Securities and Exchange Commission of India (SEBI) recently released Draft-Guidelines on Real Estate Investment Trust (REITs). In a recent significant move, the Reserve Bank of India (RBI) have cleared the decks favouring changes in the Foreign Exchange Management Act (FEMA) and Foreign Direct Investment rules, as sought by SEBI. Further SEBI has asked for ‘pass through’ status approval from Income Tax department and is awaiting the approval from Ministry of Finance.
Key provisions of the Draft-Regulations :
• REITs shall be set up as a trust and shall not launch any schemes and should have a minimum asset size of INR10,000 million (INR1,000 crore) for offering the units to the public.
• REITs should come out with an initial offer within 18 months of registration with SEBI and it would be mandatory to list all units of REITs after the initial offer.
• The Initial Offer size should be of INR2,500 million (INR250 crore) and the minimum public float should be 25 per cent of the value of the REITs.
• The Sponsor should hold at least 25 per cent of the total units of the REITs prior to the initial offer, and a minimum holding of 25 per cent of the Sponsor will be locked in for three years from the date of listing and the balance holding will be locked in for one year. Further, the Sponsor should hold at least 15 per cent of the outstanding units of the REITs at all times (which can be transferred, subject to specified conditions).
• The Manager should have minimum net worth of INR50 million (INR5 crore) and should have at least five years of specified relevant experience.
• REITs may raise funds from any investor, whether resident or foreign (subject to guidelines specified by the RBI and the Government). However, initially, till the market develops, it is proposed that the units of the REITs may be offered only to HNIs/ institutions and therefore, it is proposed that the minimum subscription size shall be INR2 lakh per investor and the unit size shall be INR ONE lakh.
• Investment by an REIT shall only be in properties or securities in India :
1. At least 90 per cent of the value of REITs assets shall be in completed (i.e. occupancy certificate received) and rent generating properties (i.e. 75 percent rented/leased out).
2. Balance can be invested in the specified assets [like developmental properties, listed or unlisted debt, mortgage backed securities (MBS), equity shares of real estate companies, government securities or money market instruments, etc., subject to specified conditions].
• REITs will not be permitted to invest in vacant land or agricultural land or mortgages (other than MBS).
• REITs are permitted to invest in properties through Special Purpose Vehicles (SPV), if SPV holds at least 90 per cent of their assets directly in specified real estate properties and REIT has control over the SPV.
• REITs are permitted to invest the entire corpus in one project but a REITs cannot undertake investment in other REITs.
• At least 75 percent of the revenues of REITs (other than gains arising from disposal of properties) shall be from rental, leasing and letting real estate assets at all times.
• In case of co-investment with any person, few conditions are specified which, inter-alia, includes that investment by other person shall not be at terms more favourable than those of REITs.
• At least 90 per cent of net distributable income after tax of the REITs should be distributed to the unit holders.
• Aggregate consolidated borrowings and deferred payments of the REITs have been capped at 50 per cent of the value of the REITs assets and where the same exceeds 25 per cent of the REITs assets, credit rating from SEBI registered credit rating agency and approval of unit holders would be required.
• Full valuation, including physical inspection of the properties, should be carried out at least once a year (with every six monthly up-dation in the valuation).
• For any purchase of a new property or sale of an existing property, full valuation should be undertaken, and the transaction shall not be less than 90 per cent/or not more than 110 per cent of the assessed value of the property for sale/purchase of assets respectively.
• All unit holders of the REITs shall enjoy equal voting rights.
• Stringent conditions have been imposed on related party transactions including detailed disclosures, valuation requirements and investor approval.
• Voluntary winding up as well as mandatory winding up in certain circumstances like public float going below the minimum the threshold of 25 percent have been prescribed.
KPMG in India, point-of-view over Draft Guidelines on REITs :
There is no denying that the introduction of REITs would help the real estate sector in India significantly. There has been considerable development of real estate, especially in Tier-1 cities, in the form of quality office spaces and shopping malls with long-term lease arrangements. The introduction of REITs would provide huge potential to monetize such assets and also help retail investors participate in such long-term income-yielding assets. The concept as a whole would be a win-win situation for both investors and developers and it would also address, to a large extent, the liquidity crisis in the sector.
As discussed, residential assets are self-liquidating, so there is no capital locked in such development projects for a long duration. However, huge capital is locked in leased assets and REIT would help monetise such capital values, which can then be used for further development. If the REIT regulations are enacted as proposed — and are regularly monitored to uphold investors’ confidence — they can go a long way toward addressing the liquidity crisis in the sector.
The concept of REIT would not only help developers in the commercial property space, but can change the overall dynamics of allied sectors like hospitals, hotels, schools and old age homes, as they would help build an asset class that can be used for operations by these allied sectors, which currently faces challenges due to capital commitments involved in developing and operating such assets.
Thus, REIT is essential for India, which is witnessing significant development of large tracts of leased assets. However, it is important that adequate regulations are kept in place to ensure adequate valuation, restrict speculations and maintain investors’ confidence.
Key aspects to be considered :
It is important to properly implement regulations to ensure smooth transition of assets by the developer community to REITs. Consequently, based on our review of the draft regulations, following aspects require clarity:
Operational Aspects of REIT’s :
• Current regulations require a REIT to have an asset base of INR10,000 million (INR1,000 crore) before it is listed. The said amount is a big commitment given that the REIT is a new concept in India and there may be associated risks involved in its acceptability when offered to the public. Accordingly, REITs shall be allowed to go for IPOs based on with a lower threshold and a commitment from the Sponsor to increase the total assets size of the fund to INR10,000 million (INR1,000 crore) within the prescribed time line].
• REITs are allowed to invest only in securities or properties in India. The term “Securities” is defined under section 2(h) of Securities Contracts (Regulation) Act, 1956 [‘SCRA’] which mean marketable securities. Partnership interests and shares of a private limited company do not get covered under definition of securities under section 2(h) of SCRA. REIT should also be allowed to invest in partnership interest and shares of a private limited company.
• REITS can make investment/s through SPVs which are defined to mean only body corporate as defined under the Companies Act, 2013. Considering that many of the real estate projects would be housed in Limited Liability Partnerships (LLP), REIT should also be allowed to invest in a LLP/s.
• Only 10 per cent of value of REIT assets is allowed to be invested in residual category which includes under developed property which shall be held by REIT for at least three years after completion and is required to be leased out. Under 10 per cent residual category, TDRs/FSI/Vacant Land forming part of overall property and un-leased building should also be allowed which are acquired for future development purpose.
• The Sponsor is required to have at least five years of experience in the real estate industry on an individual basis. This requirement needs to be removed considering that REIT model could be explored by logistics park owners, hospitality sector, healthcare sector, etc.
• Definition of Manager means a company as defined under the Companies Act 2013 which manages assets and investments of REIT. Since the LLP structure is prevalent and more popular, allowing LLP to be appointed as Manager will immensely benefit the Managers to organise their affairs in a more tax efficient manner.
• Failure to maintain minimum public float below 25 per cent mandates a trustee to apply for delisting of REIT. There is no cure period provided within which the Sponsor could divest its shareholding to bring up the minimum public shareholding. Cure period of say one year should be provided for.
Amendment required in Income-tax, FEMA and Stamp Duty Law :
• Current regulations allow a REIT to invest in SPVs subject to the latters’ meeting the specified criteria. However, if a REIT invests through a SPV, the same may result in double taxation, first in the hands of the SPV and then again there would be additional tax when such funds are repatriated by the SPV. Accordingly, it may be desirable to bring taxation under both the models, i.e. where a REIT directly holds a property vis-à-vis where the REIT holds the property through a SPV, at par, by allowing a complete pass through for tax purposes where the REIT invests through a SPV.
• Current FEMA regulations would need to be adequately amended to allow simpler investment route for foreign investors investing in REIT. As per recent article, the RBI is set to give a nod to SEBI’s proposal favouring changes in FEMA and Foreign Direct Investment rules.
• Given that a REIT is required to invest at least 90 per cent of the corpus into completed and rent-generating property, setting up of REIT may entail transfer of immovable property either to the REIT or its SPVs to meet specified conditions. Current regulations would entail stamp duty and capital gain tax on such transfer. Thus, it may be prudent to exempt specific stamp duty and capital gain tax for immovable property transferred to REIT to make it more competitive.
• Current laws provide tax exemption on the sale of listed equity shares (in case it is long term). Thus, it may be advisable to introduce provisions to bring listed units of REIT on par with listed equity shares.