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Real Estate Investment Trusts

Monday, October 14, 2013
By Mayura Shanbaug

Will The Sector Get A New Lease Of Life?

Allowing Real Estate Investment Trusts (REITs) in India has been a long pending demand of the sector. After 5 years of waiting, the Securities and Exchange Board of India’s move to issue a consultation paper hopes to revive substantial investor interest from domestic and global investors in India’s currently subdued real estate markets, as it moves towards more organised and globally well accepted practises of funding real estate development.

REIT is a security that sells like a stock on the major exchanges and invests in real estate directly, either through properties or mortgages. REITs receive special tax considerations and typically offer investors high yields, as well as a highly liquid method of investing in real estate.

“Allowing REITs to operate in India would be a sign of the maturity of the Indian RE markets as globally REITS are found in mature economies,” says Sanjay Dutt , Executive Managing Director, South Asia Cushman & Wakefield .

“This is because it reduces individual speculation in real estate assets and allows for more professional investment and management in the sector,” explains Dutt.  According to him, several developers and real estate funds eyeing Singapore for REIT may potentially look at doing REITS in India.  “Global investors who are risk or development averse in Indian real estate market may find ready leased assets with least risk and easy exits through REITS. Some of RE Funds already invested in offices would certainly welcome the move,” he says.

The draft regulations on real estate investment trusts (REITs) could benefit listed firms such as DLF, Prestige Estates and Phoenix Mills as well as unlisted ones such as K Raheja Corp and Embassy group, which have large rent-generating assets. According to analysts, these realtors would get a new avenue to cash out their assets by floating REITs and listing on the stock exchanges.

Corporate and IT companies who own large office buildings and parks could potential unlock value and invest in businesses through REITS. If implemented, the timing would be great as many developers are faced with liquidity issues as they have large amounts of capital locked in commercial assets and are finding it difficult to sell due to the large ticket sizes. Investments by REITs in these and other assets would indirectly reduce the exposure of banks to risky assets as they had provided construction finances to many projects.

 India has 400 million sq ft of office and mall properties valued at $60 billion), according to Morgan Stanley. Overall, experts believe, REITs would also bring in more transparency in the RE sector as they would have to abide by laid down procedures and obligations.

“Hence, we can expect better compliances for RE projects and developments through professional audits, valuations and management. Importantly for corporate occupiers leasing offices and retail spaces, there will more stability and security in dealing with REITs as landlords, than with individuals, sometimes many individual owners for the same spaces,” says Dutt.

The step has received thumbs up from all quarters. “Sebi seem to have taken a very pragmatic approach at the REIT regulations.A lot of emphasis has been given to transparency and disclosures,” says Bhairav Dalal, Associate Director, PwC India. As per Dalal, Indian investors will get an additional investment opportunity to invest in real estate. “It will also benefit real estate developers who will be able to transfer their developed assets into a REIT,” he says.

According to Anshuman Magazine, Chairman & MD, CBRE South Asia Pvt. Ltd, Once in place it (REITs) will provide an additional exit route for investors and enable retail money to be channelised into India’s realty sector through a regulated network. “The introduction of REITs in the long term would propel the sector, spurring capital inflows and bringing institutional credibility,” he says. 

In spite of all the hype and hoopla, the bottom line according to experts is the preparedness of the government and the regulator to move quickly and ensure the momentum remains by completing the necessary processes to allow REITs to be actually setup and ensure that much needed institutional funding and liquidity in the real estate sector comes in at the earliest.   

With approximately 132 million sq.ft  of additional office space demand by 2017 and approximately over 200 million sq.ft. of investable Grade A leased office assets “not sold”, which would be quickly monetized through REITS at a cap rate of 9% to 10.5% feel experts. 

Lalit Kumar Jain, Chairman, CREDAI, an apex developer’s body, expressed the hope that REIT will also result in increased supply of foreign funds for the sector that it is struggling for funds in view of the RBI restrictions and negative weightage given to real estate.

Jain feels that REIT will also give a big boost to the rental housing sector. However, Jain called for some clarity on taxation issues around of the instrument. “The finance ministry will have to come out with the necessary guidelines,” he said.

Another concern is with regards to the strengthening of the legal framework surrounding real estate in India, which is a pre-requisite for REITs to thrive here. The Real Estate Regulatory Bill, which was approved by the Union Cabinet in June 2013, is therefore seems to be a move in the right direction.

And as Sanjay Dutt  puts  it: “ our expectation is that this consultation exercise will be a thorough one that takes care of all concerns and leads to a well thought of policy.

The Government has to ensure that there are sufficient incentives for investors, especially individual investors subscribing to REITs and that there will be no roll backs of any measures after some time as was the case of introduction of MAT and DDT in SEZs or the intention to introduce GAAR retrospectively. ‘

“These are perceived as knee jerk reactions by institutional investors and portray the country in poor light and affect investment inflows adversely,” Dutt adds.

Broad Operating Guidelines
The eligibility criteria for REITs that have been spelled out suggest that initially, only large and established asset management firms can participate. The minimum asset size of REITs should be INR 1000 crore. The REIT shall have parties such as trustee (registered with SEBI), sponsor, manager and principal valuer. To begin with, all REIT schemes will have to be close-ended real estate investment schemes that will invest in real estate with an aim to provide returns to unit holders. Returns will be derived mainly from rental income or capital gains from real estate. The minimum size of an initial public issue will not be less than INR 250 crore, of which at least 25% has to be publicly floated.

Low leverage and limited participation seem to be the initial safeguards. While the 25% public float criteria exists, SEBI has limited participation in REIT IPO to HNIs and institutions until the market develops fully. Thus, the minimum ticket size for investment is kept at INR 2 lakhs. Also, in order to safeguard against over-leverage, the borrowing limit for REITs is limited to 50% of the asset size. If the borrowing limit crosses 25%, an approval must be sought from investors and a credit rating must be obtained from a reputed rating agency. Also, any transaction that exceeds 15% of the asset value needs investor approval.
Criteria for investment remain intact from last draft:

  • 90% of the investment must be done in ‘completed’ revenue-generating properties
  • The remaining 10% can be invested in other assets as deemed fit by the REIT manager
  • There will be no investment by REITs in vacant or agricultural land
  • 90% of the net distributable income after tax is to be distributed to investors (the issue of double taxation, as raised by industry participants reacting to the previous draft, still exist)

These guidelines amplify in some greater detail what was shared in the previous draft.
Source: Jones Lang LaSalle India

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