Indian realty likely to be streamlined by REITs

Real Estate Investment Trusts (REITs) are pooled investment trusts that predominantly invest in completed, revenue-generating real estate properties, manage such properties and distribute a major portion of the earnings to their investors.

The concept of REIT was first introduced in 1960s in the United States. Realising the benefits that a REIT provides, other countries (such as Australia, the UK, Germany, Singapore, etc) introduced REIT legislations subsequently. Globally, REITs have demonstrated the ability to attract and effectively manage investments in the real estate sector. Besides other advantages, REITs bring increased transparency in the sector by adopting better corporate governance.

In India, the real estate sector contributes significantly to its GDP, however, it continues to be largely unorganised. Despite being a natural hedge against inflation, real estate assets are kept out of the financial market and the common investor is denied the opportunity to share in the returns from this asset class.

The REIT framework was introduced by the Securities & Exchange Board of India (SEBI) in 2014. These regulations are substantially in line with global regulations. A special tax regime for REITs was also introduced by the government of India in 2014 to allow for the tax incidence to be the same as a direct investment in real estate. There are still some niggles, but the recent proposal in Budget 2016 that exempts the distributions made by SPVs (owned by REIT) from the dividend distribution tax of approximately 20 percent has created a tax framework that is actually attractive. The proposed amendment has brought the Indian REIT regime and the related tax framework in line with the global framework.

In addition to becoming an attractive investment option for non-residents – the government had late last year eased the foreign investment norms to enable this. REITs in India are also expected to provide the common man an opportunity to invest in fixed income securities which also provide long-term capital appreciation. Due to limited investment opportunities, savings made by such investors are usually channelised into gold and housing which are unproductive assets. REITs as an investment class are expected to convert such capital into a productive asset class. It also opens to small investors an arena (i.e. rent generating real estate assets) which was hitherto the monopoly of large investors.

The real estate sector in India faces severe constraints in terms of adequate and structured finance options. Bank funding to the real estate sector has been sporadic. Although there are recent signs of turnaround in the nature of capital coming into the sector, there is severe shortage of risk capital in the real estate sector and bulk of such capital is in the nature of mezzanine finance.

REITs, being pure equity capital, will help developers in improving their debt-equity balance and assist in the growth of a more stable and mature market. They would also provide developers with institutional capital to sell their assets and utilise funds for further development or for paring of bank debt. With access to public markets for IPOs not being a short to medium term option for developers in India, this option is all the more attractive.

It is also expected that the banks in India can be a major contributor of assets in REITs. These banks own vast commercial real estate for their offices and branches. These assets can be revalued and swapped into a REIT and the asset can be leased to the banks. This would enable the money raised to flow back to the bank for shoring up their balance sheets, and at the same time be a very stable asset for the investors.

The global capital allocation towards REITs is also increasing exponentially. With the introduction of REITs in India, allocated global capital for dedicated REITs can be channelised into the country, and with the tax framework being loaded in favour of non-residents, this is a very likely outcome.

REITs will assist in streamlining the real estate sector by creating a clear mechanism for raising finance in the real estate market. Since REITs operate in a regulated environment, it will bring upon transparency in transactions, thereby instilling confidence in the minds of individual and foreign investors.

The real estate industry’s need for additional source of funding and global success of REITs is compelling enough to encourage the implementation of REITs in India. The enabling framework and tax regime shows the intent of the government to make REITs a reality. However, one needs to be careful of the quality of assets being launched in the first few REITs, and it is critical that only mature assets with strong leasing and high quality asset management are put out to REITs. This, coupled with the softening in interest rates expected soon (considering the across the board reduction in rates on bank deposits and other avenues such as the PPF), will mean that the returns on REITs could actually start looking attractive.

All the blocks are in place now for the launch of REITs in India –whether it is the regulations, the tax regime or the overall macro factors and I expect that by early 2017 we should see the first of the offerings.

Credits Forbes India

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