What Foreign Investments In REITs Mean

The government has recently changed policies to allow real estate investment trusts (REITs) to exist and function in India. However, experts have pointed out that foreign investors still do not have much incentive to form REITs in the country. The major barriers mentioned were capital gains tax, minimum alternate tax (MAT) and dividend distribution tax and Foreign Exchange Management Act (FEMA) regulations. The government has already eased the norms on long-term capital gains tax and MAT.

The Union Cabinet eased the FEMA provisions on May 7, 2015, to allow more foreign investment in REITs. Some provisions in the current FEMA do not enable foreign investment in completed rent-yielding real estate projects in India. Earlier, foreign investment was allowed only in completed office and retail assets. This is expected attract investments of up to $20 billion in real estate in India in a short period. Let us find out what would this mean:

1. The countries where REITs have flourished, the large REITs that invest in industrial property often allocate a substantial part of their capital in foreign countries to benefit from international trade and to modernize and consolidate distribution facilities. REITs in India would benefit from global investors channeling their capital and expertise into them.
    
2. The appeal of the REITs is that real estate investors could hold more diversified portfolios. If diversifying your assets is important, it would be equally important that global investors are allowed to invest in Indian REITs. The real estate sector in India would become more securitized through REIT equities.
    
3. Investing in real estate abroad is a risky endeavor because of currency exchange ratios, interactions with partners, regulations and tax norms that foreign investors are not familiar with. They would be able to profit from investing in property in India only if they can leverage their expertise and the tenant-land lord relationship. This is especially true in India, where regulations and tax norms are more stringent. The government still has not eliminated the dividend distribution tax.
    
4. Real estate assets perform very differently in different countries. In India, for instance, the appreciation of real estate assets is very high, but they are not stable. The rental yield from real estate assets in India is not very high, while the rental yield from the real estate assets in the US is very high. So, investing in India would be a good deal for foreign investors only if the benefits outweigh the costs. Capital appreciation in India is not very high when adjusted for inflation. Dividend yield would be lower because of dividend distribution tax. The risk profile of Indian real estate assets is high. So, it is not clear whether investing in India would provide diversification benefits.

Read our pre-budget analysis on how the Narendra Modi government has liberalized FDI in the real estate sector.