History of Investments in REIT: A New Avenue for retail investors in India

REIT stands for “Real Estate Investment Trust”. These trusts were originally devised in the United States in 1960 under the Cigar Excise Tax Extension Act. The first REIT was listed on the New York Stock Exchange in 1965. REIT approach has flourished and served as the model for around 40 countries around the world. REITs help build local communities through new development.
In the coming decades, similar instruments debuted on European, Japanese, and Australian stock exchanges. In India, the Real Estate Investment Trusts were introduced by the Securities and Exchange Board of India (SEBI) in 2007. The original draft regulations released by SEBI were later withdrawn due to certain limitations. In September 2013, SEBI came out with revised draft REIT regulations that were approved on September 26, 2014. As the investment vehicle started gaining popularity, there were many regulations announced to facilitate the smooth operations of these investment funds.

 As per existing regulations in India REITs need to have an asset base of Rs 500 crore to start a REIT. Stock market listing of REIT is mandatory. SEBI mandates REITs to invest at least 80% of their investable assets in developed and income-generating properties. Further, they need to distribute 90% of their income to investors in the form of dividends and the remaining 10% for reinvestments in their projects. They must declare NAV twice in every financial year. SM – REIT:

SM-REIT

New amendments to SEBI (Real Estate Investment Trusts) Regulations, 2014 being approved to create a regulatory framework for the facilitation of SM REITs, with an asset value of at least Rs 50 crore vis-à-vis minimum asset value of Rs 500 crore for existing REITs. SM REITs shall have the ability to create separate scheme(s) for owning real estate assets through special purpose vehicle(s) constituted as companies.

Fractional ownership:

During the last few years, fractional ownership has gained traction in India. In fractional ownership, investors pool their money to buy a property, and the cost of an asset is split between them. There was no scope for the SEBI to regulate them as there were no guidelines in place from the regulator to oversee this space. The proposed guidelines by SEBI are proposing to enact new guidelines for this sector that would instill investor faith, and formalising the difficulty of Special Purpose Vehicle (SPV) securities issuances. The proposed regulation is anticipated to contribute to the growth and acceptance of this innovative form of property ownership.

Structure of REITs:

Sponsor: The sponsor is the persons who form the REIT and registered with the stock market regulator Securities and Exchange Board of India (SEBI). Under registration, they transfer the property owned by them to Real Estate Investment Trust (REIT). Generally, a builder or developer desirous of raising funds through REIT plays the role of a sponsor.

Trustee: The trustee is a person appointed by the sponsor, who holds the assets on behalf of the unit holders. REIT Trustees are typically companies that specialize in providing Trusteeship services. For example, Axis Trustee Services Limited operates as the trustee for both Embassy Parks REIT and Brookfield REIT. The Trustee is responsible for holding the assets of the REIT in a Trusteeship for the benefit of unit holders. Additionally, they are required to oversee the activity of the manager of SPV and ensure the timely distribution of dividends.

Manager: The trustee appoints a manager who manages the REIT assets and is responsible for making investment decisions. The manager is typically a private company closely held by the sponsor.

Investors (Unitholders): Subscribers to the units of the REIT. To invest in REITs, one needs to have a demat account. REITs are listed on the stock exchange and investors can invest in the units of REITs in the same way as one purchases shares on the exchange. It allows investors to buy ownership in real estate property in the form of equity that offers them better liquidity than the physical real estate investment.

Independent valuer: Apart from the sponsor, manager, and trustee, a REIT appoints a credible independent valuer who values the REIT’s assets at periodic intervals.

Also, auditors, registrar and transfer agents, merchant bankers, and custodians may be appointed by the manager, to carry out activities incidental to the operation of REITs and additionally, meet the requirements of law.

Upon registration with SEBI, REITs make an initial public offer or an IPO of its units within three years and get its units listed on the stock exchange. Thus, as an alternative to borrowings, real estate developers can effectively use a REIT structure to raise capital from the market and bring much-needed liquidity to their operations.

Taxation:

Dividend income is exempt in the hands of unit holders, in most cases. However, if the SPV opted for a lower tax regime, dividends along with interest/rental income are taxed at the slab rates applicable to an investor.

 In the budget 2023-24 it was proposed loan repayment’ component of the distributed income from trusts has to be taxed as part of ‘the income from other sources’ of unit holders that attracts tax at slab rates of an individual. However, the government paid heed to the industry’s plea as it modified the Budget proposal in the Finance Bill 2023. The amended tax rules indicate that the amount received as ‘loan repayment’ must be reduced from the cost of acquisition at the time of sale of the unit by the investor. This amendment brought relief to investors as well as industry players as capital gains attract just 10% tax if held for the long term (36 months). This is against the tax on ‘other income’ that is at individual’s slab rates, which can go to as high as 42% (including surcharge and cess) for those in the higher tax bracket. The amended stance substantially reduces the tax incidence, as a capital gains tax at the point of sale rather than a marginal tax rate on receipt of payment. This new amendment increases the relative attractiveness of REITs / InvITs as the major taxation overhang is removed. However, the proceeds will be taxed at slab rates and not as capital gains (10% on long-term gains and 15% on short-term gains).

Different types of REITs:

There are different types of REITs. The types of REITs are divided based on how the shares are distributed –

Equity REITs:

Equity REITS operates and manages real estate properties that are profit-generating. The main source of income for Equity REITs is rent generation from real estate and not waiting for capital appreciation and reselling.

Mortgage REITs:

Mortgage REITs, or mREITs, are investments in purchased or originated mortgages and mortgage-backed securities (MBS) that earn income from the interest paid on those assets. The main source of income for mortgage REITs is the difference between the interest they pay to investors and the rent they earn. This type of REIT real estate is highly sensitive to interest rate changes.

Hybrid REITs:

 A hybrid REIT is a real estate investment trust that is effectively a combination of equity REITs, which own properties, and mortgage REITs, which invest in mortgage loans or mortgage-backed securities. Hybrid REITs diversify their income sources, balancing the direct real estate investment risks with the financial leverage of mortgage investments.

Publicly Traded REITs:

Publicly traded REITs are listed on the National Stock Exchange (NSE) and are also registered with the Securities and Exchange Board of India (SEBI). You can buy and sell these REITs’ shares through the stock exchange, making them a highly liquid investment.

Public Non-Traded REITs: These are the same as Publicly Traded REITs but are not listed on any stock exchange. They are also registered with SEBI, but you cannot buy or sell these REITs online. Therefore, these shares are less liquid and are more stable. This is more stable because these shares are not affected by share market fluctuations.

Advantages:

The investors in REITs have many advantages. REITs maintain high-value portfolios through real estate properties and mortgages. Their major operation is leasing properties and dividing the collected rent among the shareholders. The investors benefit as their capital boosts gradually without actually buying or maintaining the property.

REIT is Suitable for small investors. It eliminates direct dealing with builders.    REITs are regulated by SEBI which reduces chances of fraud.

As per the SEBI guidelines, REITs must be listed on the stock exchange. To qualify as a REIT, at least 80% of investments must be in income-generating commercial properties and NOT residential ones. Further, they need to distribute 90% of their income to investors in the form of dividends.

If the REIT decides to sell a property, then it can choose to reinvest the sale proceeds into another property or distribute 90% to stakeholders. The investors also benefitted as their capital boosted gradually without actually buying or maintaining the property. Hence, the investors earn a regular income stream along with reduced portfolio volatility and dividends and wealth accumulation. As a result of it being a listed entity, it is bought and sold with ease providing great liquidity. It is a natural hedge against inflation as returns have been seen to consistently outpace Consumer Price Inflation.

Disadvantage:

Limited Options: Currently, there are only 3 REITs and 1 International REIT Fund in India. This significantly limits the choices for investors.

Low Liquidity: While REITs are listed and traded on Stock Markets, the number of market participants is currently low especially concerning retail investors. As a result, selling REIT investments profitably might be a challenge, especially in an emergency. This results in low liquidity of the investment.

Market Risks: Investing in REITs is vulnerable to the real estate market which has tendencies of fluctuations during deflation. Market volatility can impact its returns.

Rate of Capital Growth: The rate of capital appreciation is very low in REIT real estate. This is because 90% of their earnings are divided among the shareholders and they get only 10% to reinvest.

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