Real Estate Investment Trust (REIT) -- the new kid on the Indian bourses -- offers an exciting investment opportunity for investors and corporations, and a unique vehicle for issuers to access capital.
By Vivek Gupta and Rushank Muthreja
Real Estate Investment Trust (REIT) — the new kid on the Indian bourses — offers an exciting investment opportunity for investors and corporations, and a unique vehicle for issuers to access capital. Burdened with significant capital being locked in a commercial real estate portfolio, inclusion of commercial assets into a REIT at market value provides sponsors with a mechanism to unlock the assets’ true potential. On the investor side, low real interest rates naturally push higher return-seeking capital into avenues such as REITs, without the full associated risks emanating from equity. India has seen some REIT activity but is slated to see a lot more and that is where sponsors of such trusts must plan ahead, before moving into the REIT structure, on multiple counts including structural, commercial, legal, financial reporting and regulatory aspects.
What hurdles issuers could face
The first common hurdle for the issuers would be to get the optimal REIT structure in place that is compliance with SEBI regulations, and marries commercial and tax objectives — such as the inclusion of under-construction assets, asset valuations, leverage caps, etc. Structures must be optimised to enhance Internal Rate of Return (IRR) since it directly links to value at listing.
From a financial reporting perspective, the issuer of the REIT would need to be prepared to deal with extensive disclosure requirements, complex valuations, projected financial information, accounting for combined and carve-out financial statements and a myriad of interpretive matters that are likely to unfold. Given the unique nature of some of these issues, this may warrant consultations with regulators as well.
Additionally, performance measures such as Net Operating Income, used globally by REITs, are not ordinarily recognised measures in the Indian framework and the possibility of stitching these into the financial information would require deliberation and consultations for the issuer.
Road to listing on bourses
The runway to a REIT listing could vary depending on the readiness of the issuer. Other key work streams that would form part of this process would include activities such as developing an overall plan and strategy (timing, choice of assets, restructuring), execute on the optimal structure, obtaining various regulatory approvals, completing the due diligence exercise, launching roadshows, deciding IPO size and pricing — all of this and a lot more would finally lead to the listing. The process typically would involve various parties — investment bankers, lawyers, tax advisors, valuers, auditors and accounting advisors, media advisors and underwriters to name a few. Therefore, a well thought out plan, with enough runway and a strong team of experienced advisors would serve an issuer well.
REIT has been a success story globally and is a well-established model that investors understand. Globally, REITs are the primary capital raise avenue for real estate assets. It is estimated that REITs account for more than 90 per cent of the capitalisation of the sector in the USA and nearly 50 per cent in Singapore and Japan.
Strong capital appreciation to attract investors
India has also taken steps toward making REITs an attractive investment option. Over the last few years, enabling regulatory framework has been set up, stringent regulations such as the mandatory distribution of 90 per cent of cash flows, the prohibition of outstanding debt greater than 49 per cent and critical disclosure requirements, coupled with the ability to diversify, makes REITs a viable investment avenue.
In India, it took almost five years for us to see our first REIT. After REIT regulations were issued in August 2014, India saw its first REIT listing on 1 April 2019. About a year later, in August 2020, another mainstream commercial real estate developer listed its REIT on the Indian bourses. In our experience, these REITs have demonstrated strong performance – offering capital appreciation of at least 7 per cent Compound Annual Growth Rates and quarterly dividend payouts in the range of 1.8 per cent to 2.3 per cent (performance up to the quarter ended 31 December 2020). The COVID-19 pandemic has not dampened the enthusiasm that REITs have created in the capital markets.
Dividends and tax benefits for investors
REITs provide certain distinct advantages to institutional money-chasing yield-generating Grade A commercial and marquee mixed-use rental assets.
Firstly, SEBI regulations ensure strong governance and transparency standards. A REIT is professionally run by independent trustees and an investment manager. Other governance requirements include bi-annual valuation requirements, disclosure requirements, unitholders approval of specific matters, etc.
Secondly, REIT regulations providing for a mandatory 90 per cent distribution of cash earnings at regular intervals to the investors allow predictable regular returns to the investors and helps yield investors to meet their expectations.
Thirdly, tax pass-through benefit is significant and in line with global benchmarks – helping investors to meet their IRR thresholds. India has traditionally been a high tax jurisdiction with specific profit repatriation taxes. Profit repatriation from REITs on the other hand is tax-free for unitholders provided the underlying projects are paying regular taxes under the old income tax regime. Currently, the two REITs listed in India have made use of this option.
Further, in the recent Union Budget 2021, the Government has proposed some favourable measures for REITs. From a tax perspective, withholding tax on dividend from the special purpose vehicles to a REIT has been removed, which is expected to help reduce tax leakage. Further, REITs will now be able to raise debt from foreign portfolio investors which will further ease access of finance to REITs, augmenting funds for the sector. The provisions of Securities Contracts (Regulation) Act, 1956 (“SCRA”) are also proposed to be amended to recognise pooled investment vehicles and to recognise units, debentures and other marketable securities issued by REITs as “securities”. Some of the other key asks of the industry, such as bringing the period of holding of units at par with shares, have not been addressed in the budget.
We have a unique opportunity to tap into what is clearly a large global pool of hybrid capital — the India REIT story is well-positioned to give the much-needed capital impetus to the economy.
(Vivek Gupta is Partner and National Head – M&A/ PE Tax, KPMG in India and Rushank Muthreja is Partner, KPMG in India. Views expressed are authors’ own.)