Up and close with Real Estate Investment Trusts (REITs)

From almost a decade now, India has been gearing up to welcome Real Estate Investment Trusts (I-REITs or just REITs if you please) as a panacea to all our realty issues. REITs have been touted as the magic wand which will eliminate many of the major and minor issues plaguing our realty sector and will bring in much needed “clean” and “stable” capital.

But what are REITs? And how do they solve all these issues? Wait a minute - do they really solve all the issues? And most importantly if they do, why aren’t they here yet?

In the current scenario, with sluggish residential sales and a general negative macro perception of real estate as a whole, developers have shied away from commercial real estate which is difficult to sell in the absence of institutional and/or retail investors.

Enter REITs – a fresh avenue for developers to lighten their existing load by selling completed buildings to investors and listing them as a trust – and new hybrid asset class for institutional and retail investors, ready to invest in yield and capital appreciation assets i.e. leased office and retail space.

For external investors, REITs are essentially like mutual funds – with the original RE owner as the sponsor of the vehicle holding not less than 25% at least in the first 3 years and not less than 15% thereafter. Essentially the developer, upon completion, holds at least 15-25% and essentially divests at most 75-85% stake in yield assets, allowing him to complete other developments.

Sounds great! So what is stopping them? The same old villain – for all investors and developers – taxes! Though there has been some clarity that the sponsor will not be taxed more than STT in lieu of capital gains at the time of creation of the REIT, there are still a multitude of taxes to contend with – withholding tax, MAT, DDT, that too, at different stages – at the SPV level, REIT level and unit holder level. Despite the pass through status accorded to REITs, it is not going to be an easy ride.

But that is to be expected. Even in the US, the first 5-6 years saw a lot of teething issues in the industry, same as mutual funds in the early 90s. So, definitely, there will be some pain in the early period.

The new final rules – after drafts earlier in 2006 and 2013 – allow for leverage up to 49% with and up to 25% without credit rating and unit holder’s approval. The unit holders find an avenue at an affordable investment size of minimum Rs 2 lakhs as per guidelines and Rs 1 lakh trading lots, which is expected to be highly liquid and gaining exposure to fully constructed (minor exposure allowed for under construction projects) and ready realty asset and has potential for capital gain. While investors can opt to reinvest, akin to growth option of mutual fund, the basic option will be regular yield income for most investors.

Given India’s expected high growth trajectory, real estate assets, especially commercial, are expected to do well and offer decent returns over the long term.  Just like mutual fund investors, REIT investors are expected to do quite well. Remember, on a risk return scale, REITs are low risk medium return so the “quite well” is relative and investors certainly should not expect 20% returns.

REITs are certain to be a watershed event in the Indian real estate history. Right now they are close, but not quite; but given the intense spotlight and interest created, it is just a matter of time before the niggling issues are sorted out. Until then, wait and watch!

About the author

Vinay Rangani, General Manager, Investment Services, is a CFA charter holder and MBA with quality experience as a Buy side and Sell side Investment Professional with equal focus on equities and debt. He possesses a rich cross-sectorial experience with the major focus areas being real estate, infrastructure and technology - utilising multiple instruments and transaction sizes in the range of $2-$50mn.


Importance of REITs in India

Watch our Colliers India expert, Amit Oberoi, National Director, Valuation & Advisory Services talk on the importance of REITs in India

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