REITs to debut in the Indian market in a matter of months

The Securities and Exchange Board of India’s (Sebi) draft rules on real estate investment trusts, popularly known as REITs, are out and investors can now expect REITs to debut in the Indian market in a matter of months. Association of Mutual Funds of India (AMFI) chairman A P Kurien said, “I expect the final guidelines to come by January-end. Fund houses will be able to launch their schemes within four to six weeks thereafter.” This step opens the window for small-ticket investors to participate in the Indian real estate sector’s growth story.

REITs: The concept

REITs are trusts that are allowed to invest directly in real estate properties, mostly commercial. They earn a regular revenue in the form of lease rentals from the buildings they own and pass this income on to their investors.

Internationally, REITs are companies listed on exchanges and investors buy their shares. The Reit owns and manages properties and earns rentals from them, while investors get a share of the rentals in the form of dividends. According to Vineet K Vohra, managing director and chief investment officer of ING Investment Management, which recently launched its global real estate fund, “Globally REITs pay out almost 85-90 per cent of the revenue they generate in the form of dividends. So they are like high dividend-yielding equity stocks.”

Structurally, what is being proposed in India is different from the international model of REITs. Kurien added, “Internationally, shares of REIT companies are held by investors. But we will issue units of mutual funds. MFs will collect funds by issuing units and the funds collected will be invested in the manner prescribed in the offer document.”

Sebi’s proposal

According to Sebi’s guidelines, only registered real estate investment management companies (REIMC) will be allowed to manage the schemes of a real estate investment trust. The trust can be a scheduled commercial bank or its subsidiary trust, a public financial institution, an insurance company or a corporate body.

All schemes launched should have a rating, and there will be an evaluation by an appraising agency. Most of a REIT’s investments will have to be in income-generating real estate, though up to 20 per cent of the NAV of the scheme can be used to acquire incomplete units in a building, which is unoccupied and non-income producing.

To ensure a diversified portfolio, Sebi has proposed that no REIT under any of its schemes will have more than 15 per cent of its corpus invested a single real estate project, or more than 25 per cent invested in the projects of a single real estate group. Also the units of every scheme must be listed within six weeks of the date of closure. Every scheme will have an independent property valuer who will value the real estate. The schemes will have to declare at least 90 per cent of net annual income as dividends. Also, any capital gains on disposal of real estate will form part of the net income for distribution to unit holders.

Issues in Indian REITs

The country’s property sector is still developing and has several weak areas. However, “the Indian real estate market is not totally disorganised and opaque”, pointed out Kurien. “There are fragments that are transparent and follow standards. Fund houses will have to deal with only those properties and developers that are transparent and follow standards.”

So, in future, if developers want to attract funds from REITs, they will have to improve their transparency levels and accounting procedures. Thus, REITs are expected to provide the impetus for greater transparency in the sector.

Another issue before REITs will be that there aren’t too many ready, investment-grade projects around. According to CB Richard Ellis managing director Anshuman Magazine, “There are limited income-generating developments in the residential space. In the commercial space, too, there are very limited options where the complete development is owned by one person.” But in a year or two, he added, there should be sufficient properties available to be bought as FII money is coming in. REITs will allow developers the much-needed exit option for the buildings they develop, he noted.

Benefits and risks

The biggest advantage of REITs is that one now doesn’t need several lakh or crore rupees to invest in real estate. A sum as small as Rs 5,000 or Rs 10,000 will enable an investor to buy a stake in a commercial property, which will then generate a constant stream of revenue for him. Usually, since commercial buildings are rented for a minimum of three years and inflation is factored in at the time of lease renewal, an investment in a REIT provides the investor a steady, inflation-protected return.

However, REITs have some risks as well, the biggest being the risk of a slowdown in the real estate market, and of the property not being fully leased out.

Returns expectation

Since the investor’s income stream will depend on the rental income that the REIT earns, the yield generated in the real estate market will form the basis of his return. Magazine stated, “Currently the commercial yield is between 9 and11 per cent on an average and in case of the residential segment, it is between 4 and 6 per cent.” So the mix of residential and commercial developments that REIT holds will also determine the investor’s yield.

Finally, for investors who have watched the current real estate boom from the sidelines because they lacked the capital to participate in it, this new year brings a chance for them to join the party.

REITs snapshot

• Sebi issues first guideline;final guidelines expected by January-end.

• First REIT fund likely to debut by Feb-March

• Structure different from that of international REITs

• Limited developments available that can be bought up by REITs

• REITs provide small-ticket investors a chance to hold a stake in high-value commercial property

• Yield on commercial real estate currently 9-11%