Update: With Favourable Tax Norms, REITs Will Flourish

Update as on September 19, 2016: American multinational and the world's largest private equity manager, Blackstone Group, which has a large exposure to commercial properties in India, is said to be working on a plan to raise Rs 4,000 crore by listing a Real Estate Investment Trust (REIT) on Indian stock exchanges. According to media reports, this could well be India's first REIT listing, and it might pave the way for global investors to invest big in the country's commercial assets.

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Update as of July 2016: With Indian real estate developers not too keen on forming Real Estate Investment Trusts (REITs), Securities and Exchange Board of India (SEBI) has proposed more favourable norms for related-party transactions. SEBI recently proposed:

• REITs will be allowed to invest up to 20 per cent in under-construction properties. At present, REITs are allowed to invest a maximum of 10 per cent in under-construction properties
• SEBI also proposed making norms governing investing in Special-Purpose Vehicles (SPVs) more favorable
• Norms that insist that REITs should comply with minimum public holdings will be relaxed, too

After seeking public comments, SEBI will finalise the norms on August 7.

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Real Estate Investment Trust (REIT) has proved to be successful investment vehicle in countries like the United States and Singapore.

Wealthy Indians invest in real estate assets more than in any other asset class. The reason partly is that real estate is seen as a secure asset class to invest in. But it is almost impossible to have a diversified portfolio if you are an Indian investor who invests in real estate assets. The reason is that real estate assets are highly expensive, especially in India, when compared with income levels. The transaction cost involved in buying and selling real estate assets is high. The industry, one of the least structured among all segments, is still on its way to becoming a transparent one.

More importantly, few Indians are wealthy enough to track, invest in, own and transact in properties across the world, or even across India. But diversification is important, when you invest in an asset class. Real estate investment trusts (REITs) are likely to transform the Indian real estate industry by allowing greater securitisation. Just as owning shares of a company allows you to have a stake in a corporation, REITs allow you to have a stake in skyscrapers, hotels, residential buildings and other real estate assets. For investors, this is a great deal because they can not only own diversified assets, they can also liquidate their assets easily. They will also be able to benefit from a fairly predictable stream of cash flows.

India is yet to have a REIT because the regulatory framework does not allow the easy formation of a REIT. DLF, however, had recently said that they will float India's first REIT. This is because the government had recently made the regulatory framework favourable to REITs by easing norms on long-term capital gains tax, and on minimum alternate tax. The Narendra Modi government also allowed foreign investment in rent-yielding assets, which makes the functioning of proposed REIT's easier.  This is important, because a recent study by one of the leading real estate advisor and industrial chamber PHD Chambers of Commerce and Industry (PHDCCI) estimates that REITs may earn $ 8 billion in rents by 2019. PHDCCI suggests REITs should become exempted from stamp duty, distribution of dividends, and taxation of rents and transfer of assets.

Why are these measures important?

Stamp duty is a major reason why real estate transactions in India are not transparent. In developed countries, property tax is much higher than in Indian cities while stamp duty is much lower. This has led to more efficient functioning of the real estate sector without affecting the provision of civic infrastructure and other functions municipal corporations engage in. As the transaction of securitised real estate assets need greater transparency, lowering stamp duty seems one of the most important conditions necessary for REITs to flourish.

Investors find that the return from investing in REITs is greater in the United States (US) because

• REITs are expected to distribute 90 per cent of the profits in the form of dividends.
• REITs are also not taxed on the corporate level, though investors have to pay taxes on the dividends.

This prevents double taxation of profits. Such norms offer greater incentives for real estate companies to “REITize”, as it is called, by declaring themselves as an REIT. This also allows the government to instill better practices. The point is not that REITs should be expected to distribute 90 per cent of the revenues in the form of dividends, as they do in the US. India could allow such decisions to be guided by profit/loss calculations. India might learn from the best practices in countries where REITs are successful, allowing even Indian investors with limited means to invest in India's most preferred asset class.

Also read:

How Sebi's Move On InvITs Will Help Unlock Realty Potential

All You Need To Know About REITs

Why Are Developers Not Yet Willing To Form REITs?