REAL ESTATE INVESTMENT TRUST

(REIT)An Introduction to Indian REIT’s

Definition• A REIT is a type of security that invests in real estate

through property or mortgages and often trades on major exchanges like a stock. REITs provide investors with an extremely liquid stake in real estate.

What is REIT & How it works• REIT is an investment vehicle for real estate that is comparable to a mutual

fund, allowing both small and large investors to acquire ownership in real estate ventures, own and in some cases operate commercial properties such as apartment complexes, hospitals, office buildings, timber land, warehouses, hotels and shopping malls.• Real Estate Investment Trust, owns or finances income-producing real

estate. Modeled after mutual funds, REITs provide investors of all types regular income streams, diversification and long-term capital appreciation. • REITs typically pay out all of their taxable income as dividends to

shareholders. In turn, shareholders pay the income taxes on those dividends.

What is REIT & How it works• REITs allow anyone to invest in portfolios of large-scale properties the

same way they invest in other industries – through the purchase of stock.• In the same way shareholders benefit by owning stocks in other

corporations, the stockholders of a REIT earn a share of the income produced through real estate investment – without actually having to go out and buy or finance property. • Like mutual funds, REITs will pool in money from investors and issue

units in exchange.

What is REIT & How it works• As of August 2014, India approved creation of real estate investment

trusts in the country. Indian REITs (country specific/generic version I-REITs) will help individual investors enjoy the benefits of owning an interest in the securitized real estate market. • The greatest benefit will be that of fast and easy liquidation of

investments in the real estate market unlike the traditional way of disposing of real estate. The government and Securities and Exchange Board of India through various notifications is in the process of making it easier to invest in real estate in India directly and indirectly through foreign direct investment, through listed real estate companies and mutual funds.

GUIDELINES & FORMATION:• The REIT will have to first get registered and raise funds through an initial public offer

or IPO. Units of REITs will have to be compulsorily listed on exchanges and will be traded like securities. Most of the money so collected will be invested in commercial properties which are completed and are generate income.

• The guidelines, approved by its Sebi board, have kept the minimum requirement for asset sizes permitted to be listed in India at Rs 500 crore. The minimum issue size of the initial public offer shouldn't be less than Rs 250 crore.

• Like stocks, investors will be able to buy units of REITs from both primary and secondary markets. While investing in an IPO, the minimum investment amount will be Rs 2 lakh, while on exchange the minimum lot size will be Rs 1 lakh.

• An investor can earn two types of income from REITs. One through capital gains when he sells the units of REITs on exchanges and the other through dividend income.

Some important points Low Entry Barrier• MINIMUM SUBSCRIPTION: Rs 2 lakh (primary market)• TRADING LOT SIZE: Rs 1 lakh (secondary market) Regular Income• Dividend income: At least 90% of the distributable cash flow must be distributed and at least

twice a year. Transparency• REIT, through a valuer, will undertake full valuation on a yearly basis and update the same on a

half-yearly basis and declare NAV within 15 days from the date of such valuation/updation. Diversification• REITs will have to invest in at least two projects. Not more than 60% value of assets will be in

one project.

Some important points Low risk• Not less than 80% of the assets should be invested in completed and

revenue-generating properties. The rest 20% can be invested in under-construction properties, mortgage-backed securities, listed/unlisted debt of companies in the real estate sector, equity shares of listed companies which derive not less than 75% of their operating income from real estate activity, G-securities and money market instruments and cash equivalents.• Sponsor, trustee and manager cannot be an associate. This will ensure there

is no conflict of interest.• Sponsors must hold 25% of the units for first three years and 15% thereafter

to ensure their commitment.

DETAILED ANALYSISWhile anticipating handsome returns one must be cautious of the recent performance of the commercial real estate market in India and the associated stagnancy in asset pricing growth across most projects. Investors should also keep in mind other costs such as tax outflow, stamp duty and other conversion charges before investing in these instruments. Here is the analysis , how RIETs will stack up on returns, safety, liquidity and taxation.

RETURNS• The investment portfolio specified for REITs shows that you will receive your returns from the REIT in two

forms. One, you will receive regular dividends paid out from the rents or capital gains that the REIT makes on its properties. Two, you could make a capital gain if the price of your listed REIT unit appreciates on the exchanges. Of course, when the REIT's long tenure ends, you will also realize the gains that the holdings generate.

• Now, the first aspect dividend share mainly a function of the rental yields (rent as a function of price) on the properties that the REIT owns. Rental yields for commercial property move up or down depending on factors such as the supply, absorption and the fortunes of user sectors such as IT/BPO, financial services and retail.

• Presently, rental yields on good commercial properties in India average 9 to 11 per cent. But these yields vary widely based on location and the quality of the property. Assuming the REIT charges a fee of 2-3 per cent for managing these assets, the net returns distributable to investors by way of dividends will therefore be in the range of 6 to 9 per cent, before taxes. Yes, REITs can bump up those returns by buying and selling property and making capital gains. But this may not be easy in a portfolio made up mainly of commercial properties. The commercial property market in India lacks liquidity; which is why large developers such as DLF, Unitech, Phoenix Mills and so on have found it difficult to sell commercial assets to reduce debt on their balance sheets. The prolonged downturn in the commercial market since 2008 has only aggravated this problem. Therefore, desi REITs, if they find high rent yielding properties, are more likely to hang on to them, rather than try and generate capital gains by 'trading' on prime assets.`

RETURNS• As to capital gains to the investor from the listed units, the lack of valuation benchmarks for domestic

property makes the situation complicated. Yes, REITs are supposed to get their assets valued by a third party even six months. But given that property prices vary so widely between different localities and swing sharply between one deal and the next, most property market experts admit that the calculated NAV for a REIT would be only a guesstimate, not a watertight measure like the NAV of a mutual fund. Given that these NAVs would be disseminated only once in six months, the daily prices of REITs may deviate quite sharply from their book value.

• These facts show that it will not be very easy for Indian REITs to earn double digit returns. REIT managers who are particularly savvy in picking up prime properties at beaten down valuations may manage it. But high valuations at entry or poor selection of property can very easily decimate returns too.

• On this count, Indian REITs will have a far harder time attracting investors than their global counterparts. REITs in developed markets appear quite attractive to investors even with a 6-7 per cent income, because interest rates in those markets hover at 2-3 per cent. But Indian REITs will be attractive to investors only if they manage dividend income that is higher than bank deposits (9 per cent), small savings schemes (8-8.5 per cent) and debt mutual funds (historically 8-8.5 per cent). However, investors must keep in mind that REITs dividends are not comparable to the others above because there is a separate capital appreciation component too. This means that the rental income will also likely be a percentage of the appreciating capital value in a good REIT, as rents escalate. In fact, REITs could actually turn out to be the best way to generate inflation adjusted regular returns, which is a rarity in India.

SAFETY• It is comforting to know that REITs in India will be regulated by SEBI, one of the more proactive Indian regulators.

This is especially so because the sponsors who will come forward to manage REITs are not likely to emerge from the traditional Indian mutual fund or insurance companies, but from the corporate and real estate sectors. One would hesitate to accord the Indian real estate sector high marks on corporate governance. For one, it is well - known that most real estate transactions are subject to a grey market component due to the incidence of stamp duty. And most property deals, unlike those for stocks and bonds, take place behind a veil of opacity. Two, given the nexus between real estate and politics, and the multiple approvals needed to launch projects, the sector is riddled with corruption too. These are precisely the reasons why many Indian mutual fund houses are wary of launching REITs, though SEBI has thrown open the asset class.

• But having said this, SEBI has put in place three safeguards in its new REIT regulations to protect your interests. One, all REITs are required to register with SEBI; thus allowing it to weed out non-serious players or those with a doubtful governance record at the very outset. Two, the investment restrictions on REITs (80 per cent in completed property, 90 per cent dividend payout, investments in at least 2 projects, approval for related party deals and so on), put in place a basic governance structure to prevent mis-utilisation of funds. Three, REITs are required to start off with a minimum asset size of R500 crore which is already invested into identified property assets. What is more, the sponsors are required have their own 'skin in the game' by investing 25 per cent of the initial corpus. Disclosure requirements such as the filing of a prospectus, financial statements and half-yearly NAV calculations by an independent valuer, usher in some transparency into the vehicle.

• Given the nature of the market itself, whether these regulations deliver good governance in practice remains to be seen. Until then, investors will have to exercise considerable due diligence on the sponsors of the upcoming REITs.

SAFETY• The regulatory aspect apart, how safe will REITs be in terms of the volatility of returns? Because

they will own a diversified portfolio of properties, they may turn out to be safer than direct bets on land or property. After all, these properties are also to be selected and regularly monitored by expert professionals. The requirement that REITs pay out regular dividends from completed, income-generating properties also reduces risks to investors as this ensures a minimum return.

• But this is not to say that REITs will not suffer from any NAV volatility. Though most Indian investors seem to believe that property prices head only one way (Up!), that's not really true. In fact, the commercial sector (malls, office space, multiplexes), which REITs will focus on, has been far more sensitive to the economic downturn than the residential sector. A study by FICCI jointly with real estate consulting firm Knight Frank, shows that while residential property prices in Chennai, Mumbai and NCR have appreciated by anywhere between 38 and 55 per cent from early 2009, office rents in the same markets are today below 2009 levels. Industry statistics also show that commercial property prices, which were at record highs in 2008, tanked sharply thereafter and even today languish 20-25 per cent lower than levels five years ago. The valuations of listed REITs, obviously, will reflect such swings in their portfolio value.

LIQUIDITY• With SEBI mandating all Indian REITs to be listed, investors can be assured of anytime exit by selling their

units. The availability of six-monthly NAVs will also ensure a reasonable basis for price discovery. Therefore, REITs may offer far better liquidity than direct investments in property or plots. We all know how difficult it is to gauge the fair price, leave alone actually buy or sell property in India. But you should bear in mind that REITs, despite listing, may be far less liquid than stocks or mutual funds, because of the very nature of their underlying investments.

• In the last five years, the supply of commercial space in key cities has far outpaced demand, leading to significant unsold 'inventory' of office and mall space and vacancies of 18-20 per cent. While this will create opportunities for newly launched REITs to acquire assets at attractive prices, exit from these assets is likely to prove difficult. The illiquidity in underlying assets can cause distortions in the traded price of REITs in the secondary market.

• Further, though REITs are to be listed, the minimum lot for trading is at R1 lakh; the high outlay may restrict their trading volumes on the bourses. Given the close end nature of the vehicle, REITS may also trade at sizeable discounts to the NAV, based on market conditions. For instance, Singapore listed REITs (which include REITs sponsored by firms such as Ascendas and Indiabulls who are active in India) traded at discounts if anywhere between 25-30 per cent to their NAVs two years ago; with the markets recovering a few have now moved into a premium.

TAXATION• The evaluation of any investment option cannot be complete without factoring in

what you give away to the taxman. Going by clarifications in the recent budget, Indian REITs are likely to enjoy pass-through status on their taxation. Just like mutual funds, the REITs may therefore be required to pay no tax on their capital gains or rents earned from property. But there are other tax aspects to be unravelled before REITs can become as tax-efficient as say, equity funds. For one, while the REIT itself pays no tax, the entities or firms from which it collects rent will have to shell out taxes. Two, the world over, investors do pay taxes on the dividends as well as capital gains they make on their REIT investments.

• That poses yet another challenge for the upcoming Indian REITs. Not only do they have to navigate the tricky commercial property market and compete with other ultra-safe investments on returns, they also have to deliver a good post-tax return to the investor, compared to long term debt funds, tax-free bonds and the public provident fund.

BARRIERS ON THE WAY• Still, some barriers remain for REITs. One is dividend distribution taxes (DDT) and stamp

duty on the transfer of properties. “The lack of clarity on DDT has acted as a deterrent for the real estate players and the private equity players to launch REITs in the country.

• There should be no unrealistic expectations from REITs as they are structured to suit risk averse investors. "These are meant for risk averse investors who want regular income without taking too much risk.

• Also, real estate markets have done poorly because of oversupply and lack of demand due to high prices. The rental yields have not been very attractive either. "Yields on commercial assets (which are essentially pre-leased) do not exceed 9-10%. Hence, what a business trust can offer to the investor can be at best 7-8% a year after adjusting for expenses of managing the fund

NOW INVESTORS EYES ARE ON THE COMING BUDGET.

FRIENDS, I HOPE THIS PPT WAS USEFUL TO YOU AND YOU HAVE GAINED SOME KNOWLEDGE OF REIT’S.

IF STILL YOU NEED SOME CONSULTANCY FREE OF COST AND FOR FURTHER CONNECTIVITY YOU CAN CONTACT ME AT MY EMAIL I’d aguptacompany@gmail.com OR MY CONTACT NO. 8437733375.