A real game-changer

Written by Saikat Neogi | Updated: Aug 18 2014, 06:46am hrs
What are Real Estate Investment Trusts (REITs)

They are investment trusts that own and, in most cases, even operate income-producing real estate. The trusts operate like mutual funds and invest in income-generating real estate assets like commercial realty, residential property, warehouses, hospitals, hotels and shopping centres. So, while mutual funds invest in equities or bonds, REITs invest in real estate and make it possible for individuals and institutions to invest in real estate. The stockholders of REITs earn a share of the income produced through the investment, without actually buying the property. The concept was first introduced in the US in 1960 and is in place in many other developed nations.

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How do REITs work

A REIT is a trust which then creates a Special Purpose Vehicle (SPV) to invest in income-generating real estate. A part of the pooled money is also invested in the stocks of listed real estate companies. Like close-ended mutual funds, REITs get listed and investors are able to buy/sell units of REITs, as is the case with mutual funds. This also ensures liquidity and exit opportunities. On the

REIT board, there is a trustee ensuring that the trust's activities are being carried out according to the regulations. A manager undertakes all the operational responsibilities of the trust and a sponsor is responsible for setting up of the REIT, including the appointment of the trustees. The income of unit-holders comes from capital appreciation or rental income of the projects where the trust has invested; 90% of the income earned from rent is distributed between the investors. Also, according to the Securities and Exchange Board of Indias (Sebi) guidelines, 80% of the value of REIT assets have to be invested in completed and revenue-generating properties and not more than 20% of the value of REIT assets can be invested in developmental properties, mortgage-backed securities, listed/unlisted debt of companies in the real estate sector, government securities and money market instruments. Investment in properties which are at the developmental stage will be restricted to 10% of the value of REIT assets.

How can individual investors invest in REITs

For an individual investor, REITs bring the benefits of listing, a stable source of income, investment diversification with small initial investments and professional management of the same. REITs help people channelise their investments into the realty sector through a regulated mechanism. As investments in REITs are asset-backed, people can invest in real estate without the complex paper-work that is usually associated with buying in the sector. Through REITs, individual investors invest in companies that own and operate real estate and property across the country. The minimum subscription size for units of a REIT in India is R2 lakh. REITs that are managed well can offer dividend yields that are higher than those from other investments. In fact, rental yield on long-term commercial office space and retail space tend to be higher than that of residential property. Globally, REITs offer higher dividend yields than stocks. So, an REIT investor may expect reasonably high annual dividends and some appreciation in the long-term from the rise in capital values of the properties.

How will it benefit the Indian real estate sector

REITs can potentially transform the fragmented state of the Indian real estate sector. On the one hand, they offer a new avenue for investment, with the benefits of a regulated structure and risk diversification. On the other, they could lead to capital formation for real estate development. Valuation of real estate has been a major concern in

India. Without a robust valuation system, calculating the fair price of a real estate project is a challenging task. However, the market regulator, in its guidelines, has made it clear that an independent party would assess the property value every six months. Also, the net value of the units have to be declared twice a year to make it more transparent.

What kind of regulatory oversight will Sebi have over these trusts

In October 2013, Sebi released the draft guidelines for REITs in India. However, the concept had not gained much momentum due to the uncertainties related to taxation. In its meeting on August 10, 2014, Sebi approved the final guidelines and put in a number of safeguards to make REITs accountable. In case of a SPV route, REITs would have to hold at least 50% of the equity share in the SPV. Some of the other changes include allowing REITs to have multiple sponsors, permitting REITs to raise money through private placements and reducing the asset size requirement of REITs to R500 crore from the R1,000 crore proposed earlier. This will encourage mid-sized and small developers to participate.

How has the tax treatment of REITs been changed in the Budget

In the Union Budget 2014, the government simplified the taxation around

REITs by providing it with a pass-through status (effective from October 1, 2014), which means that income would be taxed in the hands of the investor, and not the fund. The fear earlier was that income of both might be taxed, leading to double taxation. However, now developers have to pay long-term capital gains tax of 20% once they have sold their units in an REIT. Analysts say some of the key tax issues that still need to be resolved include exempting the SPV held by REITs from dividend distribution tax and providing clarity on tax deductibility of interest payments by SPV to REIT.

What are the challenges to the successful implementation of REITs

A major challenge could be the time-consuming registration process and higher stamp duties in states, which range from 5-14%. Typically, transaction cost for physical assets in the country ranges between 5-10% as against 4-6% in Singapore and this could hamper the growth of REITs. In developed markets, there is a large pool of long-term investors such as pension funds and insurance companies. Insurance investment regulations in the India would have to change for insurers to be allowed to invest in REITs. Analysts say India should work towards adopting some of the international best-practices to reap the long-term benefits of REITs.

saikat.neogi@expressindia.com