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REIT - An Alternate Investment Window for Retail Investors

Real Estate Investment Trust

REIT market is a popular tool used globally to securitise income – generating properties. The trust that uses the pooled capital of many investors to purchase and manage income property (equity REIT) and/or mortgage loans (mortgage REIT).  REIT units are listed on major exchanges just like stocks, thereby providing investors higher liquidity in contrast to direct ownership of commercial property. They are also granted special tax considerations.  REITs own many types of commercial real estate, ranging from office and apartment buildings to warehouses, hospitals, shopping centres, hotels and even timberlands. Some REITs also engage in financing real estate. REITs were designed to provide a real estate investment structure similar to the structure mutual funds provide for investment in stocks. 

REITs offer several benefits over actually owning properties. First, they are highly liquid, unlike traditional real estate. Second, REITs enable sharing in non-residential properties as well, such as hotels, malls, and other commercial or industrial properties. Third, there's no minimum investment with REITs. REITs do not necessarily increase and decrease in value along with the broader market.

However, they pay yields in the form of dividends no matter how the shares perform. REITs can be valued based upon fundamental measures, similar to the valuation of stocks, but different numbers tend to be important for REITs than for stocks.

There are three types of REITs are available in international Market, They are:-

1. Equity REITs: Equity REITs invest in and own properties (thus responsible for the equity or value of their real estate assets). Their revenues come principally from their properties' rents.

2. Mortgage REITs: Mortgage REITs deal in investment and ownership of property mortgages. These REITs loan money for mortgages to owners of real estate, or purchase existing mortgages or mortgage-backed securities. Their revenues are generated primarily by the interest that they earn on the mortgage loans.

3. Hybrid REITs: Hybrid REITs combine the investment strategies of equity REITs and mortgage REITs by investing in both properties and mortgages.

Evolution

REITs were created in the United States when President Dwight D. Eisenhower signed into law the REIT Act title contained in the Cigar Excise Tax Extension of 1960. Around the time of their creation in 1960, the first REITs primarily consisted of mortgage companies. The industry experienced significant expansion in the late 1960s and early 1970s. The REIT concept was launched in Australia in 1971. Canadian REITs were established in 1993. REITs have been in existence in Ghana since 1994. Belgian REITs were established in 1995. In the period of 2000 to 2014 lots of countries came with REIT ACTs. They are Japan – 2001, Hong Kong – 2005, United Arab Emirates & Saudi Arabia – 2006, Nigeria – 2007, Germany – 2007, United Kingdom – 2007, Philippines – 2009, Finland – 2010, Singapore – 2013, Thailand – 2013, Ireland – 2013.

From the end of February 2009 through the end of October 2014, stock-exchange listed Equity REITs have posted total returns of 312% (28.4% per year) and all stock-exchange listed REITs have gained 295% (27.5% per year)

REIT - INDIA

In 2007 SEBI formally introduced the draft REITs regulations for public comments. Because of downturn in the market during that period, no further development took place in the REITs regulation, until October 2013 when a second draft of the regulations was issued for public comments by SEBI. After taking industry inputs, amendments to regulations were made and the draft was approved allowing setting up and listing of REITs. Post the clarifications provided in the 2014 budget, a final draft was introduced by SEBI in August 2014. 26th of September, 2014 The Securities and Exchange Board of India (SEBI) has firmed up regulations called SECURITIES AND EXCHANGE BOARD OF INDIA (REAL ESTATE INVESTMENT TRUSTS) REGULATIONS, 2014 enabling REITs. It deals with Registration of REIT, Rights And Responsibilities of Parties to The REIT, Valuer and Auditor, Issue and Listing of Units, Investment Conditions, Related Party Transactions, Borrowing and Valuation of Assets, Rights of Unit Holders, General Obligations, Disclosures and Reporting etc..

FACTORS FAVORING REITs IN INDIA

The vast and fast-paced real estate sector of India imperatively requires reliable and transparent investment vehicles like REITs, for prospering optimally, drawing more FDI, contributing more to the national GDP, and emerging fast as one of the largest and most prosperous real estate markets of the world in the nearest future. As per the latest estimates of world-famous Cushman & Wakefield, the magnitude of the real estate assets under all categories which can qualify acceptance of REITs in India, will reach the level of US$20 billion by the year 2020; and by this capacity of market capitalization, the REIT market of India is most likely to rank among the top five biggest markets of the Asian Subcontinent. Again, India's steady and fast economic growth inevitably demands more commercial and industrial buildings, modern offices, conference centers, and other objects of real estate mentioned above in future years. However, high and glamorous success of REITs in the future years will largely depend on the taxation of REITs, stamp duty and taxation for offshore investors, stamping of agreements associated with the transfer of property to the REITs, and efficient administration and management of the REITs in India.

Investment Conditions and Dividend Policy

REITs are legally compelled to invest only in diverse commercial real estate properties, either directly, or through the means of some Special Purpose Vehicles [SPVs]. In any such SPVs, a REIT is bound to hold controlling interest, not less than 50% of the equity share capital or interest. The concerned SPV must possess at least 80% of its assets directly in property, and is prohibited from making investment in other SPVs. Again, a REIT is legally bound to invest at least 80% of its assets in completed and income-generating real estate properties. A maximum of its 20% assets remaining, shall be invested in the following avenues:

a. Developmental Properties [investments in these are restricted to a maximum of 10% of the value of the REIT assets]

b. Mortgage-Backed Securities

c. Listed/Unlisted Debt of Companies/Corporations in the Real Estate Sector

d. Governmental Securities

e. Money Market Instruments or Cash Equivalents

f. Equity Shares of Listed Companies in India, which get their bulk of operating income [not less than 75%] from activities in the real estate sector.

The market regulator also dictates that a REIT must make investments in at least two projects at anytime; the major project containing a maximum of 60% of value of the assets of the REIT. These investments are compulsorily to be made strictly as per the investment conditions given in the REIT Regulations. Moreover, a REIT is rigorously compelled by the law to distribute at least 90% of its distributable cash flows [subject to tax and other applicable laws] to its investors or unit holders as dividend, compulsorily on a half yearly basis.

TAX TREATMENT

The Government of India has clearly shown its intentions to grant REITs and Infrastructure Investment Trusts, a tax pass-through status, soon in the near future. The Union Budget 2014 also advocated for making these investment mechanisms quite tax-efficient for domestic and foreign investors. The tax pass-through status means that the returns from investments made in these investment vehicles, will only be taxed in the hands of investors, and the REITs will not have to pay any taxes on incomes. Once further clarities on the taxation of REITs, foreign investments in Indian REITs, stamp duty and taxation for offshore investors, etc., are made, REITs of India are most likely to draw huge investments from the overseas investors. In connection with taxation of REITs in India, the following points are noteworthy: ---

  • The Portfolio Companies will follow strictly the Dividend Distribution Tax system; the dividends of the REITs will be exempted from tax, and the interest received by the REITs will also be tax exempt.
  • REITs will withhold tax on the interest component of the distributable incomes to the unit holders; this will be charged at the rate of 10% for the Indian unit holders, and 5% for the foreign investors.
  • Capital gains gained through disposal of any assets of the REITs, will be taxed.
  • The transfer of units of the listed REITs is quite similar to the transfer of listed shares. The long-term capital gains on the transfer of units of a listed REIT will be exempted from taxation, but the short-term capital gains shall be taxed at the rate of 15%, given that the tax on transaction of securities is paid on the transfer of such units.

Advantages - REIT

1. Portfolio diversification due to lower ticket.

SEBI has allowed a minimum investment of 2 lakh in REIT units, which can be afforded by large retail investors. Retail investors can invest in large quality commercial properties with an investment of just 2 lakh.

2. Investment security

REITs in India are easy and secure investments in the real estate sector, convenient diversification of investments, exit avenues to the cash-starved property developers, better liquidity situation in the real estate industry, increased accountability and reliability. REITs have to invest 80% of their corpus in completed and leased out properties, which are much safer compared to under – construction properties.

3. Higher transparency

Regulations of India are well-conceived, and are certainly highly elegant for bringing in the globally accepted practices to the real estate sector of India, and also for reviving the interest of both domestic and global investors in the Indian real estate industry.REITs would operate under strict regulations and guideline framed by SEBI, there by increased transparency for an investor

4. Regular Income

REITs need to distribute at least 90% of their net distributable income to its investors or unit holders as dividend, compulsorily on a half yearly basis. Any appreciation (or devaluation) in the value of underlying property owned by a REIT is likely to reflect in the NAV of the unit listed on the exchange.

5. Long – term Capital Gain – (LTCG)

No long-term capital gains will be levied if REIT units are held for at least 36 months. However, in case of direct investment in commercial property, an investor will have to pay LTCG tax of 20%

Conclusion

By the very nature, REITs are beneficial to both the investors and the real estate industry as a whole, in many different ways. Further, SEBI must take adequate measures to create awareness and educate retail investors on this alternate investment source. With the present REITs regulation, they are most suitable for investors seeking a mix of regular income and capital appreciation over a medium to long-term investment period.

REITs are expected to play a major role in helping transform the Indian real estate sector. In addition to providing developers a new avenue for funds, REITs may also change the way Indians invest in real estate. However, much of the success and profitability of REITs in India will depend on tax and stamp duty related regulations and policies, especially for the offshore investors.


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Category Shares & Stock, Other Articles by - jagadish 



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