Real Estate Investment Trusts (REITs)

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Real Estate investment Trusts or REITs are mutual fund like institutions that enable investments into the real estate sector by pooling small sums of money from multitude of individual investors for directly investing in real estate properties so as to return a portion of the income (after deducting expenditures) to unit holders of REITs, who pooled in the money.

A REIT in India is allowed to invest mainly in completed and revenue generating assets and other approved investments. Further, REIT will have to distribute majority of its income among the unit holders.

REITS are regulated by the securities market regulator in India- Securities and Exchange Board of India (SEBI). In September 2014, SEBI notified the SEBI (Real Estate Investment trusts) Regulations, 2014 for providing a framework for registration and regulation of REITs in India.

REIT can invest in commercial real estate assets, either directly or through Special Purpose Vehicle (SPVs) which invests more than 80% of its assets in properties. If REIT is investing through an SPV, REIT has to hold controlling interest with not less than 50% of the equity share capital or interest in SPV.

Here "real estate" refers to land and any permanently attached improvements to it, whether on leasehold or freehold, and includes buildings, sheds, garages, fences, fittings, fixtures, warehouses, car parks, etc. and any other assets incidental to the ownership of real estate. But the definition does not include mortgage and any asset falling under the purview of 'infrastructure' as defined vide Notification of Ministry of Finance dated October 07, 2013.

This is because a modified REITs type structure for infrastructure projects is done through Infrastructure Investment Trusts (InvITs) for PPP and other infrastructure projects.

Main Features of REITs in India

Structure of REITs

REITs are set up as trust under the provisions of the Indian Trusts Act, 1882 and are registered with SEBI. Like a mutual fund, it has three parties - Trustee, Sponsor(s) and Manager - to avoid any conflict of interest issues.
The Trustee generally has an overseeing role on the activities of the REIT.
Sponsor(s), collectively hold atleast 25% in the REIT for atleast 3 years and 15% thereafter. This is to ensure skin in the game. Sponsor’s responsibilities are to set up the REIT and appointment of the Trustee.
Manager means a company or LLP or body corporate incorporated in India which manages assets and investments of the REIT and undertakes operational activities of the REIT. In short, the manager assumes the operational responsibilities pertaining to the REIT. A manager needs to have at least 5 years of related experience coupled with other requirements such as minimum net worth, manpower with sufficient relevant experience, etc.
The trustee of a REIT is a SEBI registered debenture trustee who is not an associate of the Sponsor.

Offer of units, listing, investments and distribution

Value of the assets owned/proposed to be owned by REIT should be atleast Rs 500 crore.
The REIT can raise funds initially through an initial offer and once listed, may subsequently raise funds through follow-on offers.
Minimum issue size for initial offer is Rs 250 crore with a minimum public float of 25%.
Listing of units in a stock exchange is mandatory in India.
The minimum subscription size for units of REIT is Rs 2 lakhs and the trading lot is specified at Rs 1 lakhs so as to allow only reasonably informed investors into this market.
Permitted Investments by REIT are:
Atleast 80% in completed and revenue generating properties.
Not more than 20% in developmental properties and other eligible investments. Provided, investment in developmental assets is not more than 10% of the value of REIT assets.
REIT to invest in at least 2 projects with not more than 60% of value of assets invested in one project. Related party transactions are subject to strict scrutiny.
REIT to distribute not less than 90% of the net distributable cash flows, subject to applicable laws, to its investors.
Maximum borrowing permitted is 49% of the value of the REIT assets. Further, credit rating and post 25% unit holders approval are mandatory to raise debt.
Full valuation to be carried out atleast once a year and half yearly updation of the same has to be carried out.

Tax treatments of REITs in India

REITs are given "pass through status" from the perspective of income tax. Pass through transactions are those transactions where the ultimate beneficiary, namely, the investor receives the income (as dividends or interests payments) arising out of the loans/bonds/transactions done by a Trust. Since income is ultimately going to the investor, the Trust is exempted from paying the tax while the ultimate beneficiary is taxed. Thus, rental income from real estate assets directly held by REITs are allowed to pass through and are taxed in the hands of the unit holders of the REIT. This was announced in July 2014 in the Union Budget 2014-15.
Further, Union Budget 2015-16 proposed to rationalise the capital gains regime for the sponsors exiting at the time of listing of the units of REITs and InvITs, subject to payment of Securities Transaction Tax (STT). The rental income of REITs from their own assets will have pass through facility.
The Union Budget 2016-17 has withdrawn the 17% Dividend Distribution Tax that is applicable on any distribution made out of income of SPV to the REITs and INVITs, having specified shareholding.

Impact of REITs

The introduction of REITs in India is expected to significantly benefit the investors as well as the developers in the real estate industry. REIT are expected to provide an exit route to Indian developers who are struggling to reduce debt, while on the other hand it gives investors the ability to buy into the country’s property market which otherwise may be out of their reach due to the sheer size of the amount to be spent for acquiring such properties.
Thus, from the perspective of investors, holding units of REITs is a substitute for investing directly in real estate. This is similar to investing in Gold Exchange Traded Funds (Gold-ETFs).
REITs would also enable diversification of the portfolio of the investors and provide the investors a new product that is regular income generating.
The freeing up of developer's capital is expected to bring in more investments in real estate, thereby stimulating growth. Funds locked up in various completed projects can be released to facilitate new infrastructure projects to take off.
Assets that may qualify to be included in REITs may reach $20 billion by 2020 (according to an estimate by property broker Cushman & Wakefield). In the first three to five years, as much as $12 billion could be raised.
REITs will force much needed transparency at least in the commercial sector, and lower the reliance on financing from banks and incentivize developers to own and manage assets with a long-term view. In a market where price data is almost impossible to come by, this will be a revolution. It will help the investors in making more informed investment decisions as returns can actually be analyzed rather than be based upon anecdotes.
Opening up of REITs for foreign investors with support from the budget on such inflows is expected to generate substantial foreign interest for investment in REITs.
In time, it will help develop a more mature and liquid market with broad participation from investors.

International Comparison
Globally, framework for REIT exists in several countries including United States of America, Australia, Singapore, Japan, France, United Kingdom, etc. A comparison of Indian REITs with Singapore REITs is given below.

Type	India	Singapore
Legal Structure	Trust, with Trustee, sponsor (s) and manager	Trust with Trustee, sponsor (s) and manager
Manager	Manager has to be an external company	Manager has to be an external company
Identification of Assets	A REIT has to identify assets prior to making offer to public of units.	A REIT has to identify assets prior to making offer to public of units.
% of under construction assets allowed	Investments in developmental assets not more than 10% of gross asset value of the REIT which have to be held at least 2 years after completion.	The total contract value of property development activities undertaken and investments in uncompleted property developments should not exceed 10% of the property funds deposited property. Further, such investment in permitted only if the REIT intends to hold the developed property upon completion.
Such funds are allowed to be listed?	Yes, Mandatory	Yes, but not mandatory
Activities permitted	At least 75% of value of the REIT assets proportionately on a consolidated basis shall be rent generating.	At least 75% of the deposited property should be invested in income-producing real estate Not more than 10% of revenue from sources other than rental and other specified sources.
Income Distribution	At least 90% of its net distributable income after tax to be distributed. If capital gains from sale of property proposed to be re-invested in another property, no distribution required. If not proposed to be re-invested, 90% of the capital gains to be distributed.	At least 90% of its taxable ordinary income to be distributed in the same financial year as it is received to qualify for tax transparency. Not required to distribute capital gains
Permissible investments	Real estate assets (freehold or leasehold) includes assets incidental to ownership and operation of such real estate assets (Only Indian assets). Investment may be directly in the properties or through an SPV controlled by the REIT having at least 80% of their assets in real estate. A REIT is not allowed to invest in units of another REIT. Listed or unlisted debt of investee companies/mortgage backed securities. Investment also allowed in equity shares of companies listed on a recognized stock exchange in India which derive not less than 75% of their operating income from Real Estate activity Government Securities and Money market instruments/Cash equivalents Investments in developmental assets not more than 10% of gross asset value of the REIT which have to be held at least 2 years after completion.	Real estate, whether freehold or leasehold, in or outside Singapore. An investment in real estate may be by way of direct ownership or a shareholding in an unlisted special purpose vehicle (“SPV”) constituted to hold or own real estate. An investment in another property fund that is authorised will be considered as an investment in real estate; Real estate-related assets (listed or unlisted debt securities and listed shares of or issued by property corporations, mortgage-backed securities, other property funds, and assets incidental to the ownership of real estate (e.g. furniture).), wherever the issuers/assets/securities are incorporated/located/issued/traded; Investment also allowed in listed or unlisted debt securities and listed shares of, or issued, by local or foreign non-property corporations; Government Securities (issued on behalf of the Singapore Government or governments of other countries) and securities issued by a supranational agency or a Singapore statutory board and cash and cash equivalent items. Investments in uncompleted property developments not exceeding 10% of the property funds deposited property subject to holding of the developed property upon completion.
Concentration of investments	Minimum 2 projects with not more than 60% of the value of the assets, proportionately on a consolidated basis, in one project.	No minimum limit on no. of projects. except for non-real estate investments (5% in any one issuer's securities or any one manager's funds) For Listing – Not more than 30% of gross assets invested in unlisted securities
Restrictions on Shareholding	At least 25% of the REIT's outstanding units must be held by public at all times post-listing with at least 200 public unit holders. Minimum Investment of Rs. 2 lakh per investor Trading lot size of Rs. 1 lakh in the secondary market No restriction on maximum shareholding Approval of unit holders required if shareholding of a non-sponsor crosses 50%.	If listed, at least 25% of the REIT's share capital or units is held by at least 500 public shareholders No minimum investment limit per investor. No minimum trading lot size. No restriction on maximum shareholding Takeover code applies.
Maximum Gearing Ratio	Maximum 50% of the aggregate gross asset value on a consolidated basis, with requirement of credit rating and unit holder approval post 25%	60% (with credit rating) 35% without credit rating
Regular Disclosure requirements	Annual and Half yearly disclosures Disclosures in initial offer document/follow-on offer document/other offer document Regular disclosures in terms of the listing agreement with the exchanges Event-based disclosures Disclosures for related party transactions	Yearly disclosure (apart from financials) Disclosures in offer documents Listed REITS must announce net tangible assets per share or per unit on a quarterly basis via SGXNET and must comply with other regular disclosure requirements in listing rules. Event-based disclosures Disclosures for related party transactions
Valuation of assets	Assets to be valued fully (including site inspection) by an independent external valuer on a yearly basis. Updation required on half-yearly basis. Full Valuation including site inspection required for every purchase of asset and issue of new units. Valuer to be registered valuer under Companies Act, 2013 and valuation in accordance with International Valuation Standards/ICAI standards In case of a sale/ purchase of assets from a related party, two independent valuations of those assets to be conducted.	Full valuation of real estate assets at least once a financial year and may be required in case of issue of new units/redemption of units. The Valuer must be independent, reputed, be authorized under any law of the state or country where the valuation takes place to practice as a valuer. For related party transactions, two independent valuations required with one of the valuers commissioned independently by the trustee.
Sponsor Holding	Multiple sponsors allowed, subject to maximum 3, where each holds minimum of 5%. Sponsor(s) to hold, collectively, minimum 25% of the units of the REIT for a period of atleast 3 years. Minimum 15% of the units to be held by sponsor(s) always. Sponsor may sell stake to another person post 3 years subject to minimum holding of 5% and maximum number of sponsors at 3. Approval required from 75% unit holders for any new sponsor/change in control of the sponsor. Sponsor units greater than 25% and non-sponsor holding prior to initial offer locked-in for a period of 1 year.	No restrictions

Also See

Infrastructure Investment Trust (InvITs)

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Mr. Jaipal (IES 2011)
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