REITs: Real estate investment trusts

Source: Livemint, Financial Express, Moneycontrol

REITs help make investments in real estate more accessible, long-term and income oriented.A real estate investment trust (REIT) is a platform that allows investors to make securitised real estate investments in small amounts. It works much like a mutual fund, pooling funds from various investors into one basket.

Real estate is a physical asset. Through REITs this asset is broken into several parts and converted into a paper investment, or securitised. REITs help make investments in real estate more accessible, long-term and income oriented.

They also help to build an efficient secondary market for developers to exit the projects. REITs usually invest in commercial properties and use the rental income to give dividends to unit holders. REITs mostly invest in completed properties to get a stable income stream. They tend to bypass under-construction properties .

Globally, there are two major kinds of REITs: equity and mortgage.

Equity REITs

These own or develop and hold the properties, either individually or through special purpose vehicles (SPVs). Hence, they are referred to as equity REITs. Their income is in the form of rent received from leasing the property. This rent gets transferred to unit holders as dividend.

Mortgage REITs

These operate mainly by lending money to property owners-in exchange for a mortgage claim on the property, or through mortgage-backed securities. Their earnings come from the interest charged on such loans.

Hybrid REITs are a combination of equity and mortgage.

The advantage of REITs is that you don't need a large sum to profit from real estate. REITs are regulated and managed as a trust, which means there is accountability and audit of how investor funds are used. Real estate is often considered an unorganised sector and there can be ambiguity in transaction values.With REITs, the transactions are monitored and there is a specified method of valuation, so ambiguity is reduced.

 If you are an investor and looking for a new investment opportunity-offering tax-free returns in the form of dividend and capital gains-the Budget FY17 has opened up doors for the launch of the Real Estate Investment Trust (REIT) and Infrastructure Investment Trust (InvIT). REIT/InvIT is a structured business trust model facilitating entrepreneurs and corporates to monetise their capital locked in assets through issue of units to investors at large.

In India, generally an investor expects a yield of 8-9% tax-free in long-term savings plans or government bonds, or a similar yield if invested in debt mutual funds. Further, an investor could look at a higher yield of about 11-13% (taxable) by investing in unsecured non-convertible debentures (NCDs) or debt instruments of corporates and now units of REITs/InvITs.

So, what is REIT/InvIT?

REIT is an investment vehicle that allows both small and large investors to acquire ownership in real estate assets through purchase of units. Similarly, InvIT is an investment vehicle for owning undivided interest in other classes of assets such as hospitals, hotels, warehouses, shopping malls, roads, ports, etc. The capital markets regulator-Securities and Exchange Board of India (Sebi)-had already enacted REIT/InvIT regulations in September 2014, broadly covering a few aspects.

Units of REIT/InvIT are listed on stock exchanges in India;

Sponsor (developer/promoter) to hold at least 25% units in the business trust to start with;

Prescribed minimum asset size of Rs. 1,000 crore for REIT and Rs. 500 crore for InvIT;

Compulsory distribution of 90% of post-tax income arising from assets held under REIT/InvIT;

Minimum investment ticket size of Rs. 2 lakh for REIT and Rs. 5 lakh for InvIT by an investor.

As an investor, such units not just accrue dividend; however, from an India perspective, one could also look at appreciation in value of units, which could potentially arise out of value enhancement in assets in a longer term. Whether this holds true for certain other classes of assets like roads and ports is anybody's guess at the moment. To give wings to this popular international concept, finance minister has done his best to roll-out certain tax benefits in previous as well as in the current Budget.

How does a sponsor/developer unlock value in assets?

A sponsor/developer is required to swap (non-cash) its holdings in real properties or in shares of SPVs (holding assets) to a business trust in consideration of units of such a trust. Such units are offered to public, as a result of which liquidity is generated in the hands of the sponsor/developer. Such a fund-raising model has become popular due to its benefits of raising fresh liquidity of funds, and at the same time, the sponsor/developer continues to control and manage the property. While the swap of shares in an SPV is exempt from capital gains or minimum alternate tax (MAT)-irrespective of the period of holding-the transfer of real property held directly by sponsor/developer to a business trust remains a taxable event.

Further, such a transfer of real property directly to a trust would be chargeable with stamp duty at a rate prevailing in respective states. On the other hand, the sale of units by the sponsor/developer would also remain exempt from capital gains if the same is long term under the Income-tax Act and sold on the floor of stock exchange; however, subject to MAT (applicable in case of companies). The accompanying table shows tax incidence in the hands of a business trust.

What if you are a unit-holder?

The Union Budget 2014 paved way for capital-gains tax exemption on the sale of long-term units, but the concept didn't take off primarily due to applicability of dividend distribution tax (DDT) on dividends distributed by SPV (holding assets) resulting in lower yield. This concern has been addressed in the current Union Budget by amending Section 115-O of the Act. As far as a non-resident unit-holder is concerned, the investment in REIT/InvIT becomes more attractive in light of a very low tax cost of 5% on income earned as interest from the business trust. The table shows the summary of tax incidence for unit-holders.

 

In a nutshell, the current budgetary amendments could give the much required boost to the beleaguered real estate and infrastructure segments, as these allow the sponsors/developers to monetise their assets by tapping capital markets. For non-resident investors, there is a silver-lining of lower tax cost of 5% on interest income stream, but they should factor in the foreign exchange fluctuation risk while computing expected yield, as against the average dollar yield of approximately 7% in similar securities in a few other countries. This is a big picture and could be a game-changer for Indian players in the segment.

It's taken a full two years since the path was cleared for real estate investment trusts (REITs) and infrastructure investment trusts (InvITs) could list. And India is finally on track to getting its first InvIT. IRB Infra has become the first company to file a draft red herring prospectus (DRHP) to raise Rs 4,300 crore for an InvIT. And with talk that Sterlite Power Grid Ventures could look at a similar move in the third quarter of this fiscal year, Sebi is busy working on ways to get more companies to throw their hats in the ring. "We have already received multiple applications and some suggestions about making further changes in our regulations and we are likely to take a call on that in this month's board meeting," Sebi Chairman UK Sinha said.

However, where REITs are concerned, this optimism may not pan out. Experts say that while Sebi has pushed for new norms to sweeten the deal, and even constituted a special committee to address developer's concerns, high interest rates are making both developers and investors away. "REITs have worked in mature markets, but locking in money for 3-5 years in a country like India where fixed deposits give you 8 percent returns will not be attractive," said Hemal Mehta, Partner, Deloitte Haskins & Sells LLP. That means Sebi may look at further tweaking of the rules governing REITs, and this may happen as early as October this year. Sources say these tweaks will focus on expanding the definition of real estate, thereby giving REIT fund managers the flexibility to invest in even hotels and hospitals. But as far as the first InvIT is concerned, it is a case of "better late than never."

The markets watchdog, the Securities and Exchange Board of India (SEBI), has finally granted approval to three companies IRB Infrastructure , GMR and MEP Infrastructure to launch infrastructure investment trusts (InvITs). Accordingly, these companies will float IRB InvIT Fund, GMR Infrastructure Trust and MEP Infrastructure Trust shortly, as per SEBI, which is likely to relax norms for the real estate investment trusts (REITs) and InvITs later this month. 

 

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