Real estate is the second largest employer after agriculture and is slated to grow at 30% over the next decade. The Indian real estate market size is expected to touch $180 billion by 2020[see end note 1]. The sector has attracted a host of major Indian businesses in the last few years but continues to remain largely unorganized and poorly regulated with no technical standards for quality of construction and other parameters. Moreover, Indian banks were reluctant to lend to this sector and foreign direct investment was also highly restricted resulting in many unfinished projects due to lack of funds.
The Securities and Exchange Board of India (SEBI) initially introduced draft regulations on Real Estate Investment Trusts (REITs) in 2008, but the same was never implemented. Meanwhile, REITs have become ubiquitous across the globe with their introduction in USA way back in the sixties, Australia in the seventies and a host of other nations in the 2000s including in jurisdictions closer to home such as Japan, South Korea and Singapore. In 2013, SEBI issued a consultation paper and it seemed that this time, there was a serious move to usher REITs in India, though the tax aspects of REITs were unclear. Budget 2014 has now introduced amendments in the Income-tax Act, 1961 to provide tax benefits to REITs. SEBI has also finally issued SEBI (Real Estate Investment Trusts) Regulations, 2014 with effect from 26th September 2014 (‘SEBI REIT Regulations’) providing a detailed regulatory framework for establishment and operation of REITs in India. With these recent developments, REITs are finally ready to take-off in India.
Meaning and features
REITs in India are in the nature of private trusts registered with SEBI, to be listed on the stock exchange and with the object of primarily investing in completed, revenue generating real estate assets in India, the earnings of which shall be mostly distributed to their unit-holders. The REITs shall be governed by the ‘Trust Deed’ (registered under the Registration Act, 1908), the SEBI REIT Regulations and since REITs are in the nature of private trusts, by Indian Trusts Act, 1882.
Parties to the REIT
Further, the sponsor(s), manager and trustee must all be separate and non-connected entities. The trustee cannot be an associate of the sponsor(s) or manager. The REIT shall pool funds by issue of units to unit holders. The SEBI REIT Regulations prohibits grant of preferential voting rights or issue of multiple classes of units amongst unit holders.
Investment
The REITs can only invest directly in real estate assets or properties, securities, Transferable Development Rights (TDRs) in India or indirectly in all of the above through Special Purpose Vehicles (SPVs). Real estate has been defined to mean land and any permanently attached improvements to it, whether leasehold or freehold including buildings, sheds, garages, fences, fittings, fixtures, warehouses, car parks, etc. and any other assets incidental to the ownership of real estate. However, real estate shall exclude mortgage and assets falling in the definition of ‘infrastructure’ under notification of Ministry of Finance dated 7th October 2013.
Further, an REIT is required to invest in at least two projects and the maximum threshold limit for a single project is 60% of value of REIT’s assets.. REITs are prohibited from investing in other REITs, vacant land, agricultural land and mortgages other than mortgage backed securities. However, this does not include any land which is contiguous and extension of an existing project being implemented in stages.
Sources of revenue
REIT and SPV collectively - Not less than 75% of the revenues, other than gains arising from disposal of properties, shall be, at all times, from rental, leasing and letting real estate assets or any other income incidental to the leasing of such assets.
REIT individually - Not less than 75% of value of the REIT assets proportionately on a consolidated basis shall be rent generating.
Revenue distribution
SPV is liable to distribute 90% of its net distributable cash flows to the REIT in proportion to its holding in the SPV. Similarly, the REIT is liable to distribute 90% of its net distributable cash flows to the unit holders. All such distributions shall be made not less than once every 6 months in every financial year and shall be made not later than 15 days from the date of such declaration. Further, if any property is sold by the SPV/REIT, 90% of the sale proceeds shall be distributed to the REIT/unit holder, as the case may be. However, if the REIT/SPV proposes to re-invest the sales proceeds in another property, the REIT/SPV shall not be liable to distribute the sales proceeds.
Mandatory listing and related requirements Every REIT is required to make an initial offer by way of public issue within 3 years from the date of registration with SEBI failing which it shall be required to surrender its registration certificate. However, SEBI has the discretion to extend this period by one year. REITs can make an initial offer only upon fulfillment of following requirements:
- Value of assets is not less than INR 500 crores (including value of the specific portion of the holding of REIT in the underlying assets or SPVs);
- The units proposed to be offered to the public is not less than 25% of the total outstanding units of the REIT and the units being offered by way of the offer document. For initial offer of value greater than INR 500 crore rupees, if prior to the initial offer units of the REIT are held by the public, the units proposed to be offered to the public shall be calculated after reducing such existing units for satisfying the 25% requirement;
- The offer size is not less than INR 250 crores;
- Minimum subscription shall be INR 2 lakh per applicant.
Any subsequent issue of units by the REIT may be by way of follow-on offer, preferential allotment, qualified institutional placement, rights issue, bonus issue, offer for sale or any other mechanism as per SEBI norms. For practical purposes, it is advisable for the REIT to provide for the above mechanisms in its trust deed.
Foreign investment
Although the SEBI REIT Regulations allow subscription of units by foreign investors, foreign direct investment (FDI) in trusts other than venture capital funds (VCFs) is prohibited under the present FDI Policy. Corresponding changes shall be required to enable foreign investors to invest in REITs. However, the foreign investors may invest in the SPVs of the REIT subject to fulfillment of conditions prescribed under the extant FDI Policy.
Stamp duty implications
Although direct tax benefits have been declared by the government for REITs under the Finance Act, 2014 to come into effect from 1st April 2015, no stamp duty waivers or remissions have been declared by the government till date. The transaction cost for physical assets in India is as high as 5%- 12%. Comparatively, REIT friendly jurisdictions like Singapore offer low transaction costs of 4-6% with better asset quality than India. To make India a more attractive destination for REIT investors, it is advisable for the Indian government to offer stamp duty remissions to REITs.
Conclusion
Although real estate sector is one of the major propellants in the economic growth of India, real estate laws are in a nascent stage in India. So REITs may be considered a step in the right direction. Between 2008 and 2013, private equity funds invested more than INR 452 billion ($7.6 billion) in Indian real estate, of which more than a third was spent on office and retail assets[see end note 2]. The introduction of REIT structure in India may emerge as an alternate and new source of funding as well as one of many potential exit strategies that can be explored by investors. Various corporates are also considering cashing in on their real estate holdings by setting up REITs. According to recent news reports Blackstone Group and its partner Embassy Group have evinced interest in listing their Indian properties through REIT and they have already hived off their portfolio of assets into a separate vehicle, taking first step towards listing a trust in India. What will perhaps be on the real estate sector wishlist now are stronger system for title determination and verification and ancillary must-haves like title insurance which are already available in many other countries promoting real estate.
[The author is a Senior Associate, Lakshmikumaran & Sridharan, Hyderabad]
End Notes:
- The Confederation of Real Estate Developers’ Associations of India (CREDAI), 2014 at http://www.credai.org/indian-economy
- According to data from Cushman & Wakefield