REIT is a real estate entity that offers common shares/units to the public as an investment option. Such units represent ownership in the business of managing income-producing properties. The general characteristics of a REIT are that its investor base is broad and the units are, more often than not, listed, providing liquidity to the investor. REITs can be equity REITs, mortgage REITs and hybrid REITs. Globally, REITs have been used by the housing, industrial and hotel sectors.
The regulations envisage a REIT as a trust set up under the Indian Trusts Act, 1882. The REIT will raise funds through an initial public offering (IPO) and list the units on a recognised stock exchange. The REIT is required to be registered with the Sebi. The key parties involved in a REIT are the trustees, the manager, the sponsor, the valuer and the auditor. Significant criteria for registration of a REIT are (a) net worth of the sponsor, which is at least INR 20 crore and for the manager, is at least INR 5 crore; and (b) experience of parties to the REIT, which is slated to be not less than five years in the real estate industry or in the development of real estate. In addition, the sponsor has a minimum commitment, by way of continuing interest, to hold at least 25% of the total units of the REIT, which shall not fall below 15% of the outstanding units of the REIT at any time. Further, the regulations also provide for a suitable lock-in period on the units held pre- and post-IPO.
Public offer and listing
All offers of units (initial and follow on offers) of the REIT can be made by filing of offer document with the Sebi and the designated stock exchange. If a REIT fails to undertake the IPO within 18 months from its registration, it has to surrender its registration certificate and shall cease to operate.
The issue structure of the REIT requires a minimum REIT asset size of not less than R1,000 crore. At least 25% of the value of the REIT is required to be offered public and the offer size shall not be less than R250 crore. The face value of the units shall be R1 lakh and the minimum application for subscription shall not be less than R2 lacs.
Listing of the REIT units on a recognised stock exchange and maintaining a minimum public float of 25% at all time is mandatory. A delisting of the REIT units is mandatory when the minimum public float falls below 25% or the number of unit holders fall below 20%. Delisting requires the REIT to surrender its registration and discontinue the permitted activity under a REIT.
The REIT structure under the regulations provides for a governance mechanism through various parties viz., the manager, a formation of investment committee, appointment of a valuer and an auditor, all of whom are expected to be independent in discharging their role. The trustee has the obligation to ensure that the REIT is operating in line with the provisions of the trust deed, the offer document and the regulations.
Dividend policy and rights of unit holder
The REIT is required to distribute at least 90% of the net distributable income to its unit holders. In addition to receiving dividend, the unit holders have a right to vote. On issues affecting governance and operation of the REIT, approval of 75% of the unit holders is required whereas approval of 60% unit holders is required for operational matters. Change in sponsor or control of sponsor or change in the manager requires prior approval of unit holders.
Investment by REITs is permitted only in properties or securities in India and at least 90% of value of the REIT assets should be in completed and rent generating properties, i.e. property, of which, not less than 75% of the area has been rented/leased out. The REIT can invest up to 10% of the value of the REIT assets in other assets. REITs can also invest through a 51% controlled special purpose vehicle. The entire corpus of a REIT can be invested in a single project. In case of any breach of the investment conditions, the manager shall have six months to rectify it.
The Income Tax Act, 1961 does not provide for any specific treatment to the parties involved in the REIT or the REIT itself. However, in view of the international practice, most stake holders would expect tax concessions.
Areas for consideration
Though a launch pad for the REIT regime, the regulations will require clarifications and updating on points such as (a) sponsors minimum holding of at least 15% of the outstanding units of a REIT, can prove restrictive for Real Estate Funds acting as a sponsor to a REIT, since they have a defined fund life; (b) minimum asset size restriction of R1,000 crore in values to undertake an initial offer could prevent a number of quality sponsors and rent generating assets from participating in the development of the REIT market; (c) there is no clarity on under subscription/shortfall in an IPO and how the funding gap will be addressed; (d) It is not very clear whether the real estate assets are required to be transferred to the REIT prior or post the listing as transfer of assets prior to listing could expose the REIT and the sponsors to the risk of incurring cost on tax loss /stamp duty expenses should the public offer fail; (e) inflexibility in the REITs ability to raise capital i.e. can be done through an IPO/follow on offer; (f) lack of clarity in the pricing of a follow-on offer; (g) lack of clarity on the manager being unable to ensure leasing out of the REIT assets due to market conditions; (h) it is not clear that in the event of delisting whose obligation it would be to delist and provide liquidity to the investor; (i) restriction on borrowing up to 50% of the asset value couldresult in breach of the regulations due to market price fluctuations of the REIT assets.
The Sebi has taken a major step by releasing the consultation paper on REIT. Adoption of the regulations will go a long way in providing the essential link between the capital market and development of real estate sector in India.
The author is partner, Khaitan & Co