A Real Estate Investment Trust or REIT is a financial instrument that pools money from investors and invests in real estate through direct investments in physical property, mortgages and related assets.
A REIT may be publicly traded on major exchanges, public but not listed or private. The most popular format of REITs is that of an exchange traded fund since it provides investors with a liquid and non-capital intensive way to invest in real estate. REITs receive special tax consideration and typically offer higher yields.
REITs IN INDIA
REITs are expected to make their debut in India in the next 12-18 months, helped largely by enabling regulation and favourable impact of demonetization. SEBI has already notified REIT regulation (in 2014), and to make these instruments more attractive, budget 2016 gave REITs tax pass through status (exempted DDT on SPV). This means that a REIT shall not pay any corporate tax in exchange for paying out consistent dividends. However, taxes are liable to be paid by individual shareholders.
Demonetization has added to the supportive environment for REITs by encouraging formalization of the real estate sector. Moreover, the resultant flush of liquidity with banks has led to a considerable fall in government bond yields, thereby increasing spreads between yields on prime office properties and government securities. This also implies a compression of capitalization rates and consequent appreciation of property prices.
Giving a further fillip to REITs, SEBI and RBI have allowed Mutual Funds and Banks to invest in REITs and INVITs. While mutual funds can invest 10% of its NAV in REITs & INVITs, banks have been allowed to invest in REITs from within the 20% of net owned funds umbrella that it is allowed for investments in equities, equity linked mutual funds and venture capital funds.
OBJECTIVE & LEGAL FORM
In India, REITs shall be set-up as a trust under the Indian Trusts Act (1882) and must be registered under the SEBI Regulations (2014). A REIT will be required to list units on recognized stock exchanges by floating it through an initial public offering (IPO). Investors may buy units from either primary or secondary market. Minimum asset size for a REIT is prescribed as Rs 500 crore with minimum offer size of Rs 250 crore. The underlying assets of a REIT shall be held with independent trustees who shall be responsible for ensuring compliance and adherence to all applicable laws that protect the rights of investors.
A REIT’s objective is to provide investors with dividends that are generated from rental income as well as capital gains accruing from the sale of real estate assets. Since the predominant focus of REIT investors is earning a high dividend yield, it is unlikely that REITs will invest in residential asset class in India which yields only 2%-3%. On the other hand office commercial which yields 6% to 10% (or more) annually is likely to attract most attention from REIT managers and investors.
ADVANTAGES OF REIT INVESTMENTS
Regular Income: REITs will be required to distribute 90% of their income from stable assets to investors at least twice in a year. Given the high rentals in commercial real estate, REITs can provide a consistent source of income to investors.
Diversification: according to the SEBI guidelines, REITs will have to invest in a minimum of two projects with no more than 60% of fund value in a single project. Thus the investment is spread across multiple assets, thereby providing benefits of diversification.
Lower Risk: REITs shall be closely monitored and as per regulation, at least 80% of a REIT’s asset value will have to be invested into revenue-generating and completed projects. The remaining 20% may be allocated to under-construction projects, equity share of listed property companies, mortgage based securities, money market instruments etc. Since REITs will primarily invest in completed prime properties, they is expected to provide a stable source of returns to investors.
Transparency: REITs are required to update full valuation on half yearly basis and declare it on an annual basis. Moreover the professional approach of REIT managers and role of trustees shall help in bringing more transparency to Indian Real Estate.
Liquidity: since REITs shall trade on established exchanges, much like stocks, they will be easy to buy and sell at short notice and through electronic mediums.
THE WAY FORWARD
SEBI had notified REIT regulation in 2014 but no trust has been set-up so far since investors are looking for further easing of norms and more tax breaks. In particular, they are hoping for more clarity on withholding tax on interest paid and possible exemption from stamp duty in certain situations.
Addressing these issues is important for bringing the REIT framework in India at par with successful global structures. However, given the positive intent of regulators and commitment of government towards structural reforms, it is likely that REITs will soon be a reality in India and provide a diversified investment play on Indian Real Estate with reduced risk, consistent income and professional management.