease/rentals and as aggregators of quality realty stock, REIT holders will be able to offer better returns as they won’t have tax binding on them if they give out 90 per cent of the earnings as dividends to investors.”

Air India to be the first REIT

In a move that could give the company significant tax breaks and also improve its finances, ailing state-owned airliner Air India is planning to convert its non-core real estate assets into a Real Estate Investment Trust (REIT) and list it on the stock exchanges. Air India has about 800 properties at prime locations across the world, which include several acres of land, office buildings, sports stadiums and residential colonies. Its Mumbai headquarters on the high street of Marine Drive alone is estimated to be worth about Rs.2,250 crore. “If it works out, we will hold 51% in the REIT; the properties will remain ours but be leased out at the best prices,” an Air India executive, who did not want to be named, said.