The Securities and Exchange Board of India, or Sebi, is soon likely to allow real estate investment trusts, or REITs, in India—a move that will increase the depth of India’s real estate market, in terms of both exit and financing options for developers and avenues for investors.
After about five years of releasing its first draft regulations for REITs, the capital market regulator put out a consultative paper on REITs for public feedback on Thursday.
After considering the feedback, Sebi will formalize the regulations, bringing in the first set of rules for REITs, and allow these entities to do business in India, said a Sebi official who did not want to be named.
REITs are common globally and invest primarily in completed, revenue-generating real estate assets and distribute a major part of the earnings among their investors. Typically, the income of these trusts comes from the rentals received from such properties.
REITs offer a less risky alternative to investing in under-construction properties and also provide a regular income. To begin with, though, only wealthy individuals or institutions will be allowed to invest in REITs, and not retail investors.
Recent research by the Asia Pacific Real Estate Association (APREA), which promotes and represents the real estate asset class in Asia, showed that India’s share of the global investable real estate market is currently just 1.3%, said Lim Swe Guan, chairman of APREA.
“However, this is expected to increase to 6% in the next 20 years with the size of the domestic real estate market rising 16-fold over that period. India REITs are poised to capture a substantial share of such capital inflows,” Lim said.
The Sebi move is a “big positive” for the sector, said Pirojsha Godrej, managing director and chief executive officer of Godrej Properties Ltd.
“It will create opportunities for developers to exit commercial real estate projects and will create a new investment vehicle through which smaller investors can gain exposure to income generating real estate assets,” Godrej added.
The objective of REITs, to be registered as trusts with Sebi, will be to organize, operate and manage collective investments. To launch REIT schemes, these trusts will have to float a real estate investment management company. All REIT schemes, to begin with, will be close-ended real estate investment schemes that will invest in property with the aim of providing returns to unit holders. The returns will be derived mainly from rental income or capital gains from real estate.
A REIT will have trustees, sponsors, managers and a principal valuer. A trust, once formed, will initially apply for a Sebi registration and once the market regulator grants the REIT approval, it will be allowed to offer units to the public and get the units listed, similar to an initial public offering of equity shares, albeit in a different structure. Once listed, a REIT may subsequently raise funds through follow-on offers. Listing of units will be mandatory for all REITs, Sebi said in its paper.
For floating an initial offer of REIT units, the size of assets under the REIT will have to be at least Rs.1,000 crore. Sebi said this would ensure that initially only large assets and established entities enter the market. Further, the minimum initial offer size has to be Rs.250 crore, in which the public float has to be at least 25%.
Sebi has proposed that while purchasing or selling properties both prior to and after an initial offer, a REIT will be required to get two independent valuation reports from two different valuers. And transactions for purchase or sale of assets will have to be done at a price average of the two independent valuations and the principal valuer will have to be appointed every two years.
The market regulator said though a REIT may raise funds from any type of investors, resident or foreign, initially only wealthy individuals and institutions will be allowed to subscribe to REIT unit offers. “It is proposed that the minimum subscription size will be Rs.2 lakh and the unit size will be Rs.1 lakh,” Sebi said.
REITs will offer an alternative investment opportunity to retail and high net worth individuals who have been mainly investing in gold and help curb capital flows from the country.
“There are a lot of assets which are investment-grade and we would be interested in investing in such assets,” said V. Hari Krishna, director, Kotak Realty Fund.
To ensure regular income to REIT investors, Sebi has proposed to make it mandatory for the trusts to distribute at least 90% of the net distributable income after tax to investors.
Similar to the practice in US, Australia, Singapore and other nations where REITs are common, Sebi has proposed to allow these trusts to invest primarily in completed revenue-generating properties. The regulator proposed that at least 90% of a REIT’s assets should be invested in completed and revenue-generating properties. The balance 10% can be parked in other assets.
REITs may invest in properties directly or through a special purpose vehicle (SPV) if such an SPV holds at least 90% of the REIT’s assets, Sebi said in its paper.
Also, no REIT will be allowed to invest in vacant or agricultural land or mortgages other than mortgage-backed securities. Further, a REIT can invest its entire corpus in one project only if the size of the asset is at least Rs.1,000 crore.
Sebi had initially planned to allow REITs in 2008, but shelved the plan because of various hurdles. One major bottleneck was the absence of a real estate regulator and possible discrepancies in the valuations of properties in which REITs invest their money.
This time, to ensure that underlying assets of REITs are valued accurately, Sebi has proposed that a full valuation including a physical inspection of the properties be made at least once a year, and be updated every six-months. Accordingly, the net asset value of REIT units will be declared at least twice a year.
Further, while purchasing a new property or selling an existing property, the value of the transaction cannot be less than 90% of the assessed value of the property while selling or more than 110% while purchasing.
Among other proposals, Sebi said a sponsor of a REIT will be required to maintain a certain holding in it at all times. A sponsor selling its unit holdings will have to arrange for another entity to act as the re-designated sponsor. Sponsors will also have to meet a certain criteria in terms of net worth.
REITs will provide the sponsor (usually a developer or a private equity fund) easier avenues of exit, which, in turn, will provide liquidity and enable them to invest in other projects, say analysts.
And as and when retail investors are allowed to invest in REIT units, they will be able to play in a market usually restricted to institutional and high net worth investors.