In a major step to fuel the growth of the country’s real estate sector, SEBI recently released a consultation paper together with the draft Real Estate Investment Trust 2013 (REIT) regulations. Issued after discussions with stakeholders, the draft regulations have been widely seen as robust and along the lines of regulations in other countries. It is critical that the initial REITs prove successful for investors so that they can become a stable platform for providing developers exits from commercial projects and replenishing equity for new projects. This would also offer investors a relatively lower-risk opportunity and access to commercial real estate without need for large outlays.
To protect investor interests and make REIT returns less risky and more predictable, SEBI has been cautious on some of the requirements. The regulator might subsequently relax some of the regulations based on the initial REITs’ experience.
The indicative requirements include holding 90 per cent of the REIT assets in the completed revenue generating properties, no investments in vacant or agricultural land, leverage capped at 50 per cent with credit rating, majority consent for leverage above 25 per cent, minimum unit size of Rs 1 lakh, specific provisions for related-party transactions and prescribed majority consent for identified matters.
The current regulations, however, seem to facilitate only large developer-sponsored REITs, with the sponsor holding 25 per cent stake. The prescribed minimum asset size of Rs 1,000 crore translates to a sponsor holding of Rs 250 crore (lower with leverage). This would effectively mean that professional fund managers, including reputed ones, cannot sponsor the REIT owing to the significant amount involved.
The Alternate Investment Fund (AIF) regulations OR the mutual fund regulations, for example, do not require such large investment by fund sponsors/ managers. Unless the issue is suitably addressed, there may only be a handful of REITs ; and several medium-scale developers may not get an exit for their commercial properties, including Grade A properties and those with quality tenants. The desired benefits may, therefore, not be widely available to the real estate industry.
Another important aspect is the participation of foreign investors in REITs. The guidelines permit both domestic and foreign investors, subject to exchange control regulations.
Under the current exchange control framework, the participation of non-residents in REIT could be broadly characterised as :
- Investment in the real estate space;
- Investment in a Trust;
- Investment in listed securities.
However, there are limitations to each of them. Investment by non-residents in real estate is generally restricted and subject to prescribed conditions. Also, investment by non-residents in a Trust requires approval from the Foreign Investment Promotion Board, whereas investment through listed securities is open only to some.
The RBI needs to liberalise current regulations to specifically allow REIT investments by non-residents, including NRIs. This would facilitate the creation of India-specific asset REITs in India, rather than abroad as happens currently.
However, SEBI’s efforts to facilitate REITs in India may not be fruitful without the necessary amendments in income tax regulations. Currently, up-streaming income from special purpose vehicles (SPVs) — which are incorporated companies — to the REIT through dividends would first attract corporate tax at the SPV level and then dividend distribution tax. Together they constitute an effective tax rate of almost 44 per cent of the SPV income. Given the yield investment nature of REITs, where every basis point matters, this tax rate may make the REIT un-viable.
To illustrate, a Singapore-based REIT investing in Indian companies with ready commercial assets can, in certain cases, repatriate income at an effective tax rate of 15 per cent in India, under the India-Singapore tax treaty. The parity should be provided for both domestic and foreign investors. Singapore, for example, offers complete tax exemptions to REITs that satisfy certain conditions such as distributing 90 per cent of the income.
With certain modifications in the supporting laws, the REIT regime can go a long way in stabilising the Indian real estate sector while, at the same time, providing the much-needed ability to invest in quality commercial assets for reasonable returns at lower risk.