After a seven-year wait, the Securities and Exchange Board of India (SEBI) finally approved the creation of REITs over the summer.
Incentivized by an advantageous tax structure and high annual dividends – early projections are 7 percent to 9 percent – it is hoped Indian REITs will encourage retail and institutional investors alike to place more of their wealth into property.
It has been a long haul, however. The government’s initial effort to establish a regime unfortunately stalled in 2007, partly because of the global financial crisis and partly because the tax structure could not be agreed. Seven years on, and with the business-friendly Narendra Modi elected as prime minister in May, their introduction has seemed surprisingly straightforward.
Similar in nature to mutual funds, these security vehicles have been devised to attract money from investors keen on exposure to income-generating real estate such as leased-up offices and shopping malls. According to the published guidelines, the Indian REITs can be invested only in commercial real estate, not residential, and the units will be listed on an exchange. In addition, in order to maintain transparency they will acquire real estate through a special purpose vehicle (SPV) that must hold a controlling interest of at least 50 percent.
REITs in general have received a cautious welcome. Under government rules, foreign direct investment has been restricted to under-construction assets except in special economic zones. By buying shares in REITs, however, foreign investors will be able to acquire completed and tenanted real estate – forgoing the risks inherent with development.
Another advantage is private equity fund managers can use them as an alternative exit route. While those invested in residential developments oftentimes sell direct to end-users, exiting commercial assets have historically been an altogether trickier sell, as Sachin Shah explained.
Shah, who is the founder and managing principal of Mumbai-based private equity real estate firm Samsara Capital, said: “[Till now] retail assets really did not have an exit apart from a sale to a third party or a listing abroad.”
While India has plenty of development, there is ample finished stock to be placed in REITs. Property broker Cushman & Wakefield lists seven Indian cities among the top fifteen in Asia in terms of net absorption of office space, thereby highlighting the potential.
Further, there is now around 376 million square feet of Grade A office space, of which 50 percent is expected to be listed in the next two to three years, according to Jones Lang LaSalle.
Yet Sachin Doshi, head of non-listed real estate in Asia at Dutch pension manager APG, said it was right for portfolios that could be monetized through a REIT to start small. “In India, the market is still a little immature when it comes to REITs. It is okay if it starts a little smaller as long as the asset quality is right,” he added.
Despite the focus on income generation, the SEBI noted REITs in India will have a 20 percent allocation to under-construction projects in keeping with the ongoing swathes of development happening in the country. That is expected to mean a little volatility for traders, however, which could be compounded by a further 20 percent allocation to real estate stocks.
APG’s Doshi saw those elements as challenges for the industry. He also said he preferred greater clarity on their tax implications. “One of the benefits of REITs globally is an efficient tax structure, as long as the vehicle is distributing more than 90 percent of what it can. Not having that, and having multiple layers of taxes yet still paying dividend distribution tax makes it unclear as to how the economics of REITs could work,” he said.
Samsara’s Shah has further fears: SEBI has also reduced the minimum asset pool requirement for listing a REIT from INR10 billion to INR5 billion (€61.2 million; $81.74million), which Shah says might lead to “a rush of smaller developers listing very small assets.”
New investors could also face supply-side challenges. Khushru Jijina, managing director of manager Piramal Fund Management, pointed out: “There are more late-stage or last mile construction assets available in the market today than there are fully completed or leased assets that have not already been traded or spoken for,” he pointed out.
“Wait and see,” said Ravi Hansoty, managing partner at advisory firm Cedar Figs Capital Partners, who believed small investors could pile into the market while institutions initially tread more cautiously. “If you plug issues of transparency, lack of liquidity from banks and high interest rates into the model, I am not sure how rapidly the REITs market would explode.”