Divaspati Singh & Saiya Savooji
Though Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs) were introduced in 2014 with much fanfare, the response from investors and managers has been tepid owing to the absence of several enabling benefits required to kickstart interest in them. However, given the importance of REITs and InvITs as long term and considerably safe investment structures which help infuse capital into the cash-starved real estate and infrastructure sectors, Sebi has been extremely pro-active in ensuring the introduction of the required reforms, even liaising with other regulatory authorities where necessary.
One of the examples of Sebi’s active approach is the permission given by RBI for banks to invest in REITs and InvITs in April 2017, by way of release of the Prudential Guidelines. Under these guidelines, investment by banks in REITs/InvITs is subject to an umbrella cap of 20% of the bank’s net owned funds, which already applies to investment in equity-linked mutual funds, venture capital funds, and equities. Further, such investment is also subject to a separate limit of 10% of the unit capital of a REIT or InvIT. Additionally, banks must formulate a board-approved policy for exposures to REITs/InvITs, which must be within the overall exposure limits applicable to the real estate sector and infrastructure sectors and must also adhere to other RBI guidelines relevant for these sectors. With the release of these Prudential Guidelines, RBI has brought a lot of cheer to the markets, due to the overwhelming benefits conferred on both banks and the real estate and infrastructure sectors.
Banks are one of the largest investor classes globally, with deep cash reserves and a wide investment net. Fuelled by the present economic situation and the rise of alternate asset classes, banks have been reducing their equity exposure and replacing it with investments in low-risk and long-term assets providing steady returns. REITs/InvITs are predominantly income-generating structures that derive their value from the underlying capital-intensive, locked-in assets. They provide steady, regular yields.
REITs/InvITs provide scope for earning higher returns from long-term holdings, due to capital appreciation of the underlying assets. Under Sebi regulations governing REITs and InvITs, at least 80% of the asset value must be invested in completed, revenue-generating infrastructure projects, and at least 90% of the net distributable cash-flows must be distributed to the investors—an attractive proposition for banks as they require liquidity due to the nature of their liability payments.
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Real estate and infrastructure projects are capital-intensive in nature and have long gestation periods, thus requiring continuous capital. Banks, being institutions with deep pockets, are best qualified to cater to the same. However, given the risks of investing directly in these sectors, participation of banks has remained stagnant, which has now been given a fillip due to the relaxation announced by RBI.
Moreover, the participation of banks in REITs and InvITs is also beneficial for attracting other institutional and retail investors, who have been wary of the risks involved. This is because investment by banks acts as a due diligence check for many investors, and hence encourages infusion of more capital into these sectors. The relaxation provided to banks to invest in REITs and InvITs joins a long list of reforms that Sebi has brought into effect for institutional investors seeking to invest in these structures. Globally, the largest investor classes which typically invest in REITs/InvITs are banks, insurers, pension funds and mutual funds. For instance, allocation by pension funds to the US REITs in 2009 was about 32% of the market capitalisation of the FTSE Composite REIT Index, while bank exposure of REITs globally has been in the range of 18-20%.
In view of the same, Sebi has already permitted or persuaded the relevant regulator to permit, pension funds (in 2015-16), mutual funds (in February 2017) and insurers (in March 2017) to invest in REITs and InvITs. With the introduction of the Prudential Guidelines bringing down yet another barrier to an investor-friendly REITs and InvITs regime, it appears as if the beleaguered real estate and infrastructure sectors will finally receive the much-needed boost in the coming months of 2017.