FICCI Note - Development of Real Estate Investment Trusts in India


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FICCI Note - Development of Real Estate Investment Trusts in India

  1. 1. 1 Development of Real Estate Investment Trusts in India India’s Real Estate Sector India’s real estate sector has traditionally been unorganized and fragmented, which has resulted in it being perceived and identified as lacking transparency with weak systems, processes and favoring the developers rather than the buyers. Nevertheless, the real estate sector has grown exponentially in the last decade to close to US$ 57 billion from US$ 12 billion in 2005i due to healthy economic growth, an emerging middle class driving demand through increased consumerism and higher disposal income. These factors will continue to drive the growth of the real estate sector and it is estimated that the market will increase to US$ 105 billion in 2015-16ii . Foreign capital has also become attracted to the India real estate sector and at the same time expects transparent and liquid ways to invest in the market. During the financial year 2011, foreign venture capital investment in real estate was US$ 600 million, an increase of more than two times from US$ 250 million in financial year 2007iii . Even the government is working towards establishing a Real Estate Regulatory Authority. The government has released a draft real estate regulations bill, 2011 which primarily seeks to increase transparency, increase accountability of the builder and provide a redressal mechanism for the buyers particularly individual home buyers. The real estate sector has evolved well with developers focusing considerably on project planning, size, technology, output quality and financial management. Even access to organized financing has increased through primary and secondary markets, financial institutions, and alternative financing routes such as private equity. REIT is one such form of secondary market financing which has been successful globally but is non-existent in India. Introduction to REITs REITs are a common pool of funds raised from institutional, high net worth and retail investors, which acquire regular income-generating commercial real estate. The structure allows investors to participate in ownership, management and development of real estate assets. REITs act as a tax efficient tool as tax is payable either by the trust or by the investors for the income received thereby avoiding double taxation. The structure of a REIT is similar to that of a mutual fund with the existence of a Trustee, Asset Management Company (REIT Manager), Assets (Properties), Property Manager and Unitholders. Sponsor and Lenders may or may not exist.
  2. 2. 2 A Typical REIT Structure Benefits of REITs REITs are essentially income stocks which invest in mature income producing commercial properties with requirements of distributing major share of the income to its unit holders. 1. Income distribution – Distribution of at least 90% of its distributable profits to the unit holders making a regular income yielding asset for investors 2. Alternative asset for investors – Exposure for retail investors to real estate with low capital requirements 3. Liquidity – If a REIT is listed it will result in the creation of healthy secondary market and increase liquidity 4. Professional asset management – The structure of a REIT results in increased accountability due to professional asset managers and disclosure obligations on the part of the developer 5. Alternative financing for developers – Provides an alternative route for equity financing for developers and provides an opportunity to reduce leverage 6. Ownership of immovable property – By investing and owning immovable property default risk is partially reduced 7. Restricted from entering into development – Most countries do not permit REITs to get into development of land, which is riskier when compared to constructed property REIT Lenders Unit Holders Sponsor TrusteeREIT Manager Debt Principal and Interest Tax exempt distributions Units Units Tax exempt distributions Fees Asset Management Fees Trustee Services Properties Ownership Net Property Income Property Mgr Sub- Contract Property Management Services
  3. 3. 3 Real Estate Funds in India At present in India, investors (high net worth, institutional) have the ability to invest in private equity real estate funds. Private equity real estate funds are regulated and are to be registered with SEBI. A drawback of this route of investment is that the minimum investment in such funds is INR 5 lakh resulting in retail investors being unable to participate. To add to further woes of the retail investors, such funds will now be regulated under the new Alternative Investment Fund (AIF) regulations, which mandate a minimum investment of INR 1 crore from each investor in a private equity real estate fund. Currently, there are 21 SEBI registered private equity funds with Kotak Mahindra Realty Fund, HDFC Property Fund, INDIAREIT Fund, CIG Realty Fund, Red Fort India Realty Fund being the large funds. ASK Property Investment Advisors has recently raised an INR 1,000 crore Real Estate Fund; however, this fund is an offshore fund which is registered in Singapore. Private Equity Investments in Real Estate Source: Venture Intelligence Real Estate Mutual Fund Schemes SEBI introduced guidelines for Real Estate Mutual Fund Schemes (REMFs) in April 2008, however, no REMFs has been launched till date due to lack of clarity about the regulations. One drawback of the regulations is that it does not allow investing in a real estate asset which is not free from all encumbrances. Other major concerns include the calculation of the net asset value of the scheme on a daily basis, when up to 25% of the scheme's corpus can be invested in unlisted companies. Also, with respect to taxation of these schemes, confusion exists whether these entities are to be taxed as a debt fund or an equity fund. 532 3,000 2,250 675 1,582 2,679 0 1,000 2,000 3,000 4,000 2006 2007 2008 2009 2010 2011 Amt. in INR millionAmt. in INR million
  4. 4. 4 Comparison of REIT framework across developed economies and India Singapore United Kingdom United States India* Organization rules 1. The REIT manager of a listed REIT should be a corporation with a physical office in Singapore and have minimum shareholders’ funds of SGD$1 million 2. REITs must comply with the listing rules (i.e., at least 25% of the units issued should be held by at least 500 public shareholders) to be listed on the Singapore Exchange 1. A REIT must be a closed-ended corporation and listed on a recognized stock exchange 2. A REIT must have only one class of ordinary share 1. A REIT must have at least 100 shareholders 2. The REIT may not be a financial institution or an insurance company 3. The REIT must be otherwise taxable as a domestic corporation 1. Minimum assets under management (AUM) of INR 20 crore 2. Limitation of not more than 1,000 investors 3. Minimum investment from each investor INR 1 crore 4. Sponsor to contribute 2.5% of the total AUM 5. Minimum tenure of three years Income and asset rules 1. The REIT’s income must be derived from qualifying investments 2. The REIT must have at least 75% of its property invested in income-producing real estate (inside or outside Singapore) 1. At least 75% of income must be derived from qualifying property investment activities to maintain its tax- exempt status 2. Rents must be derived from at least three properties, with no one property representing more than 40% of the total value of the properties involved in the rental business 1. At least 75% of the REIT’s gross income annually (excluding prohibited income) must come from real estate-related Sources 2. At least 95% of the REIT’s gross income annually (excluding prohibited income) must come from real estate-related sources plus passive sources, such as dividends and interest 1. Investment of not more than 25% of AUM in one investee company 2. Investment in only unlisted entities 3. Lock-in period of one year for an investment
  5. 5. 5 Distribution rules 1. At least 90% of income in relation to Singapore assets must be distributed annually 2. REIT taxable income not distributed is taxed at the corporate tax rate At least 90% of income from qualifying activities must be distributed within one year from end of accounting period 1. At least 90% of REIT taxable income must be distributed annually 2. The REIT is subject to corporate tax on amounts retained and not distributed 1. Income taxable on the basis of corporate tax rate 2. Distribution is taxed on the basis of existing dividend distribution tax Gearing restrictions The REIT’s maximum leverage is generally 35% of property. Leverage may exceed 35% (but capped to 60%) provided the REIT discloses its credit rating from a major rating agency 1. The UK-REIT may not be party to a loan relationship which provides a return of interest which is linked to the results of the UK-REIT 2. Convertible loans can be issued by the UK-REIT, provided that conversion is into the single class of shares of the UK-REIT There are no restrictions on REITs No leverage is permitted. Borrowing permitted only for day-to-day operational requirements 1. Source: Ernst & Young Global Real Estate Investment Trust Report 2010 – “Against All Odds” 2. *Real estate funds are regulated by SEBI (Alternative Investment Funds) Regulations, 2012
  6. 6. 6 Key regulatory issues to be addressed for REITs in India The new AIF regulations by SEBI will include the existing private equity funds that invest in real estate; however, the first step SEBI should take is to formalize the SEBI Draft REIT Regulations, 2008. It is essential to have a formal regulatory framework for REITs to grow in India. 1. Tax laws should be amended to provide for a basis of taxation of REITs as well as unit holders. Ideally, REITs should be pass-through for tax purposes over and above the property income. Mature REIT markets such as Singapore, U.K. and U.S. have pass through tax rules. 2. No capital gains tax (tenure of three years or higher) for investments in properties by REITs. 3. As stamp duty and registration charges accumulate to 5% to 15% of the value of the asset, partial or complete exclusion from stamp duty on real estate transactions by REITs should considered as it will aide in reduction acquisition costs for REITs and eventually increase returns for the unit holders. 4. Eligible real estate assets should be clearly defined to avoid ambiguity: a. Type of assets – can be defined for e.g. as retail and commercial b. Occupancy levels – minimum occupancy levels can be specified at 70% c. Status of completion should be an integral part of the guidelines 5. Asset enhancements can be aided by clear classification of REITs. Varied asset classes have varied income streams and challenges. Hence, a particular REIT should be restricted to a specific asset category viz. Retail or Commercial. This means that investments by a Retail REIT shall be restricted to Retail Assets while a Commercial REIT may invest only in Commercial Assets. 6. Among the various classes of Real Estate, the one which is most needed in India today is Affordable Housing. Affordable housing is developed and sold by the Developer to individual home owners. This asset class, partly due to the prevailing tenancy laws, is not held by Real Estate Developers for giving out on Rent. REITs should be encouraged to invest in such affordable housing properties so as to enable the growth of mass housing over a longer period of time. 7. Minimum investment from an investor should be low to attract knowledgeable retail investors and ensure broader investor base. The number of investors should not be restricted. 8. Definition for efficiency is required as some real estate assets are sold at lower efficiencies, while others have a higher efficiency. 9. 90% of net property income should be mandatorily distributed to unit holders each year. 10. REITs should be permitted to leverage and enhance the efficiency of the capital employed. As the market for REITs develops, external commercial borrowing should be permitted. 11. Relevant provisions of building regulations should be amended to facilitate enhanced asset efficiencies and the quality post acquisition.
  7. 7. 7 Business Trust as an alternative REITs invest in commercial properties which enable the REIT to provide regular income to the unit holders; however, this may hamper the growth of residential properties. Even globally, the regulation of REITs requires that the investment be made in regular income generating real estate assets. An alternative to the restriction is the creation of a Business Trust. Business trusts are similar to REITs except for no regulatory defined limitation on borrowing and the trust can invest in assets other than only commercial real estate. By pooling of various other assets the business trust provides an opportunity to increase the returns for the unit holder. REITs and Business Trusts in Singapore Singapore has a significant number of listed REITs and business trusts. Trusts have invested in retail assets, commercial assets, industrial assets, hospital assets and hospitality assets also. Examples of listed trusts in Singapore: Parkway Life REIT First REIT Ascendas India Trust 1 Type of Trust Real estate investment trust Real estate investment trust Business Trust 2 Assets Hospitals, medical center, nursing homes, pharmaceutical product distributing and manufacturing facility Hospitals, nursing homes, cancer center and country club Information Technology Parks 3 Assets owned in Singapore, Japan and Malaysia Indonesia, Singapore and South Korea India 4 Yield – FY 12 4.8% 7.4% 7.6% 5 Portfolio Value S$ 1.3 billion S$ 340.9 million US$ 686 million
  8. 8. 8 Religare Health Trust: A recently listed business trust in Singapore In October 2012, Fortis Healthcare sponsored a business trust to be listed in Singapore. Hospital related assets of Fortis Healthcare form part of this business trust. Structure of Religare Health Trust Religare Health Trust Unit Holders Fortis Healthcare Limited (Sponsor) Religare Health Trust Trustee Manager Tax exempt distributions Units Units Tax exempt distributions Fees Asset Management & Trustee Services Hospitals & Clinical Establishments in India (Assets) Ownership Net Property Income Fortis Operating Companies (Property Manager) Property Management Services Sub-contract
  9. 9. 9 Annexure I FICCI Recommendations on Draft (Real Estate Investment Trusts) Regulations, 2008 1. The taxation on REITs income should be such that the income gets taxed only once till the stage of its distribution to the end investor. In a Mutual fund if it is dividend, the fund pays the dividend distribution tax and there is no tax in the hands of the investors. A similar tax structure should be worked out for REITs as well. 2. There should be no Capital Gains Tax on sale of assets of REITs. 3. The stamp duty payable by the REIT should be considered VATable. All assets covered under REIT should pay duty on the incremental sale value. 4. The cash flows for the REITs up to 90 % needs to be distributed and not the profits made on account of accrued gains. 5. Dividend by way of bonus issue may be considered. 6. The concept of non-income generating assets needs to be defined since there is a limit of 20% on non income generating assets. 7. Among the various classes of Real Estate, the one which is most needed in India today, is Housing. Middle Income Housing is developed and sold by the Developer to individual home owners. This asset class, partly due to the prevailing tenancy laws, is not held by Real Estate Developers for giving out on Rent. Section 51 (1) & (2) stipulates that investment should only be in income-generating real estate. This would mean that funds from REITs cannot be employed for residential housing at all. In other words, REITs will only promote commercial buildings and give no assistance whatsoever to promote Housing. It is therefore recommended that Section 51 be amended so as to allow REITs to invest in housing development activities as well, and not be restricted to income-generating real estate only. 8. The real estate property covers the purchase and leasehold rights. The rights under the license agreement are not covered. It is suggested to cover the license agreements as well. 9. If the intention of the legislation is to prevent money from REITs being invested in speculative land holdings, this can be achieved by inserting a stipulation that wherever REITs invest in vacant land, construction must commence within 6 months of receipt of all approvals pursuant to such investment. 10. Increase in exposure of REITs to single project and all projects of the group as a whole to say 30% and 40% respectively should be allowed. 11. Clarification is sought on the role of the “credit rating agency” and “appraising agency”. It is suggested to have guidelines for them. 12. Chapter I, Section 2 (aa) is incomplete and should add “by way of” after the word Trust. 13. Opening subheading of Chapter II “No person other than REIT to make public offer or seek listing of units” should be incorporated as a section under the Act. 14. Definition of “connecting person” includes “controlling person”. While “Control or controlling interest” has been defined, controlling person has not been defined in the draft. 15. In Chapter I definition of controlling interest in 2 j (iii) defined as “Majority of Directors in any Company….” Seek clarity on implementation of Chapter II, section 12 (e) in case the individual directors are changed in a step wise manner. i Indian Real Estate and the prospects for REITs, June 2007, Moodys and ICRA ii Grant Thornton-CII “Future Cities – The choices we make today” 2011 iii SEBI Venture Capital Investment Details