A Real Estate Investment Trust (REITs) is a trust or a corporation that owns and operates real estate income-producing assets. It can own a range of diversified commercial real estate including hotels, offices, apartments, hospitals, shopping complexes, warehouses, and special economic zone. These are comparable to Mutual Funds as investment instruments for the real estate. Investors can invest in various kinds of properties through REITs as we can invest in any company by purchasing its shares. REITs allow its unitholders to be part of income-producing real estate assets without having to invest large amounts and helps in generating rental income to the investor.
A REIT is created by a sponsor who transfers the ownership of the assets from an SPV, Special Purpose Vehicle to a REIT in exchange for its units. The sponsor is obligated to hold certain units of the REIT. The remaining units are issued to investors through a public issue of the REIT. The IPO proceeds accrue to the sponsor who sells units of the REIT. A REIT sponsor utilizes pooled money of investors to purchase and operate income-generating assets. Subsequently, tenants of the assets owned by the REIT will pay lease rentals to the SPV that manages the assets. After statutory dues and tax deductions, lease rentals flow to the REIT and from the cash flows that are distributable at least 90% (in most countries) flows as dividends to the unitholders. In this way, REIT works as an innovative vehicle useful for developers in monetizing their revenue-generating real estate and simultaneously gives retail investors an opportunity to invest in commercial real estate and generate a stable rental income and moderate capital gains through appreciation in the value of assets owned.
REITs are generally publicly traded on major exchanges or publicly registered but non-listed, or private. Equity REITs were recognized as a distinct asset class in the Global Industry Classification Standard by S&P Dow Jones Indices and MSCI in November 2014. Few statistical measures to examine the operation and financial position of a REIT are net asset value (NAV), funds from operations (FFO), and adjusted funds from operations (AFFO).
REITs first came into existence in the United States after President Dwight D. Eisenhower signed Public Law 86–779, sometimes called the Cigar Excise Tax Extension of 1960. The first REIT was founded by Thomas J. Broyhill, American Realty Trust. More than 30 countries around the world have established REIT regimes until now. Globally as investors are more aware of it, they have accepted REIT as an investment alternative to real estate.
According to a report “India REITS Heralding a new era in real estate investments” by JLL India REIT (Property.jll.co.in/) has become an alternate investment with nearly USD 1.7 tn global value in 2018. Higher returns than equity markets over the longer-term have derived this growth.
Real Estate investment trust was recently introduced in india and it has to be mandatorily registered with the securities and exchange board of india (SEBI) under SEBI(REITs) Regulations, 2014. After consultations with the industry and market experts amended SEBI (Real Estate Investment Trusts) (Amendment) Regulations, 2016, were notified.
REIT should get listed its units on a recognized stock exchange having nationwide trading terminals. In India REIT initially had requirements of high investment as it was meant for HNI, but then the regulations were amended by SEBI to a lower amount (minimum 200 unites) to allow retail investors to participate. REITs invest mostly in completed commercial real estate assets, either directly or through SPVs. The units issued by REIT are traded based on their net asset value.
REITs are an interesting investment avenue as they maintain high dividend pay-out ratios (90%), making them attractive for income-seeking investors. REITs get the benefit to save tax in this transaction, but investors still have the liability of direct tax.
Infrastructure Investment Trust
Another asset for investment in infrastructure in India is Infrastructure Investment Trust (InvITs) which is similar to a mutual fund and allows direct investment in infrastructure projects either directly or through an SPV (special purpose vehicle) to earn a small portion of the income as a return. InvITs can be seen as the modified version of REITs specifically designed to suit the infrastructure sector
InvIT is an India specific product mainly useful for a particular set of infrastructure assets as well as for government organizations. Currently, there are 3 InvITs listed in India. Returns have been low for all of them
- Digital Fibre Infrastructure Trust
- India Grid Trust
- India Infrastructure Trust
- Indian Highway Concessions Trust
Global Outlook for REITs
REITs have been in existence since 1960 when they were first introduced in the USA. REIT has become an instrument for alternative investment in real estate with investments of a really low amount and has allowed earning continuous income. To attract investors regulators in most countries have made it a requirement for the REITs to distribute 90% (net of cost) and above the income generated from these assets. Apart from the US, Australia, and Japan REIT market has seen phenomenal growth. The other developed markets for REIT include Hong Kong, Canada, Germany, and Singapore.
Types of Global REITs
Equity REITs purchase, own, and manage income-producing real estate properties.
Equity REITs are beneficial for long-term investors as they along with dividends from rental income, investors also get a share of capital gains from the sale of properties.
Mortgage REITs lend money directly to real estate owners and their operators, or indirectly through the acquisition of loans or mortgage-backed securities.
They do not invest in properties but generate revenue through the interest paid on their mortgage loans.
Hybrid REITs are a combination of equity and mortgage REITs.
The REIT portfolio consists of both income-producing real estate properties as well as money directly lent to owners and their operators.
Table 1: Types of Global REITs
Source: Deloitte, “Exploring the new investment world of REIT”, March 2019
REITS in India
India is still in the early stage of REIT implementation and witnessed the successful launch of its first REIT- Embassy Office Parks in March 2019, raising Rs 4,750Cr in IPO. This has signaled the coming of age of Indian real estate. This first REIT was launched nearly five years after the regulations were notified in 2014.
According to a report “India REITS Heralding a new era in real estate investments” by JLL India the REIT office space in India is currently around 294mn. Sq. ft. with valuation near to USD 35 bn. The report also mentions that the commercial office space is expected to dominate the REIT market as high growth is expected, which will result in higher rental yields and higher value for the property.
India’s total office market has 541 mn sq. ft. Grade — A stock with an average annual demand of 30 mn sq. ft. over the last 4 years. The office absorption was more than 33 mn sq. ft. in 2018, with the expectation of an increase in the same over the next few years. This growing demand is coming from both domestic as well as MNCs. The commercial office space has attracted nearly USD 17 bn from 2006 to 2019, showing that it has been a favorite asset class for the institutional investors.
The real estate market is the most important factor for the success of REIT as it helps in attracting capital from domestic as well as international markets. Real Estate Regulation and Development Act 2016 (RERD), was introduced by the government but it has helped only the well- established developers in the country, as only such players can cope up with the accountability and disclosures that the act demands.
The success of REITs in developed markets has been led by Institutional investors such as insurance companies, pension funds, and other corporate and private investors, other private and corporate investors. Various institutional investors have received approvals from SEBI to invest in India as developers and real estate investors under REIT structure which shows the interest in REITs and can help in developing the REIT market.
Brief of Embassy Parks REIT: -
- The IPO was subscribed 2.5 times
- More than half of the investors were individual investors
- The REIT has a portfolio of 32.6 mn sq. ft. of which 24.2 mn sq. ft. is completed with 2.9 mn sq. ft. under construction office space along with 5.5 mn sq. ft. proposed development area. (as on April 2019)
- The REIT owns one operational hotel and three others are under construction
- It has 100 MW captive solar plant within the office parks
- REIT stock trading at 36% premium to allotment price as on 18th January 2020
REITs Regulatory Actions/regulations
The REIT regulations in India came into effect in September 2014. The main purpose was to help the real estate industry which was having huge unsold inventory and high debt, by setting a set a regulatory regime.
The regulations are progressively reformed continuously be the regulator to make REITs feasible to the investors. On April 22, 2019, the Securities and Exchange Board of India (SEBI) had notified amendments to the regulations governing Real Estate Investment Trusts (REITs) in India. The amended regulations are likely to result in increased penetration of these financial instruments.
The key change includes a reduction of the minimum subscription from any investor for publicly issued REITs to Rs. 50,000 from Rs. 2 lakhs too. Similarly, the minimum trading lot for REITs to Rs. 50,000 from Rs. 1 lakh. This is expected to increase the reach of retail investors in such instruments. Listed REITs can be a transparent and stable investment option for retail investors due to the various regulatory stipulations.
Salient features of SEBI regulations on investment trust
Structure of investment trust
- Sponsor to hold not less than 25% of the total units of the investment trust after the initial offer, on a post-issue basis, for at least three years from the date of listing of such units
- Investment trusts to invest not less than 80% of the value in completed and revenue-generating projects, and not more than 10% in under-construction projects.
- Investment trusts to hold assets either directly or SPV
- Investment trusts to hold controlling interest and not less than 50% equity share capital or interest in the SPVs
- SPVs to hold not less than 80% of assets directly in properties and not invest in other SPVs
- SPVs to not engage in any activity other than those pertaining and incidental to the underlying projects
Stipulations to ensure transparency
- Trustee to hold assets for the benefit of unitholders, oversee activities, and ensure compliance concerning reporting and disclosure requirements
- A full valuation to be conducted by an independent valuer at least once every year
- All related-party transactions to be on an arms-length basis
- Not less than 90% of net distributable cash flow of the SPV to be disbursed to the investment trust in proportion to its holding in the SPV subject to applicable provisions in the Companies Act, 2013, or the Limited Liability Partnership Act, 2008
- The distribution of dividend is to be declared and made at least once every six months for REITs
- If an asset is sold by the investment trust or SPV, it can reinvest the proceeds into another property or infrastructure asset and will not be required to distribute the sale proceeds. However, if no such reinvestment is made, it will be required to distribute not less than 90% of the sales proceeds
- The aggregate consolidated borrowing and deferred payment of the investment trust net of cash and cash equivalents should never exceed 49% of the value of the investment trust assets.
- If the aggregate consolidated borrowing and deferred payment of the investment trust, net of cash and cash equivalents, exceeds 25% of the value of the assets, for any further borrowing, credit rating to be obtained from a registered credit rating agency
Key Provisions for Manager of REIT
A REIT can be managed by a Company or LLP or body corporate incorporated in India
Other eligibility criteria include
- Minimum net worth / net tangible assets of Rs10Cr
- No fewer than five years’ experience in Fund management or Advisory services or Property management in the real estate industry or development of the real estate
- Governing body — Minimum 50% of members to be independent and not a director or member of another
Key stakeholders of REIT:
Sponsor to set up REIT and appoint a trustee
- Trustees to hold assets on behalf of and for the benefit of investors
- Manager to assume operational responsibility of REIT
- Valuer to ensure the fair and transparent valuation
- In respect of financial valuation
- In respect of technical asset valuation
Limits on Holdings by REIT in India
- Only Completed and income-generating properties
- Excluding vacant or agriculture land or mortgage
- Hotels, hospitals and convention centers allowed under REIT
- Under construction properties which will be held by REIT for at least three years after completion
- Completed and not rent generating properties which shall be held by REIT for at least 3 years from the date of purchase
- Debt securities in real estate companies whether listed or unlisted
- Government securities
- Mortgage-backed securities
- Listed and unlisted equity shares of companies deriving 75% or more income from real estate
- Money market instruments and cash equivalents
Source: Deloitte, “Exploring the new investment world of REIT”, March 2019
REIT Taxation in India
Taxation in hands of SPV
- Interest is tax deductible
- Rental Income is subject to tax as business income/Income from house property
- Dividend Distribution Tax will not be payable by SPV for dividends paid to REIT
- Sale of Real estate is subject to Capital Gains Tax
Taxation in hands of REIT
- Rental Income/Interest income is exempted
- Required to withhold tax from payments to unit holders: 10% for residents and 5% for Non-Residents
- Dividend is exempt
- Gains from transfer real estate asset is subject to Capital Gains tax
Taxation for Unit holders
- Capital gains chargeable on transfer of units at applicable rates
REIT allows developers to monetize high investment assets. As the Indian real estate sector is facing the heat for quite some time which has strained the balance sheets of many developers, REIT can allow them to repay their liabilities and invest in newer assets. Also, REIT can attract foreign flows which are good for developers and investors. REIT is an attractive asset class and can become popular in the Indian perspective too as the benefits such as tax-efficiency, liquidity, and transparent transaction mediums in an otherwise opaque sector globally.
Following are highlights that can attract an investor towards REIT
Competitive long-term performance: Long term returns of the stock are not much less than that of stocks
Substantial, stable dividends yield: REITs help in generating steady rental income for the investors
Liquidity: REITs is generally listed on stock exchanges providing liquidity to the investor’s
Transparency: REITs come under the regulatory directions for any other listed company and is well covered by the analysts as well as business media
Portfolio diversification: REITs give access to the real estate market which has seen a lower correlation with stock and bonds historically
Key benefits to the REITs sponsor
- Monetizing revenue-generating real estate assets
- Lower the cost of capital
- Exemption from dividend distribution tax and relaxation of capital gains tax
- Converts illiquid assets into liquid listed assets
- Management and control over assets to continue even after listing
- Unlock capital and deleverages balance sheet
- Attracts investments from retail investors apart from Institutions
Key benefits to the unit holder
- Invest in real estate or infrastructure without actually owning the asset
- Benefit from favorable tax norms
- Liquidity in Real estate
- Professional management
- Regulated by authorities — investor protection ensured
- Capital appreciation opportunity
- Low risk
- Low ticket size
Diversification in a portfolio is a necessary tool to protect oneself from a storm in any particular asset class at any point. Various asset classes are there in which an individual can invest such as equities, bonds, gold, mutual fund, index funds, real estate. Real estate as an asset class is important to be included to get diversification benefits as it gives both rental income as well as capital gains.
The asset allocation is to combine different asset classes that have low correlations, the aim being optimization of the risk-return profile of the portfolio. A traditional portfolio would have an allocation to stocks and bonds — but not many portfolios would have an allocation to REITs in that mix for investor portfolio.
This article was written by Koushik M for Pvot.