REITs: Reading between the Lines

Recently, after much deliberation and consultation, the formal notification outlining the basic rules for setting up real estate investment trusts was issued by the Securities and Exchange Board of India. All REIT schemes, to begin with, will be close-ended real estate investment schemes that will invest in property with the aim of providing returns to unit holders. The returns will be derived mainly from rental income or capital gains from real estate.

REITs will be allowed to invest in commercial real estate assets, either directly or through special purpose vehicles. In SPVs, a REIT must have a controlling interest of at least 50% of the share capital and will have to hold at least 80% of their assets directly in properties. REITs will be allowed to raise funds only through an initial offering and units of REITs have to be mandatorily listed on a stock exchange, similar to initial public offering and listing for equity shares.

A REIT will be required to have assets worth at least Rs.500 crore at the time of an initial offer and the minimum issue size has to be Rs.250 crore. The minimum subscription size for units of a REIT on offer will be Rs.2 lakh and at least 25% of the units have to be offered to the public. Subsequently, REITs can raise money through follow-on offers, rights issues or qualified institutional placements and the trading lot for such units will be Rs.1 lakh.

According to the norms, although a REIT may raise funds from any type of investors, resident or foreign, initially only wealthy individuals and institutions will be allowed to subscribe to REIT unit offers. The market regulator said a REIT may have up to three sponsors, with each holding at least 5% and collectively holding at least 25% for a period of at least three years from the date of listing. Subsequently, the sponsors’ combined holding has to be at least 15% throughout the life of the REIT.

To ensure that REITs generate continuous returns, Sebi has said at least 80% of the REIT’s assets have to be invested in completed and revenue generating properties. And only up to 20% of assets can be invested in properties that are being developed, mortgage-backed securities, debt of companies in the real estate sector, equity shares of listed companies that derive at least 75% of their income from real estate, government securities, or money market instruments. No REIT can invest more than 10% in properties that are under construction.

Further, every REIT has to invest at least in two projects, with a maximum of 60% of assets going towards one project. All REITs have to distribute at least 90% of their net distributable cash flows to the investors. To ensure transparency, Sebi has made it mandatory for every REIT to undergo yearly valuation and declare its net asset values within 15 days of the exercise.

The introduction of REITs will make India’s real estate market more institutionalized and transparent while also making it more attractive for developers as well as local and foreign investors by bringing in long-term domestic and foreign capital flows. With REITs regulations coming into force, investors have much to look forward to in terms of transparent pricing, which will be a refreshing change from pricing based on speculation. As a new source of finance and income, REITs will benefit developers to own and manage assets with a long-term view as well as monetize their assets and use the funds to complete their cash starved projects. Retail investors will be incentivized to diversify their portfolio and benefit from regular income and capital appreciation of real estate. It is also expected to provide impetus for fresh boom in construction, which will help absorb labour migrating from the farm sector and boost the economy.

The operationalization of REITs holds out several promises such as:

1. Give developers easier access to funds and create a new investment avenue for institutions and high net-worth individuals, and eventually ordinary investors. The introduction of REITs will provide a new source of cash to Indian developers while giving investors the ability to buy into the country’s property market.

2. Creation of new investment channels in the real estate and infrastructure sector. REITs will reduce the cost of business for both local and foreign investors. It will help ease liquidity for developers and provide access to retail investors to benefit from regular income and appreciation from real estate.

3. If done properly, REITs will change the landscape as it happened in 2005, when foreign direct investment was allowed. Now, we can hope to see sovereign funds coming in.

5. REITs may help unlock as much as $20 billion of listings. Assets that may qualify to be included in REITs may reach $20 billion by 2020, according to an estimate by property consultancy Cushman & Wakefield. In the first three to five years, as much as $12 billion could be raised.

6. REITs will help to inject transparency at least in the commercial sector, lower the reliance on financing from banks, and incentivize developers to own and manage assets with a long-term view.

7. It will encourage investors to pool their money to buy real estate such as shopping malls, office buildings and rental housing.

8. REITs will help India’s real estate market become more institutionalized.

9. It will help free up capacity for a new construction boom which will give a boost to India’s economy.

About P. Sahel

As Vice Chairman of Lotus Greens, Sahel is responsible for giving directions on overall business strategy and key investments decisions of the firm. Being one of the founding members of Lotus Greens, Sahel has been instrumental in formulating various company policies, setting up systems and processes, and building a strong team of professionals. Prior to Lotus Greens, Sahel worked for more than 16 years in some of India’s largest and most respected real estate companies like Jones Lang LaSalle for 13 years as the Managing Director of the Markets & Solution Development and DLF prior to that. The views expressed are personal

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