– Prof. Kiran Kumar K V, Faculty-Finance, ISME, Bangalore– Mrs. Gayathri C S, Legal Advisor, Brigade Group, Bangalore (gayathric@brigadegroup.com) 
REITs, the new catchphrase in the financial markets seem to be drawing quite an attention from the investing community. Adding to the zing, SEBI recently nodded in approval for the launch of REITs in India, which were so far unregulated and inaccessible for retail investors & Finance Ministry has generously granted few taxation sops.What’s in Store?
First, let’s simplify the working model of REIT. REITs are legally formed trusts that offer an alternate mode to invest in real estates. These trusts will pool money from retail, corporate and other institutional investors and issue units of the trust in exchange. The funds collected thus will be employed primarily in commercial properties that are expected to generate constant income (rentals to be precise). Similar to mutual funds the parties for REITs will be three viz., Trustee, Sponsor and Fund Manager. A REIT with not less than INR 500 Crores of owned asset value in hands, will launch its units for subscription through an IPO/NFO, with a minimum offer size of INR 250 Crores. Post the allotment, the units will be listed in secondary market, just like the listing of shares, and will be available for trading. Thus, any investor with Rs. 1 lakh will be able to add units of REIT into his portfolio. Investors earn income in two ways: (i) Capital Gains by reselling the units at a higher price; & (ii) Dividend income distributed twice in a year by the trust (as per SEBI, 90% of the distributable cash flow must be distributed).The REIT will also publish its NAV.
REITs are not new to the global financial markets. More than 30 countries around the world have REITs in full force. Economies like US and Singapore have fuelled their realty growth through REITs. The ongoing and proposed realty projects in India and development of Smart Cities are seen to be the fodder for rise of REITs. Quoting Finance Minister Arun Jaitley – “a large quantum of funds is locked up in various completed projects which need to be released to facilitate new infrastructure projects to take off”. And hence the tax relief was offered by rationalizing capital gains for sponsors exiting at the time of listing. Pass-through facility is offered, thereby the double taxation effect on rental income is avoided and REITs are not liable to pay the same.
What makes it Stimulating?
Such support from the economic planners of India to REIT, will no doubt ensure a smooth percolation of the product into the markets and creates accessibility for retail investors. Few advantages REITs offer to investors, especially the retail and HNI investors are:
ü Low-entry level (Minimum investment of INR 2 lakhs during IPO, INR 1 lakh for exchange-traded transaction)
ü No-hassle ownership participation in real estate
ü No searching cost
ü Provide liquidity when compared to direct ownership
ü Opportunity for diversification beyond equity and commodities (say, gold) and also within real estate portfolio
ü Well-regulated (by SEBI)
ü A decent 7-8% expenses-adjusted return (As per Deloitte Report)
ü Suitable for conservative investors, looking for constant income, rather than capital appreciation (Almost 80% of the fund will be invested in rent-earning commercial projects, and 20% in under-construction projects – by way of debt, mortgage or equity of property owner company)
Being Devil..!!
Despite the virtues outlined above, investors may have to deliberate over below aspects before investing:
‽ Problem of liquidity – Unlike equity markets, the trade volumes and number of participants will be low, and might lead to skewness in pricing
‽ Raising interest rates – Raising interest rates will bring about fall in realty demand, which will bring down the overall asset value of REITs and thus the NAV
‽ Capital Gains & Security Transaction Taxes– Rationalization of capital gains announced by Finance Ministry during the Budget in March, 2015 is applicable for sponsors who handover the fund to public by exiting. REIT investors are still liable to pay Capital Gains taxes on selling of these units (in addition to STT)
‽ Property Taxes – 80% of the funds will be invested in owning commercial properties that will attract property tax on the municipal value of the assets. While the rates of tax differ across properties depending on the locality, the tax will have to be borne irrespective of market conditions. It’s also a threat that municipalities might raise the taxes to meet their budget constraints.
‽ Taxability of dividends – The dividends from (existing non-listed) REITs are currently taxed as ordinary income. It is expected that the same might apply for listed REITs also. (Even though pass-through facility is available, that’s not applicable on the dividends)
‽ MAT and DDT – No clarity given yet on the Minimum Alternate Tax and Dividend Distribution Tax applicable to REITs
‽ Risks of real estate investing – All the risks of investing in real estate are applicable to REIT investments also, like the illiquidity, long-term commitment, no proper valuation methodology, municipal value vs market value etc.
‽ Effect of non-real estate economic events – Over and above the risks of real estate investing REITs are also exposed to overall systematic risk of the market, as they are traded like any other stock in the market
‽ Expense ratio – Considering that the REIT managers have to incur high costs to search, evaluate and conduct due diligence of properties, the expense ratio is expected to be higher, which will bring down the on-hand-return to investors
‽ No benchmark – There is no benchmark index for commercial property prices. (There are indices like Housing Price Index (HPI) of RBI, Residential Property Price Index (RPPI)of RBI and Residex of National Housing Bank which stand as benchmark to residential properties.)
‽ Transparency – Unlike stock markets, which are essentially the ownership of businesses underlying and that have strict corporate governance mechanism, realty assets are purely market-based securities and no further layer of underlying assets
‽ No historical data – There is no historical price data of market prices of properties that makes the valuation exercise vague. All one can at best collect would be the historical property registration prices from the registration authorities, which include transactions that are unauthentic, black-white, gifts and never-traded.
‽ Losing out on the benefit of depreciation – In comparison to owning a property directly, REIT investors lose out on claiming depreciation and taxes as expenses while assessing their income taxes.
‽ No control over the property – REIT investors are indirect investors into the properties and hence, cannot exercise control over the properties owned by the REITs
In summary, we can say that REITs are undeniably welcome to Indian capital markets, but, investors need to be doubly cautious till such time clarity emerges with regards to its tax treatments, property selection criteria and investor protection regulations by watchdogs.
References
Madhumita Nandy. (2015, march 1). Govt proposes tax overhaul, clears way for listing REITs. Live Mint. Retrieved from http://www.livemint.com/Politics/MVbdPVPHtFs114tKi1DmFN/Budget-2015-Govt-proposes-tax
-overhaul-to-allow-REIT-listin.html
PTI. (2014, Sep 26). Market regulator Sebi notifies final rules for REITs. The Economic Times.
Securities Exchange Board of India. (n.d.). Orders and Rulings. Retrieved from Securities Exchange Board of India: http://www.sebi.gov.in/cms/sebi_data/attachdocs/1411722678653.pdf
