12 Mar 2015

by Ketan Chaphalkar

Commercial rental yields in India ranges from 4% to 7% depending on geography. At these levels of yields, REITs generating income from rentals would be ineffcient as bank deposit/ liquid fund yields are around 8%. REITs would then look at capital appreciating in properties and given that commercial real estate is highly volatile in prices as seen over the last few years, investments in REITs would be that much riskier.

India’s real estate sector has witnessed rapid growth in recent years underlined by robust economic growth in the country. The growing scale of operations of the corporate sector has increased the demand for commercial buildings and space including modern offices, warehouses, shopping centres, conference centres. For such rapidly growing industry, it is crucial that investment vehicles such as Real Estate Investment Trusts (REITs) evolve in the country.

REITs are corporations that own and manage a portfolio of real estate properties. They offer the benefits of real estate ownership without actual ownership of the property. Globally, REITs invest primarily in completed, revenue generating real estate assets and distribute major part of the earnings among their investors. Typically, most of such investments are in completed properties that provide regular income to the investors from the rentals received from such properties. The investor receives dividend in the form of rent and capital gains on the sale of property.

The Real Estate Property Developers receive capital from investors similar to the capital received by a company against the issue of shares. Real Estate Property Development in Commercial and Residential Segment involves huge land bank investments that are locked in for years until the construction and handover to the owner is completed. In case the property is rented out by the company after completion of the building or a mall, a monthly cash inflow is generated on its investment. Foreign Investors are also allowed to invest in REITs in India and as such can provide the much needed investment for the capital hungry sector. Since it is difficult to own commercial properties for the retail individual investor, REITs provide the much needed opportunity for all those who are interested to invest in it without the hassle of taking complete ownership of the same.

Large companies are often able to raise capital in the form of loans for real estate property development but small companies are not able to raise it because of their creditworthiness. Small real estate development companies can come together to raise capital through REITs and get an opportunity to access capital with the underlying responsibility of providing income to the shareholders via rent or capital gains or both.

Actual Real Estate investments are highly illiquid and REITs would provide the much needed liquidity convenience to the Real Estate Property Developers as well as the investors. Sales growth on account of high liquidity would give the much needed boost to the players reeling under huge land bank investment coupled with poor sales.

Transparency has always been a serious concern for the real estate property development sector and REITs would provide the necessary professional money management services along with the much needed transparency that is required to gain the trust of the Real Estate Developers and the investors. This process would bring about an efficient price discovery mechanism in the Real Estate sector of India.

REITs would be registered as trusts with SEBI. These trusts would not be allowed to launch any scheme. They would be able to raise funds through initial offers and would have to list their units on exchanges for trade. They would be allowed to raise additional funds through follow-on offers as well.

At least 90% value of REITs assets should be in ready properties generating revenue. The remaining 10% can be in other specified assets. REITs would have it mandatory to distribute at least 90% of their net distributable income after tax to investors.

REITs provides an investment avenue that is less risky than under-construction properties, along with regular income and easier exit routes.

In the Union Budget 2015 the Finance Minister Mr. Arun Jaitley proposed that the sponsor would be given the same treatment on offloading of units at the time of listing as would have been available to him if he had offloaded his shareholding of special purpose vehicle (SPV) at the stage of direct listing. The rental income arising from real estate assets directly held by the REIT is also proposed to be allowed to pass through and to be taxed in the hands of the unit holders of the REIT