21 August 2014
India has for the first time approved legislation allowing the creation of real-estate investment trusts (REITs), a long-awaited move that should result in greater stability for the real estate industry in the country.
The formation of REITs – funds that own real estate but have shares that are listed on the stock market – will encourage the creation of big-ticket institutional-grade buildings, and will give developers a ready outlet for development projects.
Many institutional investors are put off investing in Indian property because it is highly fragmented, sometimes with multiple members of an extended family owning a building in strata-title fashion.
In a statement on Sunday, the Securities and Exchange Board of India outlined the basic rules for REITs. Industry insiders say the rules are very similar to the REIT legislation on the books in Singapore and Hong Kong.
The first talk about introducing REITs came as far back as 2008. But previous administrations dragged their feet on codifying them. Property professionals see their relatively sudden introduction after a consultation paper last October as a credit to the administration of new Prime Minister Narendra Modi and his BJP party.
Indian REITs, like many others around the world, will be required to pay out 90 percent of their income from stable assets to investors. That will result in a twice-yearly dividend.
It makes REITs perfect “widows and orphans” stocks since they spin off cash regularly and are relatively low-risk.
Only 20 percent of an Indian REIT’s assets can be invested in development, the riskiest end of the real-estate industry or in cash and cash equivalents for liquidity management, with a maximum of 10 percent for the former. The remaining 80 percent of the fund’s assets must be invested in income-producing property.
Since those projects – often office buildings or shopping malls – have already been developed and already have tenants, their income stream is relatively easy to predict. While they may increase in value, the REIT will hold them long-term and won’t trade in and out of real estate.
The buildings must have multiple tenants to reduce risk to any one company, and there must be a single ownership structure for any building that is folded into a REIT. The REIT must also hold multiple buildings, and cannot have more than 60 percent of its assets in any one project. It must own assets worth US$82 million at the time of going public, and must have an initial size of US$41 million on the stock exchange when it lists.
Agarwal says that the market was not prepared when India opened up its real-estate market to overseas investors. The government at the time was keen for foreign investors to fund residential development rather than office property. Under existing rules, foreign direct investment must go into new projects under development.
Now overseas investors will be able to access stable assets via REITs. JLL estimates that of the 370 million square feet of Grade A office stock in India, 170 million is of REIT standards.
At the same time as introducing REIT rules, SEBI also created a similar structure known as an infrastructure investment trust that will allow developers of infrastructure projects to sell those into a fund, with the same requirement to distribute 90 percent of profits twice a year.
Agarwal believes the current REIT legislation will appeal most to overseas investors because their tax will only be a 5 percent on capital gains, with dividends untaxed. Indian investors paying corporate taxes are faced with paying tax of 20 percent or more.
But the government is looking into that disparity. SEBI is likely to refine the REIT rules as the industry develops.
“What they have announced is a base – it can only get better from where it is,” Agarwal says. “It is a big step for the government.”