Theodore Roosevelt, U.S. President once said, “Every person who invests in well-selected real estate in a growing section of a prosperous community adopts the surest and safest method of becoming independent, for real estate is the basis of wealth”. In India, real estate has been the most favoured form of the venture over hundreds of years and generally, interest in Real Estate has implied purchasing private property essentially for self-residence.
Option of investing in Real Estate related to commercial properties such as shops, office space, etc. has been comparatively explored less, as an investment in such type of Real Estate requires large investment amounts; and in addition to the investment hurdles, the hassles of getting necessary regulatory approvals, long-term leases from viable tenants, ensuring timely receipt of lease rent, majorly form the reason due to which investment in commercial real estate is exploited less.
Until the emergence of Real Estate Real Estate Investment Trust (“REIT”), another prominent way to gain exposure to the real estate sector was in the form of making investments in equity stocks of listed Real Estate companies such as DLF, Embassy Office, Oberoi Realty etc. However, such investments have always been prone to market risk and despite the fact that real estate is the underlying asset, they carry a high degree of volatility with themselves. Consequently, only a handful of individuals are able to include Real Estate in their investment portfolio.
The Securities and Exchange Board of India (SEBI) introduced the concept of REITs in India with an intent to provide the much-needed capital to the real estate sector and channelize funds of retail investors into the formal system by way of implementing SEBI (REITs) Regulations, 2014 as amended from time to time. The SEBI REITs Regulations, inter alia, set out the registration requirements, procedure of registration, and eligibility requirements of REITs, however, it is mandatory for units of all REITs to be listed on a recognised stock exchange having nationwide trading terminals, whether publicly issued or privately placed.
In common parlance, REITs are those investment vehicles which operate in a fashion similar to mutual funds, wherein, they own, operate or finance rent/income generating real estate assets such as apartment complexes, office buildings, hotels and shopping malls. REITs are companies that own or finance income-producing real estate in a range of property sectors. They provide all investors with the chance to own valuable real estate, present the opportunity to access dividend-based income and total returns, and help communities grow, thrive and revitalise. REITs allow anyone to invest in portfolios of real estate assets the same way they invest in other industries – through the purchase of individual company stock or a mutual fund or exchange-traded fund. The stockholders of a REIT earn a share of the income produced through real estate investment – without actually having to go out and buy, manage or finance property.
What are REITs?
REIT is an acronym for Real Estate Investment Trust, which is basically a company developing and owning ‘income producing’ real estate properties. Unlike a listed real estate company, a REIT isn’t created to develop real estate properties and resell them, rather the main objective is to acquire the real estate properties with sole aim of leasing such properties and manage the same to ensure a consistent yield as part of an investment portfolio. REIT allows the investors with relevant exposure to Real Estate without burdening them to purchase or manage properties by themselves.
REITs are like Mutual Funds as they both permit investors to pool in their resources and the assets are managed by a designated person-in-charge. But, while the underlying asset of Mutual Funds is usually equity, debt, gold, or a combination of these, the underlying asset in the case of REITs is primarily real estate holdings or loans secured by Real Estate.
When a company agrees to formulate a REIT, it becomes the sponsor for that REIT and appoints a trustee. The trustees hold the underlying real estate assets of such established trust in trusteeship and such assets are no longer directly controlled by the Sponsor. Companies owning or financing real estate must meet a number of organizational, operational, distribution and compliance requirements to qualify as a REIT.
Different Types of REITs
Though the first REIT came into existence in India only in March 2019, which was an equity REIT permitted to invest only in commercial properties as pe the regulations issued by SEBI. Nonetheless, it is not inconceivable that more types will come into existence soon as the Real Estate sector is quite dynamic in nature and constantly undergoing a shift. Thus, based on the type of Real Estate holdings, the REITs may be classified as:
1. Equity REIT
Such REITs acquire, manage, build and sell real estate, and distribute most of the income earned through them to its investors in the form of dividends. Generally, when referring to REITs is made, it refers to equity REITs.
2. Retail REITs
These are a type of REIT that invests in the retail sector like shopping malls, grocery stores, supermarkets etc. However, such REITs are not directly involved in running these retail outlets as simply lease out the space to retail tenants.
3. Residential REITs
Residential REITs own and operate residential facilities like apartment buildings and gated communities. Considering the never-ending demand for residential property in India, this is one of the most promising areas of growth.
4. Healthcare REITs
These primarily invest in and operate healthcare-focused Real Estates such as hospitals, nursing facilities, retirement homes, and medical centres.
REIT in India and its structure
In India, the concept of Real Estate Investment Trust is fairly new, and the first set of guidelines with respect to the same were introduced by SEBI back in the year 2007 and after undergoing numerous modifications and receiving clarifications from SEBI, the same were later updated and notified vide a notification dated 26th September 2014 aiming towards regulating investments in REITs. Nonetheless, nearly after five years and various additional amendments to the original regulations of 2014, India saw its first REIT. The current SEBI guidelines related to REITs in India were.
At present, there are only three REITs – Embassy Office Parks REIT, Mindspace Business Parks REIT, and Brookfield India Real Estate Trust – that have been duly registered and approved by SEBI and all are operating primarily in the sphere of commercial real estate.
As stated before, a REIT is an investment trust that owns real estate assets, comprising of a Sponsor, a Manager and a Trustee, each of whom is vested with certain key responsibilities to be undertaken with respect to the trust.
A sponsor is a person who forms the REIT. They set up the REIT and transfer the property owned by them i.e., the real estate assets to the trust. Therefore, a builder or developer desirous of raising funds through REIT generally plays the role of a sponsor.
The trustee is a person appointed by the sponsor, who holds the assets on behalf of the unitholders.
The trustee appoints a manager who manages the REIT assets and is responsible for making investment decisions. The manager is typically a private company closely-held by the sponsor.
They are the beneficiaries of the trust, who become indirect holders of REIT assets by subscribing to the units of the REIT. Unitholders can be Indian residents or foreign investors.
5. Independent valuer
Apart from the sponsor, manager and trustee, a REIT appoints a credible independent valuer who values the REIT’s assets at periodic intervals.
Additionally, auditors, registrar and transfer agents, merchant bankers and custodians may be appointed by the manager, to carry out activities incidental to the operation of REITs and additionally, meet the requirements of law.
The assets belonging to a REIT may be directly owned by the REIT or through a “special purpose vehicle” (SPV) or through a holding company (Holdco) that, in turn, holds such SPVs.
A SPV is a company in which either a REIT or Holdco, holds or proposes to hold, an equity stake or interest of at least 50%. The SPV holds at least 80% of its assets, directly in properties, and is not allowed to invest in any other SPVs nor engage in any activity, other than holding and developing a property and any incidental activity relating to such holding or development.
A Holdco is a company or a limited liability partnership in which the REIT holds or proposes to hold an equity stake or interest of at least 50% and which, in turn, has made investments in other SPV(s), which ultimately hold the real estate property or properties.
The Holdco does not engage in any other activity other than holding of the underlying SPV(s), holding of real estate or properties and any other activities pertaining to and incidental to such holdings. The aforementioned structure allows the retail investors with an opportunity to invest in commercial real estate and generate stable passive income.
Eligibility of REITs
As the name itself denotes, a REIT is a trust and thus must be setup in accordance with the provisions of the Indian Trust Act, 1882, duly registered under the SEBI REITs Regulations. It is imperative that the trust deed of a REIT desired to be established is duly registered, which specifies the main objective and the responsibilities of the Trustee(s). It must be further ensured that no disciplinary actions are taken by the SEBI or any other regulatory authority against the REIT or any related party. For a company to qualify as a REIT, it is vital that the following criteria are satisfied:
- 90% of the income must be distributed to the investors in the form of dividends;
- 80% of the investment must be made in properties that are capable of generating revenues;
- Only 10% of the total investment must be made in real estate under-construction properties;
- The company must have an asset base of at least INR 500 crores;
- Net Asset Value must be updated twice in every financial year
How to Invest in REITs
REITs entered the Indian market only in April, 2019 when Embassy Business Park REIT became the first REIT to be listed in India. Unlike in other countries such as the U.S. wherein, private REITs and public non-listed REITs are also regulated; in India, only public REITs registered with SEBI are in place as of now.
REITs are listed and traded on stock markets just like exchange traded funds (ETFs), as a result, purchasing units on the stock market is the best way to invest. Thus, a Demat account is mandatory for investing in REITs in India. Just like ETFs, the price of REITs units on stock markets changes depending on both the demand for units as well as the performance of the REIT. To encourage investors, SEBI has made two significant amendments to rules of investing in REITs in India –
(i) the previous minimum requirement of INR 50,000/- for an investor to invest in units of REITS, has been done away with. Presently, the minimum investment amount required is INR 10,000/- INR 15,000/- only, for investment through initial public offerings and follow-on offers; and
(ii) the minimum lot size of REITs traded has been reduced from 100 units to 1 unit.
Benefits of Investing in REITs
The following are some key benefits of investing in REITs:
REITs allow you to diversify your investment portfolio through exposure to Real Estate without the hassles related to owning and managing commercial property. This diversification allows you to go beyond the usual asset classes of Equity, Debt, and Gold as part of your overall Asset Allocation Strategy.
2. Small Initial Investment
As mentioned earlier, one of the key problems associated with making Real Estate investments is the large ticket size especially in the case of commercial properties. REITs require a much smaller initial investment of around Rs. 50,000 to provide similar portfolio diversification benefits.
3. Professional Management
Properties owned by a REIT are managed professionally. This ensures smooth operations and with no effort on your part towards managing Commercial Real Estate.
4. Regular Income Generation
REITs generate income from rental collections and are required to mandatorily distribute 90% of this income to investors as dividends and interest payments. In this way, REITs provide regular income to investors.
Limitations of Investing in REITs
However, there are also a few limitations that an investor must be aware of:
1. Limited Options
Currently there are only 3 REITs and 1 International REIT Fund of Fund in India. This significantly limits the choices for investors.
2. Low Liquidity
While REITs are listed and traded on Stock Markets, the number of market participants is currently low especially with respect to retail investors. As a result, selling REIT investments profitably might be a challenge especially in an emergency. This results in low liquidity of the investment.
3. Taxable Dividend
Any dividend or interest earned from REITs is completely taxable in the hands of the investor according to the applicable slab rate. Thus those in the 30% tax slab will lose a substantial portion of their dividend income as taxes. Another important aspect to consider before investing in REITs are the taxation rules and that is discussed next.
Further, REITs are required to invest in at least two projects and investment in any one project should not be more than 60% of the value of assets owned by the REIT itself. Further, REITs are restricted to investing only in the assets situated in India.
REITs are innovative but may not be right for everyone. The REIT as an instrument has not been very successful due to several factors like low rents for the commercial real estate and the performance of commercial real estate varies with the geographical locations. Though a lot has been done to liberalize investments in REITs, further regulatory incentives coupled with taxation benefits are required to be provided to the investors to make REITs a real success in India and attract the desired investors.
In light of the above, it is imperative for the Government to fast-track taxation and other regulatory amendments and reforms to promote REITS in India.