Will real estate investment trusts go the right way?
With markets watchdog Securities and Exchange Board of India (SEBI) finalising the long-pending guidelines for the creation and regulation of Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (IN ITS), the stage is set for the launch of these new instruments of investment-pooling that could provide a lifeline to fund- starved developers and also prove to be a boon for the small investors by providing them avenues for safe and profitable investments.
Today, the banking system faces tremendous pressures due to high degree of non-performing assets and, as such, this cheap funding is not easy to come by. This is especially so for the real estate sector, which has so far not been given industry status to entitle it to priority lending for accessing long-term funds at reasonable rates. On the contrary the Reserve Bank of India (RBI) has put restrictions on lending to the real estate sector. This has made bank lending more cumbersome and costly, forcing real estate players to look for alternate avenues. Even FDI and PE funding has been restricted due to low yields, long gestation periods and limited exit options.
The infrastructure sector requires huge funding of Rs. 65,000 crore (USD 10.6 billion) during 12th Five Year Plan (2012-17). An investment outlay of Rs.70 lakh crore is anticipated in affordable housing and in urban roads and transport in next two decades. The funding requirement has further increased for real estate in view of the abysmally low sales and substantial increase in raw material and labour costs. This is a matter of serious concern for debt-laden companies. The total debt of top 11 listed companies has touched Rs.42,000 crore, with DLF topping with Rs.19,000 crore.
Against this backdrop, REITs may well prove to be a game changer for the real estate sector as there may be 80-100 million square feet (msf) of Reitable office space worth Rs.60,000 generating Rs.6,000 crore of annual rental income.
Global property consultancy Jones Lang Lassale anticipates that nearly half of the 376 msf Grade A office space will get listed in next 2-3 years. To capitalise on the opportunity, leading funds like Xanders, Red Fort, Blackstone and Kotak and developers like DLF, Prestige, RMZ, Panchshil and Phoenix are preparing to launch their REITs.
Despite the government's tall promises, real estate has remained out of reach for millions of Indians due to its unaffordability. REITs will provide an opportunity to small investors to invest in a hassle-free manner with ease of liquidating their investment, besides coming in handy for developers of commercial property who require huge capital.
SEBI has also attempted to safeguard interests of property investors through stringent disclosure norms, related party transactions and valuation of assets. The regulator has put a condition that in under-construction properties, where investors are facing the brunt of delays, REITs can invest only 10 percent of their assets and at least 80 percent of assets should be deployed in completed and income-generating properties.
SEBI has also tried to take the risk out of investment by mandating that REITs must invest in at least two projects with not more than 60 percent of the assets invested in one. It has been made mandatory for sponsors to hold 15 percent stake throughout the tenure of REIT. Compulsory listing of REITs on the stock exchange will make investments transparent and less prone to risk.
However, there are quite a few misapprehensions on the part of real estate sector on the operational success of REITs. The restrictive investment in commercial real estate is being seen as a less attractive opportunity for REITs. Also, there is not complete pass through on the dividend distribution tax. Moreover, there will not be much choice for investors in terms of number of projects as only a few big developers will have a Reitable portfolio.
There are also misgivings that REITs won't be remunerative for investors as the current tax structure is unviable and irksome. Developers are particularly uneasy with the long-term capital gains tax to be paid on selling their units to REITs. They want REITs to be treated like IPOs. Also, exemption from stamp duty would have made REITs more attractive, they say.
It will not be before the next fiscal beginning April 1, 2015 that REITs will get launched. Much of their success will depend on SEBI ensuring that only good quality assets are brought for investment, valuations are right and transactions are well regulated.
It will also be advisable to bring in real estate regulation to make REITs truly attractive to realise their full potential. Notwithstanding the initial hiccups, both REITs and IN ITS will prove to be a boon in channelising domestic and foreign investment into the real estate and infrastructure sector.
(Vinod Behl is editor of Realty Plus, a leading real estate monthly. The views expressed are personal. He can be reached at email@example.com)
(Posted on 12-08-2014)
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