Introduction

In its recent board meeting held on 10 August 2014, the Securities and Exchange Board of India (SEBI), has approved the SEBI (Real Estate Investment Trusts) Regulations, 2014 (REIT Regulations). The approval of the REIT Regulations builds upon the consultation paper on REITs and the draft SEBI (REIT) Regulations, 2013 (Draft Regulations) published by SEBI in October 2013 and follows the Finance Act, 2014 which introduced certain tax concessions for REITs to facilitate the introduction of a REIT regime in India.

Background

Globally, REITs have been a key instrument in the development of the real estate sector, by providing a platform for retail and institutional investors to invest in real estate properties, with the benefits of a regulated structure and risk diversification. Investors are attracted to REIT structures by the opportunity to obtain exposure to completed and yield generating real estate assets providing regular flow of income.

SEBI has been contemplating the introduction of a REIT framework in India for quite some time with the first set of draft regulations being published in 2008. Following this, SEBI conducted several rounds of discussions with market participants and incorporated their feedback in the Draft Regulations. The REIT Regulations appear to have taken the process further by modifying certain aspects of the Draft Regulations that had generated considerable feedback from market participants and should provide an enabling framework for REITs to take off in the Indian market.

It should be noted however that while SEBI has approved the draft REIT Regulations, they have not yet come into force and shall take effect only on publication in the official gazette. Our analysis therefore is based on the salient features of the REIT Regulations outlined in the press release issued by SEBI post the meeting held on 10 August 2014. The analysis seeks to capture the key differences between the Draft Regulations and the REIT Regulations and we request you to refer to the issue of ERGO dated 14 October 2013 for our detailed analysis on the Draft Regulations.

Key Differences between the REIT Regulations and the Draft Regulations:

Minimum Value of Assets of a REIT

The REIT Regulations provide that the minimum value of assets owned/proposed to be owned by a REIT should be INR 500 crore. This is a significant difference from the Draft Regulations which provided that the minimum asset size required for a REIT would be INR 1,000 crore. However, the minimum offer size has not been proportionately reduced and remains at INR 250 crores.

Khaitan Comments:

The reduction of the minimum asset size for a REIT should ease entry requirements for a lot of developers with smaller assets who would be interested in obtaining liquidity through the medium of a REIT. Further, this would lead to a corresponding reduction in the minimum sponsor commitment and should therefore, allow smaller developers an opportunity to tap the REIT market. This is a welcome move as it would add diversification and depth to the REIT market and increase investor choice. However, on the flip side, this relaxation of minimum asset norms could likely result in SEBI exercising higher caution on the quality of players accessing this product.

Number of Sponsors

The REIT Regulations enable a REIT to have a maximum of three sponsors in contrast to the Draft Regulations which envisaged only one sponsor for a REIT. Further, the REIT Regulations provide that each sponsor would hold at least 5% of the units of the REIT at all times.

Khaitan Comments:

The proposal to enable more than one sponsor should cater to the interest amongst professional managers to aggregate assets from multiple sponsors into a REIT to meet the requirement for a REIT to have a minimum asset size of INR 500 crore and allow the third party professional manager to act as the manager to the REIT. This proposal could make REITs widely accessible for relatively smaller developers with quality assets which would otherwise not meet the asset size threshold on a standalone basis. This could also in some form encourage professional REIT managers to aggregate assets improving the chances of success of REITs as an investment product and may encourage institutional investors (both domestic and foreign) who may prefer to invest in products backed by professional managers. However, one would need to see how the allocation of responsibilities and liabilities would be allocated between the sponsors and the manager in such a case. It would also be interesting to see whether a non-contributor of assets would also be able to become a sponsor under the said relaxation.

Investment Related Conditions

The Draft Regulations provided that at least 90% of value of the REIT assets should be in completed and rent generating properties [[1]]and that a REIT can invest up to 10% of the value of the REIT assets in other assets. [[2]]The REIT Regulations have revised the above requirement and a REIT is required to invest at least 80% of the REIT assets should be in completed and rent generating properties and a maximum of 20% of its assets can be invested in other investments. However, a REIT can invest only a maximum of 10% of its assets in developmental properties.

Further, the REIT Regulations differ from the Draft Regulations in making it mandatory for a REIT to invest in at least 2 projects with a maximum of 60% of value of assets of a REIT invested in one project as compared to the Draft Regulations which permitted a REIT to invest 100% of its corpus in a single project.

Khaitan Comments:

The provision to allow a REIT to invest up to 20% of the value of the REIT assets in assets that are not completed and rent generating properties provides greater flexibility to the manager of a REIT. While the 10% limit provided other investments for in the Draft Regulations included all forms of other investments including investments in developmental properties, the REIT Regulations by providing a separate category of 10% for developmental properties has offered greater flexibility to the manager to obtain greater exposure to developmental properties. At the same time, the limit of 10% investment in developmental properties ensures that the REIT is not exposed to undue risk. While, SEBI’s intention in requiring a REIT to mandatorily have a minimum of two assets appears to have been driven by the objective of risk diversification, it goes against the globally accepted principle of a REIT being a vehicle that could hold a single pre-identified revenue generating real estate asset. Further, the Draft Regulations had provided the REIT with a flexibility to invest in more than one asset if it so desired and from that perspective, the REIT Regulations appear to be reducing the flexibility that prevailed under the Draft Regulations.

Conclusion

The reduction in asset size required for a REIT, greater flexibility in making investments and the proposal to allow multiple sponsors illustrate that the regulator is seeking to evolve a REIT framework in India in tune with the market reality in India and should help in making REITs a successful product in the country. However, policy makers still need to address certain challenges especially from a taxation and stamp duty perspective to ensure that REITs as an investment product become a success in India.