Getting a grip on REITs

By Larissa Fernand |  19-09-19 | 
 
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Larissa Fernand is Website Editor for Morningstar.in. She would like to hear from you and welcomes your feedback.

So we finally have REITs in India. After a long, long wait.

The Securities and Exchange Board of India, or SEBI, first issued the REIT regulations in 2014, which were then revised in 2016 and 2017.

The Blackstone Group-backed Embassy Office Parks REIT was India’s first that focussed entirely on a few Tier-I cities.

Now the private equity firm is talking to the K Raheja group for India’s second REIT and is in the process for finalising bankers. According to media reports, it is expected to file it’s draft red herring prospectus by the end of this year. In this REIT, the stake of Blackstone Group will be 15%, while K Raheja Corp will hold the remaining 85%. 

REITs, or real estate investment trusts, are companies that own or finance income-producing real estate across a range of property sectors. REITs trade on the stock exchange and provide a low entry point for investors in the real estate sector. 

Shobhit Agarwal, MD & CEO of ANAROCK Capital shares his views.

 CRE Developers’ Saviour

REITs couldn’t have come at a better time for Indian commercial real estate developers as they provide them a viable funding alternative. They will help developers to improve their liquidity by unlocking the value of their assets and raise capital. Developers are also free to exit the commercial asset and focus on their core task of developing real estate. This option is particularly beneficial for developers facing a cash-crunch, as REITs give them an opportunity to make an exit when the property is fully operational, and reap maximum returns on investments.

These instruments would also enable banks to free up their balance sheets by reducing loan exposures and creating head room to finance fresh projects.

The success of the Embassy Parks REIT has given global investors strong reason to increase their stake in multiple commercial assets across the country so that these could be listed under REITs in the future. Some of these global institutional investors who are eyeing the country’s real estate market via REITs include Japan’s NikkoAm StraitsTrading Asia, US’ North Carolina Fund, Taiwan’s Eastspring Investments, Malaysia’s Hwang Asia Pacific REITs and Infrastructure Fund, and Canada-based Sentry Global.

Retail REITs - Next in Line?

Retail REITs focus on owning and managing retail real estate and can be a viable instrument for mall developers to raise funds. The Indian retail scenario is bound to benefit from REIT funding, but issues like smaller lease tenures and business models must be ironed out before a retail REIT is launched.

In fact, several institutional investors have already bought stakes in malls, while many have funded greenfield assets. As India’s retail sector matures and gets more organized, a retail REIT seems likely in the foreseeable future.

The Future of Indian REITs

While an Indian residential REIT may not be imminent, the commercial sector is certainly buzzing with excitement. The Prestige Group is known to have plans to list its first commercial REIT soon, and has already started segregating its residential, office, retail and hospitality businesses. The Bengaluru-based developer may also later launch a retail REIT in the near future.

Other players such as RMZ Corp, K Raheja Corp, Godrej Properties and Panchshil Realty are also said to warming up to the idea of launching REITs for their commercial assets.

2018 saw large foreign institutional investors like Japan’s NikkoAm-Straits Trading Asia and US’ North Carolina Fund, among others, receive SEBI approval to invest in India under REITs. Several FIIs had already 'conquered' India’s equity markets in the past, and now it is the turn of the real estate market via REITs.

It is not only the timing that is right, but also the stance that FIIs have assumed for real estate plays in India. Most of them are patient investors focused on stable long-term returns which will hopefully exceed those they could expect in their own countries.

Nevertheless, whether Indian REITs will indeed be an unequivocal blessing to foreign and domestic investors still remains to be seen. As things stand now, India's REIT environment is not really a faithful emulation of that of developed international markets like Singapore, UK, Canada and Australia.

In those countries, REITs are a market-proven model that has withstood the test of time and produced very attractive returns for their investors. Globally, REITs have responded quite favourably to the evolving market dynamics. Indian REITs hope to take a cue from their western counterparts by bringing in regulations in line with the globally recognized norms so as to maximize profits for REIT investors here.

In Canada, the average return for REIT investors was around 10% in 2017, while in the UK, it hovered between 8-10%. This average return is on all REITable assets including commercial and residential projects together.

In India, the projected five-year returns on commercial assets is an optimistic 14%, largely because Grade A commercial real estate has been on a protracted winning streak since 2017. Commercial real estate withstood the vagaries of the various reforms much better than the residential asset class.

In the US, smaller investors account for between 25-30% of REIT participation from the previous 50% about a decade ago. In India, we can reasonably start with at least 15-20% of participation by smaller individual investors. All of this certainly bodes well for both FIIs and smaller investors focused on REITable commercial real estate - a space which has also benefited from the incumbent government’s efforts to improve the ease of doing business in India.

The issues to be ironed out

Residential real estate, the sector that is in greatest need of institutional funding, is not included under REITs while in developed global markets, residential assets are included under REITs.

This is obviously not without good reasons. Lack of a sound and inclusive rental policy in India is one of the major hurdles for REITs in residential segment. Countries like Singapore and US have a defined rental policy which makes it easier for them to host residential REITs. However, the recently announced draft Model Tenancy Act, 2019 is a step in the right direction and could make residential REITs a possibility sometime in the future.

Also, the yields on residential projects in India are nowhere near those of developed countries and mostly hover between mere 2-3% in the prime locales here. In short, low returns coupled with the overall negative hype that has followed the Indian residential sector in recent years have thus clearly negated its candidature for Indian REITs - at least in the foreseeable future.

Another area of difference is the taxation structure currently being proposed for Indian REITs. Like in the more developed countries with successful REIT platforms, India too must offer a logical tax regime with a single point of taxation if they are to rise to globally comparable stature.

The success of REITs in India will be based on the benefits it offers to investors. Currently, taxes such as capital gains tax are not conducive to attracting investors in large numbers. Mature markets like UK have exempted REITs from income and gains tax on the property rental business. In other countries there have been exemptions from stamp duty as well.

For India to truly join this elite club of global REITs markets, tax benefits must be offered to make the investment instrument more functional and lucrative in the long run.

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