INTRODUCTION
Ending a tedious seven-year waiting (from the year 2008), the Securities and Exchange Board of India [SEBI], finally approved on August 10, 2014, the establishment of the Real Estate Investment Trusts [REITs] in India, and listing of these on stock exchanges for trading, along with offering detailed provisions and regulations for these purposes. The Infrastructure Investment Trusts were also covered under this bold and prudent step of SEBI, the market regulator of India. This web-article offers very enlightening and useful information regarding the REITs in India exclusively. It is hoped that the REITs in India can contribute substantially and remarkably to growth, accountability, and transparency in the real estate sector of the country. Today, REITs are highly successful and beneficial in about 20 countries of the world over, in respect of providing less risky investment options in real estate to small and big investors, regular and dependable income to the unit holders, drawing massive FDI in the real estate sector of the specified country, providing exit avenue and liquidity to the cash-strapped property developers, and huge contribution to the national GDP of the mentioned country. According to Cushman & Wakefield, the REIT market of India has immense potential to emerge out as one of the top five largest markets in Asia by market capitalization.
The real estate sector of India presently contributes about 5% to the national GDP, is the second largest employer after the agricultural sector, and is growing rapidly with a compound annual growth rate [CAGR] of over 11%. Currently, the real estate sector of India is the fourth biggest in respect of FDI inflows [the Government of India has allowed FDI of up to 100% in the development projects for township and settlements], and is constantly growing to reach the level of US$650 billion by the year 2020, and thus become the third largest real estate market of the whole world by then. Here, it may also be noted that growth in the real estate industry is linked to developments in the corporate and commercial sectors, hospitality sector [hotels, restaurants, resorts, etc.], retail sector [shopping complexes and malls], information technology (IT) and ITES sector, (urban) infrastructure, modern housing, education and teaching sector, service sector [hospitals, etc.], tourism and entertainment sector, and many other fields. Though this real estate sector of India has regularly been in the limelight of the domestic and international investors, it still lacks easy and adequate sources for finances, accountability and reliability, and transparency, which prevail in the well-developed countries. This Indian real estate sector has traditionally been dominated by a number of small regional players, and has been drawing funds from high net-worth individuals and other informal sources of financing, and consequently lacked high levels of transparency.
WHAT IS A REIT?
A Real Estate Investment Trust [REIT] is basically a trust-like company or organization which owns, and in most cases operates income-producing real estate assets, and most of the earnings of which are distributed to its shareholders regularly as dividends. These REITs generally get special tax treatment, and essentially deal in the commercial real estate assets, such as Office buildings, commercial and residential buildings and apartments, hospitals, shopping malls and complexes, hotels and resorts, cinema halls and multiplexes, warehouses, timberlands, etc. These REITs are initially started in USA in 1960s, and now functional very successfully and lucratively in about 20 countries of the world over, including USA, Australia, UK, Singapore, France, Japan, etc. Broadly, the REITs fall under three main categories --- Equity REITs, Mortgage REITs, and the Hybrid REITs. The most common and popular among these are the Equity REITs, which typically own and operate fully completed and income-generating real estate assets of commercial nature. Again, these investment vehicles in the real estate sector could be private or public; the public REITs are capable of being listed on stock exchanges.
Investment in a listed REIT is quite like investing in a mutual fund of the stock market. The listed REIT raises money from a pool of investors and utilizes the same for buying income-producing real estate assets, to draw rental and capital gains regularly. Most of the gains thus obtained are then distributed to the unit holders or investors of the REIT in form of dividends. Thus, REITs reliably facilitate investors to acquire a diverse portfolio of real estate assets, or easy liquidity for their completed real estate projects, in a rather tax-efficient way.
FACTORS FAVORING REITs IN INDIA
The vast and fast-paced real estate sector of India imperatively requires reliable and transparent investment vehicles like REITs, for prospering optimally, drawing more FDI, contributing more to the national GDP, and emerging fast as one of the largest and most prosperous real estate markets of the world in the nearest future. As per the latest estimates of world-famous Cushman & Wakefield, the magnitude of the real estate assets under all categories which can qualify acceptance of REITs in India, will reach the level of US$20 billion by the year 2020; and by this capacity of market capitalization, the REIT market of India is most likely to rank among the top five biggest markets of the Asian Subcontinent. Again, India's steady and fast economic growth inevitably demands more commercial and industrial buildings, modern offices, conference centers, and other objects of real estate mentioned above in future years. However, high and glamorous success of REITs in the future years will largely depend on the taxation of REITs, stamp duty and taxation for offshore investors, stamping of agreements associated with the transfer of property to the REITs, and efficient administration and management of the REITs in India.
By the very nature, REITs are beneficial to both the investors and the real estate industry as a whole, in many different ways. REITs will provide new and swift sources of finances to the cash-starved Indian property developers, who have been suffering from one of the highest interest rates of Asia, through buying their developed property, and enabling them for starting fresh projects or investing in units of the REITs. REITs will also help the overleveraged companies in getting themselves deleveraged. Small to big investors will get promising and secure investment options in the real estate, which are rather less risky and uncertain than those in the under-construction properties, for getting regular income. Thus, REITs are most likely to infuse a fresh and bright lease of life into an otherwise choppy market in the real estate sector of India. Besides these benefits, other benefits and facilities offered by REITs are the following --- A Less Risky Investment Avenue to general investors; Investment Diversification; Regular Dividends; Better Liquidity Situation; Limpid Transparency; Bright Growth Prospects; Increased Possibility for Disposal of Non-Performing Assets [NPAs]; Increased facilities for getting Finances by cash-strapped property developers; Improvement in Debt-Equity Balance in the Real Estate Market; Tax Efficiency, etc.
SALIENT FEATURES OF REGISTRATION AND REGULATION OF REITs IN INDIA
On August 10, 2014, SEBI gave final consent to establishment and trading of REITs in India, and presented mandatory rules, provisions, and regulations for the design and operations of these well-tried investment vehicles in India. The salient features of the SEBI (Real Estate Investment Trusts) Regulations, 2014 (REIT Regulations), are the following: ---
Structure and Registration of REITs: --- REITs in India shall be established properly as per the provisions given in the Indian Trusts Act of 1882, and shall be registered strictly with the SEBI. The parties to such REITs shall be Trustee, Sponsor(s), Manager, and Principal Valuer; responsibilities of these all parties are elucidated in the REIT Regulations. The trustee must be a SEBI registered debenture trustee, not associated with the sponsor or manager. The trustee shall carry out overseeing role on various activities of the REIT; while the manager is accountable for all operational and managerial activities of the same. A REIT may have a maximum of 3 sponsors who are collectively required to hold at least 25% of the units of the REIT, for a minimum time-period of 3 years counted from the date of listing. Each sponsor is compulsorily required to hold at least 5% of the total units of the REIT. After the completion of these three years, sponsors are legally compelled to hold collectively the 15% of the units of the REIT at a minimum, for the entire life of the concerned REIT.
Offer of Units to the Public and Listing of Units: --- Once duly registered with SEBI, REIT is eligible and prescribed for being listed on any recognized Stock Exchange, and for raising funds through making an initial offer. The subsequent gathering of investors' money may be made through follow-on offers, rights issue, qualified institutional placements, etc. REITs are not allowed to launch any schemes. For making an initial offer, a REIT must possess assets worth INR-500 Crore [5 Billion], at a minimum. The minimum issue size for the initial offer has been decided at INR-250 Crore. The minimum subscription size for the units of REITs has been fixed at INR-2Lakhs. At least 25% of the total units of the REIT on post-issue basis, shall be offered to the public in the initial offering. A minimum public float of 25% is demanded to ensure adequate public participation. The size of one unit under the initial offer shall be worth INR One Lakh.
Disclosures: --- Detailed information about the disclosures to be made by REITs regularly from time to time, is provided in the REIT Regulations, for the ultimate purposes of full accountability and transparency. These disclosures include the periodic disclosures as demanded by the revised Listing Agreement; certain event-based disclosures; disclosures in the offer-documents/follow-on offer-documents; and the disclosures to be made in the annual and half-yearly reports to investors.
Investment Conditions and Dividend Policy: --- REITs are legally compelled to invest only in diverse commercial real estate properties, either directly, or through the means of some Special Purpose Vehicles [SPVs]. In any such SPVs, a REIT is bound to hold controlling interest, not less than 50% of the equity share capital or interest. The concerned SPV must possess at least 80% of its assets directly in property, and is prohibited from making investment in other SPVs. Again, a REIT is legally bound to invest at least 80% of its assets in completed and income-generating real estate properties. A maximum of its 20% assets remaining, shall be invested in the following avenues:
- Developmental Properties [investments in these are restricted to a maximum of 10% of the value of the REIT assets]
- Mortgage-Backed Securities
- Listed/Unlisted Debt of Companies/Corporations in the Real Estate Sector
- Governmental Securities
- Money Market Instruments or Cash Equivalents
- Equity Shares of Listed Companies in India, which get their bulk of operating income [not less than 75%] from activities in the real estate sector.
The market regulator also dictates that a REIT must make investments in at least two projects at anytime; the major project containing a maximum of 60% of value of the assets of the REIT. These investments are compulsorily to be made strictly as per the investment conditions given in the REIT Regulations. Moreover, a REIT is rigorously compelled by the law to distribute at least 90% of its distributable cash flows [subject to tax and other applicable laws] to its investors or unit holders as dividend, compulsorily on a half yearly basis.
Property Valuation and Updation: --- A REIT shall regularly undertake full valuation of its properties on a yearly basis, and updation of the same on a half-yearly basis, with help of an accredited valuer. The Net Asset Value [NAV] is to be declared within 15 days from the date of such valuation/updation.
Borrowings and Deferred Payments: --- To avert excessive leverage, it is prescribed that the borrowings and deferred payments of a REIT at a consolidated level must not exceed 49% of the value of the REIT assets. In the event of its borrowings or deferred payments go beyond 25% of the value of REIT assets, then proper and strict approval from the unit holders and the credit rating agency is mandatory.
Rights of investors: --- In order to safeguard and promote interests of the investors, a variety of legitimate rights are stipulated in the REIT Regulations. These rights are related with making changes in the structure or administration of the REIT, performance of the REIT, latest annual accounts, related party transactions, changing in investment strategies, delisting of units, borrowings and deferred payments, valuation of assets, disclosure requirements, etc.
TAX TREATMENT
The Government of India has clearly shown its intentions to grant REITs and Infrastructure Investment Trusts, a tax pass-through status, soon in the near future. The Union Budget 2014 also advocated for making these investment mechanisms quite tax-efficient for domestic and foreign investors. The tax pass-through status means that the returns from investments made in these investment vehicles, will only be taxed in the hands of investors, and the REITs will not have to pay any taxes on incomes. Once further clarities on the taxation of REITs, foreign investments in Indian REITs, stamp duty and taxation for offshore investors, etc., are made, REITs of India are most likely to draw huge investments from the overseas investors. In connection with taxation of REITs in India, the following points are noteworthy: ---
- The Portfolio Companies will follow strictly the Dividend Distribution Tax system; the dividends of the REITs will be exempted from tax, and the interest received by the REITs will also be tax exempt.
- REITs will withhold tax on the interest component of the distributable incomes to the unit holders; this will be charged at the rate of 10% for the Indian unit holders, and 5% for the foreign investors.
- Capital gains gained through disposal of any assets of the REITs, will be taxed.
- The transfer of units of the listed REITs is quite similar to the transfer of listed shares. The long-term capital gains on the transfer of units of a listed REIT will be exempted from taxation, but the short-term capital gains shall be taxed at the rate of 15%, given that the tax on transaction of securities is paid on the transfer of such units.
IN A NUTSHELL:
Thus, the REIT Regulations of India are well-conceived, and are certainly highly elegant for bringing in the globally accepted practices to the real estate sector of India, and also for reviving the interest of both domestic and global investors in the Indian real estate industry. The most obvious benefits obtainable from REITs in India are easy and secure investments in the real estate sector, convenient diversification of investments, exit avenues to the cash-starved property developers, better liquidity situation in the real estate industry, increased accountability and reliability in this sector, and greater FDI in the real estate sector of India. However, much of the success and profitability of REITs in India will depend on tax and stamp duty related regulations and policies, especially for the offshore investors. The huge amount of INR 5 billion is prescribed probably to ensure that only the large and well-established players enter the Indian REIT market initially, while the retail investors participate in it later as the market develops.
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