TURNING POINT IN INDIAN REAL ESTATE! MAYBE?

Real estate is one of the favorite asset classes for Indian to invest their savings in, however, investing in this class comes with a lot of baggage, hassle and even fear; as real estate carry a very bad name; and sometimes rightly so. Now with the debut of India’s first REIT, Indian investor may have a new vehicle to invest in their favorite class stress-free.

Looking a little back

The dynamics of Indian demographics is fast evolving and shifting towards urbanization which demands a growing real estate. But, in reality the real estate developers; who are more reliant on bank loans, don’t have sufficient avenues to liquidate their holdings and free up capital for new projects. So in-order to increase investor interest in this sector to facilitate the necessary growth and capital flow SEBI along with Government of India have introduced REIT structures in India.

Status quo

On 26th September 2014, SEBI; Securities and Exchange Board of India, notifies the REITs; Real Estate Investment Trusts, regulation thereby paving the way for a new investment structure in India. These REITs aims at the following: providing an organized market for retail investors to invest and be part of the Indian commercial real estate, acts as a professional managed systems that is risk averse and is aimed at protecting the interest of public, and is a platform for the real estate sector to ease out liquidity burden. And now with Embassy Office Parks in Bangalore backed by Blackstone Group India has firmly entered the REIT arena.

A world view

Since the inception of REITs in the USA in 1960s several developed as well as developing countries have introduced these REITs in their jurisdictions, case in point: Canada and Brazil launched their REITs in the 1990s, while Japan, Singapore, Hong Kong, Malaysia and UK got on the bandwagon in the 2000s, while countries like Mexico, Pakistan and South Africa started their REITs during the 2010s. The USA and Australia; 1971, which were the first two to introduce REITs have witnessed high growth in the REITs markets; possibly due to the tax reforms they introduced.

Why REIT a success overseas

REITs which is aimed at both real estate developers; as this gives an alternative funding mechanism and provides liquidity, and investors; as it provides them access to high value real estate and earn steady returns, have proved overseas to be a good investment, as shown by the overall competitive returns given by various REITs markets. Following points prove that REITs around the world are a success: first, REITs have provided long term total returns similar to those of other stocks. Second, REITs dividend yield historically produced a steady stream of income through a variety of market conditions. Third, shares of publicly listed REITs are readily treated on major stock exchanges. Fourth, independent directors, analysts, auditors as well as the business and financial media monitor listed REITs performance and outlook, which provides investors with a measure of protection and more than one barometer of a REITs financial condition. And fifth, REITs offer access to the real estate market typically with low correction with other stocks and bonds.

Some of the SEBI regulations

A REIT is similar to a mutual fund in that they pool money and invest in income generally assets. But, what makes REIT different is that it only invests in large scale real estate projects such as office buildings, hotels, warehouses and apartments. REIT need to be a trust set up under the Indian Trust Act, 1882 and must be registered under SEBI, regulations 2014. The minimum asset size to be proposed by REITs is prescribed as Rs. 500 crores and the minimum offer size for initial offer are prescribed as Rs. 250 crores. A minimum of 200 subscribers are needed to form a REIT. In REITs investors make returns on their investments based on yield. This yield is driven by the profit made by the real estate property and an increase in the asset’s value. REITs are directed by SEBI to mandatory distribute at least 90% of the net distributable cash flow to the investors on a half yearly basis. And any transfer/acquisition of REIT assets needs to meet the prescribed valuation guidelines. Another point which makes REITs to pay dividends to investors – SEBI regulations makes REITs to invest at least 80% assets in completed and rent generating properties.

Indian investor needs to beware

As already explained REITs are to be listed on stock exchange so that investors can sell them off if they need to, however, no one expects them to be readily saleable at a fair price or indeed an agreeable price to be discoverable easily. In REITs rents, income, dividends, whatever the underlying investments generate, will have to be disturbed in that form and most importantly, will be taxed. This makes REITs distinctly less tax friendly and less flexible. REITs can be like a fixed income investment that can additionally generate capacity gains which one like to except, if all goes well. As in any new venture, it is the unknowns that should be the one to be vary off, i.e. no matter how much attractive the story sounds, individual investor should adopt a cautious approach. And, to top it all, everyone understands that there are too many undesirable and hidden mechanisms that drive the real estate industry in India.

How can one invest in REIT

Choosing the right REIT is paramount; same as in the case of shares, so it is important that an investor makes sure that the segment the REIT is investing has good potential, only then should an investor invest. Now let’s look at the basic process how an investor can invest in a REIT. A new REIT comes out with an initial public offer; IPO open to investors. An investor can apply for the IPO and if his/her application is accepted the investor will be allotted units in the REIT. For Embassy Office Parks IPO investors had to invest Rs. 2.4/- lakh for the units, this initial subscription amount is reduced to Rs. 50,000/- (at the time of writing the article). After the IPO, the REIT will be available on the secondary market, i.e. it will be listed on the stock exchange like shares. An investor can purchase them on stock market, in the case of Embassy Office Parks an investor had to pay Rs. 1 lakh to purchase them. And, an investor should except returns which is in keeping with commercial rental yields; i.e. around 8-10%

A thought

Through real estate sector in India is remarkable, but it still suffers from great complications in generating funds from banks and the major huddle is that REITs cannot lift off until changes are made in the tax rules. If proper regulations are followed and tax breaks are provided then REITs may emerge as a new source of investment for the India investor.

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