PropTiger Simplifies REITs For You

India is likely to soon see its first Real Estate Investment Trusts (REITs) . Finance Ministry said today that it expects REITs to start functioning in India very soon. In the previous budget, the Union Finance Minister Arun Jaitley had eased the norms on long-term capital gains tax. The government had also eased norms on minimum alternate tax (MAT) . Foreign Exchange Management Act (FEMA) regulations were relaxed too, enabling foreign investment in rent-yielding real estate properties. Before the FEMA regulations were revised, foreign investment was allowed only in completed office and real estate assets. SEBI had earlier recommended abolishing capital gain tax on REITs and doing away with Minimum Alternate Tax (MAT) for the sponsors of REITS and investors.

What are REITs?

Real Estate Investment Trusts (REITs)  are entities that own and, in many cases, manage income-producing real estate assets. REITs invest in real estate assets either directly, or through investing in property mortgages. In countries in which REITs exist, REIT securities are traded on major stock exchanges. 

REITs are very similar to mutual funds. REITs generally invest in residential projects, hospitals, shopping malls and such real estate assets. In the United States,  REITs have performed better than most other investment vehicles in providing high returns to investors. 

If REITs are formed in India, they will comprise of shares of Special Purpose Vehicles (SPVs) . The SPVs will have to pay corporate tax and dividend distribution tax. They will also have to pay capital gains while selling their REIT units in the stock market in the future. If the SPVs raise funds through the equity market, they will have to pay Securities Transaction Tax but they are exempted from paying capital gains tax. Hence, with the current taxation norms, it will be easier for SPVs to raise funds from the equity market than through the REITs. 

DLF claims that they will float India's first REIT. With REITs, the construction industry is likely to see greater investment. Why are REITs important?

Professional Management: REITs are a good deal for real estate investors because they will have professional managers investing their money in assets after due diligence. They will also be able to invest in real estate projects with less money. The REITs will invest largely in income-generating real estate assets. This will lower real estate prices by channeling funds to more competent and efficient developers. By investing in REITs, investors would be able to gain from the expertise of professional managers who are more aware of currency exchange ratios, and are more experienced in handling foreign partners and regulations and tax norms in different countries.

Diversification: Real estate is an asset class in which it is difficult to diversify your investments. There is less transparency in real estate transactions. REITs will change this. Few Indians are wealthy enough to buy properties across the world or even the country to benefit from diversification. As the government wants to global investors to invest in Indian REITs, real estate investments of Indian investors would become more securitized and liquid. 

Low Ticket Size:As of now, the price of one unit of proposed REIT is Rs 1 lakh and the minimum subscription amount is Rs 2 lakh. Even though this is high, it would still allow many small investors to invest in real estate in India. When people can participate in the real estate markets at a lower cost, the construction industry is likely to see greater investment. Economists think that the government should lower the ticket size further and that REITs should ideally hold real estate assets directly. 

Efficiency and Easier Exit Options:With more professionally managed REITs, it would be easier to ensure that the real estate developers in India finish and deliver their projects on time. The REITs will also offer the investors easier exit options. 

Transparency:The more scrupulous standards of REITs might convince many global investors to invest in the real estate markets in India, which has for long remained an opaque sector. Foreign investment in REITs will enhance the supply and quality of real estate projects and lower property prices in India.