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India prepares to invest in REITs

Monday, March 27, 2017
By Dominic Rebello

The real estate investment trusts (REITs) are likely to kick off in the next 12-14 months helped largely by liberalised regulatory norms and demonetisation, leading property consultant Knight Frank said in a report.

REITs is an investment vehicle, which invests in rent yielding completed real estate assets (i.e. commercial properties, hospitals, schools, etc.) and derives its income and profits from real estate assets in form of rental income, capital gains, etc.). REITs distributes upto 90% of its income to its investors.

As per Knight Frank, REIT is expected to have a large opportunity in the Indian real estate market, which is supported by a strong economic growth, a large portfolio of completed commercial real estate and conducive investment climate.  

While, capital market regulator Sebi had notified REIT regulations 2014, no single trust has been set up so far as investors were seeking further easing of the norms as well as various tax breaks, to make these instruments more attractive.

The government has brought amendments in the IT Act to provide a tax efficient and stable regime for REITs in India, while Sebi had also eased up REITs norms in December, 2016.

"Amidst the conducive environment of liberalised REIT regulations, clear guidelines on disclosures and governance of REIT, the demonetisation decision of the Government of India has only accentuated the cause of REIT," said Dr. Samantak Das, Chief Economist & National Director - Research, Knight Frank India.

Das noted that demonetisation of high value currency notes has pushed up the liquidity in the banks which has further led to a considerable fall in government bond yields.

"From the REIT perspective, the decline in government bond yields and the overall interest rate regime has increased the spread with prime office properties," Das said.

Ameet Hariani, Founding & Managing Partner, Hariani & Co. said, “Real estate can be hard to liquidate. Indian REITs will help to split the bill on real estate investments. Developers divesting through REITs can get in and out of developments quickly. Investors can also make lower ticket investments in property through REITs. Last year has seen a considerable easing up of Indian REIT regulations – it's time for investors, developers and owners to get in on the REIT action. It appears that, now, the REIT way is the right way.”

Sai Venkateshwaran, Partner and Head – Accounting Advisory Services, KPMG India, “REITs provide a good opportunity for foreign investors to participate in the Indian real estate market. The regulations have also been developed with the intent of making this platform attractive to the international investor community by adopting standards on reporting, disclosures and compliance in line with global norms. Apart from bringing in the much needed additional funds into the sector, this will also help reduce the reliance on banks for funding, and also free up capital for deployment in other projects.”

Girish Vanvari, Partner and Head – Tax, KPMG India said, "The Indian REIT Regulations have been aligned with the global regulations in many aspects and the Government has provided pass-through tax treatment for REITs so as to ensure tax efficiency barring few areas like direct transfer of property to REIT, payment of interest by LLP, pass-through tax treatment for two level holding company, etc. We expect further liberalization in the REIT regime especially in the area of income-tax, stamp duty and foreign exchange regulations so that Indian REITs become more competitive with the global REITs."

Majority of issues restricting launch of REITS have been addressed through changes in the tax and regulatory regime, but there still exist some key demands on the taxation, the report said.

Among others, these include exemption from dividend distribution tax paid by special purpose vehicles (SPV) to holding company and holding company to REIT and similarly exemption from withholding tax on interest the paid.

"The government also ought to consider waiving the stamp duty where a REIT holds property over a specified period of years or alternatively the state governments could consider a one-time waiver of stamp duty on transfer of assets to REITs," the report said.

"If the sponsor seeks to consider an alternative route (other than SPV model) to hold the REIT assets, this may not be feasible for REITs in India due to high state stamp duties and registration costs applicable in various states on acquisition of properties," it added.

Going by the report, REIT as an investment vehicle has a huge opportunity in India as the country has a rent yielding office inventory to the tune of 537 million square feet valued in excess of USD 70 billion.

Besides, there are other properties like warehousing, retail malls, shopping centers, school buildings which hold huge potential REITs, the report said.

Key takeaways:

  • REIT as an investment vehicle has huge potential in India
  • India has a rent yielding office inventory to the tune of 537 mn. sq. ft. worth more than USD 70 billion. Warehousing, retail malls, shopping centers and school buildings to name a few comprise a massive REITable assets spread
  • REITable assets may cover completed and rent-generating real estate assets. It is estimated that approximately USD 121 billion or 1.73 billion sq. ft. occupied CRE (Commercial Real Estate) across office, retail and warehouse segments could potentially benefit from the REIT opportunity
  • In the case of office and retail, approximately 537 mn. sq. ft. and 75 mn. sq. ft. respectively is REIT-able area located in the top seven cities, namely Mumbai, NCR, Bengaluru, Chennai, Hyderabad, Kolkata and Pune. With respect to warehousing space, the all-India estimate is approximately 1127 mn. sq. ft.
  • Returns on equity of traded REITs fared better than returns on leading stock markets indexes globally over the past 10 years
  • Five year returns for REITs was between 7 and 16 per cent globally. With Japanese and Malaysian markets providing returns in the range of 8 to 10 per cent, expectations from Asian economies on the rise
  • In Asia, REITs debuted in Japan followed by Singapore, Indonesia, South Korea, etc. Japan and Singapore are the market leaders in Asia for REIT. More than 20 countries now have REIT or a similar structure. Since, its birth in the US close to five decades ago the REIT market has mushroomed across the globe
  • The global REIT market over the years has showcased a gradual yet substantial growth following investor-friendly changes in the REIT tax and regulatory
  • Internationalisation of REIT has deepened the global real estate sector and boosted market liquidity. Key takeaways from international REITs which currently do not form part of the REIT regime in India are the concepts of stamp duty remission, overseas property portfolio
  • Foreign exchange regulations applicable to REITs: RBI has granted permission for foreign investment and ECB in REIT, which shall channelize overseas investment into India and shall provide low cost funds to cash strapped real estate sector in India
  • Income tax implications: Budget 2017 pronounced certain direct tax proposals for the real estate sector albeit a miss on aspects such as ‘pass through’ regime to Hold Co Structure under REIT, including LLP in the definition of ‘SPV’ (Special Purpose Vehicle) etc. Appropriate representations should be made before the Finance Ministry to consider the same for removing road blocks and making REIT structure successful in India.
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