A whole new experience awaits investors, thanks to the recently unveiled regulations on real estate investment trusts (REITs). Allocations to real estate will now be more affordable, and we may see this asset class increasingly feature in many new portfolios.

REITs, in which a participant has to put in at least Rs 2 lakh, will expand the horizon for investors, providing them with an additional means of diversification and enabling them to spread their risk.

Investments of REITs have been limited to commercial real estate. Such investments may be done directly in projects. These may also take place through special purpose vehicles (SPVs). In an SPV, a REIT has to hold a controlling interest and not less than half of the share capital.

The regulations have also specified that not less than 80 per cent of the value of a REIT’s assets will be in “completed and revenue generating properties”.

This is likely to provide sufficient room for income. Also, a REIT will be open to investing in a few other areas, such as

Listed and unlisted debt securities of companies engaged in real estate

Listed equity shares of companies which derive not less than 75 per cent of their operating income from realty

Government securities, mortgage-backed securities and money market instruments

Similarity with mutuals

Investors will be happy to know that there are a lot of similarities between mutual funds and REITs. Regulations call for the setting up of trusts that will be registered with the securities watchdog. These structures will have trustees, sponsors and managers as in mutual funds. Each of these entities will need to play a specific role. While the trustees will oversee the function of the trusts, the managers will need to bear operational responsibilities.

When a REIT is registered with Sebi, it will be free to mobilise resources from the market through an initial offer. Units will be allotted to investors. Subsequently, additional funds may be raised through follow-on offers, rights issues and qualified institutional placements.

It must be mentioned that MFs, too, take the new-offer route to raise funds from the market. In the case of a REIT, however, the units will be compulsorily listed on a stock exchange. Incidentally, exchange-traded funds (ETFs) are similarly listed.

REITs must make continuous disclosure in their listing agreements. The trading lot for their units has been pegged at Rs 1 lakh.

The similarity with mutual funds, however, ends here. If a REIT intends to come out with an initial offer, the value of the assets owned (or proposed to be owned) by it should not be lower than Rs 500 crore. Additionally, the minimum issue size for an initial offer needs to be Rs 250 crore.

How will investors gain?

REITs can emerge as a distinct sub-category among all investible asset classes. These trusts will allow an investor to participate in the dynamic realty sector in a rather convenient manner. These days even small parcels of commercial property, especially the ones that have the right addresses, command considerable value. Yet a REIT investor need not allocate huge resources to enjoy the appreciation in property prices.

In terms of asset allocation, REITs will allow investors to spread their risks further. They have a scope for considerable diversification, particularly if the trust manages to broaden its investment horizon in the desired manner.

According to the rules, a REIT must invest in at least two projects, and not more than 60 per cent of the value of the assets can be invested in a single project.

On the sharing of income among unit holders, a REIT must distribute at least 90 per cent of its net distributable cash flow to investors, at least on a half yearly basis. It must also engage a valuer who will perform a valuation of its holdings annually.

This must be updated every six months. The net asset value must be declared within 15 days from the date of such valuation or updation.

As financial advisers will no doubt agree, the domestic real estate has provided a decent yield in the last few decades.

Unlocking of the value is a continuous, relentless pursuit for many investors who want to leverage their real estate holdings. REITs will do these participants a great service.

Strategy to follow

REITs will pave the way for investors to enter (and gain from) the real estate market in a transparent manner. These will be a completely new asset class — there will be no track record, no history, to take lessons from.

Participants will have to select the right vehicle once REITs are made available to public. Discretion will be critical. A hard look at the promoters’ business and experience will be necessary.

Real estate is traditionally not a domain marked by super-fast returns. Gestation often takes plenty of time, while price discovery frequently becomes a complicated process.

Therefore, it will not be wise to expect REITs to perform miracles overnight. Instead, a long-term approach is recommended — this may well increase the probability of capital appreciation.

The author is director, Wishlist Capital Advisors