Description
REIT in India
REITs in India
Analysis of REITs with an Indian perspective
Submitted in partial fulfillment of the Real Estate course offered at XXXXX To Prof. XXXXX XXXX Submitted by: XXXXXX 14/03/10
Indian financial institutions seem to have escaped the current financial crisis mainly due to the lack of a complex structure and products in place, unlike in the developed world. Analysts say lack of a range of financial products has worked to our advantage now, but we need to analyze if it will always be so. There are some products that, if adopted, would bring about a change in the way of investing. One such product group is REITs, which would bring about greater transparency, among other things, in the real estate sector. This paper is aimed at analyzing the launch of REITs in the Indian Market scenario.
What is REIT
A REIT or Real Estate Investment Trust is a security that invests in real estate directly, either through properties or mortgages, and like stocks it can be traded. The property is securitized by means of dividing the ownership of an asset (property) into multiple units and then selling the units. The rent that is collected from the property is paid to the investors as dividend. REITs receive special tax considerations and typically offer investors high yields as well as a highly liquid method of investing in real estate. Presently, a REIT is a company that buys, develops, manages and sells real estate assets and allows participants to invest in a professionally managed portfolio of properties. Some REITs are also engaged in financing real estate. The REIT structure, like that of Mutual Funds, involves the sponsors, REIT, trustees, a real estate asset management company and the unit holders. Since REITs are required to distribute a large majority of their income as dividends, which may be taxable in the hands of the investors, they are a means of reducing or eliminating corporate income taxes. •
•
•
•
specific REIT, diversification could also be seen in asset quality, geographical location and tenant base. Low Volatility: Generally physical property has a negative correlation with stocks, so investing in REITs becomes more attractive. Thus, reducing the volatility linked with traditional stocks. Transparency in Working and Reporting: The traditional route of investment has lot of scope for misappropriation or manipulation. The REIT does away with such a system and induces greater transparency and order in the real estate market in India, because trusts are obliged to supply a flow of information about rents and capital values to their investors. Professional Management: REITs in general are valued higher than their property is actually worth. This is because REIT units are more predictable, less risky and easily traded. Convenience: No legal hassles related to the authenticity of the title, etc.
How REITs make money?
• Buying and selling property, thus pocketing gains from any appreciation in value. Developing commercial space Renting and leasing commercial space, and Financing mortgages and loans on property
Advantage to investors
• Stable Dividend Growth: REITs pass a major portion of the profits on to investors since the REITs business activity is generally restricted to generation of property rental income (In USA, a REIT must distribute 90% of its annual taxable income to shareholders as dividends) Diversification: Diversification of investment in real estate sector as more choice is offered to the investor in terms of class of asset: retail, office, residential, industrial, etc. In a sector • • •
Types of REIT
REITs are classified in the following categories: • Equity REITs own and operate incomeproducing real estate. They focus on the ‘hard asset’ business of real estate operation. They tend to specialize in
•
•
•
owning certain types building such as apartments, regional malls, office buildings or lodging facilities. Some are diversified and some are specialized, for example a REIT that owns golf courses. Mortgage REITs lend money directly to real estate owners and their operators, or indirectly through acquisition of loans or mortgage-backed securities. They are mainly finance companies that use several hedging instruments to manage their interest rate exposure. Hybrid REITs are companies that both own properties and make loans to owners and operators.
•
liquid methods of investing in real estate. REIT structure also offers a better chance for companies to release property assets from corporate balance sheets into professionally managed firms. They would also usher in a greater professionalism in the real estate sector and the association of dividend reinvestment plans, resulting in higher capital flow to the market.
Launching REITs in India
Presently, the introduction and facilitation of the REIT concept is still in the planning stages with the securities exchange bureau of India (SEBI), Reserve Bank of India (RBI) and the Finance Ministry evolving a blue print for customizing REITs for the Indian marketplace and formulating the changes in regulations required to enable this structure. The Satwalekar Committee, formed as a Sub-Committee of Association of Mutual Funds of India (AMFI), conducted a detailed study and prepared an exhaustive report on the above subject and formulated a working plan for launching Real Estate Investment Schemes (REIS). The Sub-committee deliberated on the appropriate structure to be recommended for the introduction of the real estate funds in the country which focused on two different models: • Real Estate Investment Trust of USA, which have been in operation since 1962, and The Mutual Fund Structure prevalent in UK.
Advantages introduced
•
to
India
if
REITs
are
•
•
•
The establishment of a REIT industry would provide a much-needed capital infusion (also in terms of increasing foreign capital) to the Indian real estate market. Real estate developers presently have limited means of financing, few developers have tapped capital markets for fund raising, and there is too much dependence on debt. The introduction of REITs in India would provide a further boost to the real estate industry. This would result in increased rental housing generation and also raise cheaper funds for this sector. REITs would also provide an opportunity for small investors to access commercial property returns that are now unavailable without significant capital outlays. REITs could also foster improvement in investors' portfolios by diversifying the investment base and increasing the stability of income sources. Instruments like equity, mortgage and hybrid REITs can offer investors high yields as well as
•
The favoured model for India was found to be the one prevalent in UK where real estate investments are done through pooled managed vehicles (PMV).
SEBI is a also working with various central and d state gove ernment agen ncies includin income tax ng x authorities, representat tives from th real estate he e industry and local governments on issues s s relating t stamp dut to ties, registrat tion charges, , property taxes, etc. (w which vary f from state to o state). , nching a REM all Real MF, l However, before laun Estate In nvestment Sc chemes wou uld need the e
roval of SEBI and will als have to file the I so appr Offe Document as per th existing SEBI er t he (Mut tual Fund) Regulatio ) ons. An asset Man nagement co ompany cou uld launch these Sche emes if it has the appro opriate investment management skill and if not then it can us the ls se ices of an adv visor. servi
Is India ready for REIT? n
Befo one could even think of introducing a ore f
Map pping the gene REIT stru eric ucture to the I Indian Real E Estate Market
product as REIT to the investment community, many aspects of real estate in India must be addressed. The dual nature of REITs emphasizes their dependence on the real estate asset/physical space market. Without an organized real estate market, REITs can’t deploy the funds they raise. The model below shows the various components of an efficient REIT market and what India is lacking. The absence of even one of these elements could lead to an inefficient REIT market and trigger a collapse in the entire system.
Figure: Mapping the generic REIT structure to the Indian Real Estate Market
How REITs can be improved in India?
Introducing REITs to the Indian market place requires a favorable legal, regulatory, accounting and tax system and environment. To make the REITs a success in India, a more relaxed regulatory and tax regime needs to be created. As in other countries, incentives should be provided like exemption from the payment of corporate tax. Also in some nations, no capital gains tax is levied on the investors, or no tax is paid on dividends paid to investors. India’s real estate market is particularly hampered by tedious registration processes and burdensome stamp duties that vary across states. This can be done away with, as is done in Singapore for a 5 years period (to promote REITs). Along with the regulatory issues, there are some legal issues that are caused by our antiquated laws and which will hamper the smooth and profitable functioning of REITS. Thus these laws need to be reformed since they also increase the risk level of a Real Estate Investment: • Stamp Duty - is recommended that either there should be no stamp duty for a SEBI registered REMF or even if a minor stamp duty is imposed it should take the form of value added stamp duty structure and thus double stamp duty will be avoided in case of frequent transfer of the properties Property Taxes - It recommended that the relevant authorities provide exemption from annual property taxes to real estate investment schemes. This would help real estate investment schemes to provide better returns to investors. Rent Control Act - It is one of the main reasons why people are not very enthusiastic in building a house and
Restrictions on REITs
SEBI and other regulatory authorities intend to impose certain restrictions on REIT/REMFs for proper control and management of these bodies. Some of them are: • All units under the REIT scheme must be listed on a recognized stock exchange within six weeks of the closure of the REIT scheme. A REIT scheme shall be close-ended. A REIT must not have exposure to more than 15% of any single real estate project. A REIT must not invest more than 25% in real estate projects developed, marketed, owned or financed by a group of companies. The REIT scheme must distribute at least 90% of its annual net income after tax each year as dividends to unit holders. REITs may invest in real estate involving encumbrances.
• •
•
•
•
•
•
•
•
giving it on rent. The provisions of the act have been amended in some of the states, however several states still continue with the ancient Rent Control provisions. Urban Land Ceilings and Regulations Act – It is recommended that if the REIT has to come to any meaningful existence, this law has to be scrapped. Records - It would be very helpful to the REMF if all the property records are computerized and the properties be transacted in a dematerialized format
References:
• Real estate investment trusts: A ‘REIT’ choice for the economy, Kaushik Rajan, IIM Indore, 2008. Is India ready for REITs?, Vivek Sah, ICA Institute.
•
Also, Pension funds are currently not allowed to invest in equity markets and real estate. As pension reform takes place it is expected that this long-term money will flow into the capital markets, making REITs or real estate-dedicated funds a desirable investment option.
doc_368128920.pdf
REIT in India
REITs in India
Analysis of REITs with an Indian perspective
Submitted in partial fulfillment of the Real Estate course offered at XXXXX To Prof. XXXXX XXXX Submitted by: XXXXXX 14/03/10
Indian financial institutions seem to have escaped the current financial crisis mainly due to the lack of a complex structure and products in place, unlike in the developed world. Analysts say lack of a range of financial products has worked to our advantage now, but we need to analyze if it will always be so. There are some products that, if adopted, would bring about a change in the way of investing. One such product group is REITs, which would bring about greater transparency, among other things, in the real estate sector. This paper is aimed at analyzing the launch of REITs in the Indian Market scenario.
What is REIT
A REIT or Real Estate Investment Trust is a security that invests in real estate directly, either through properties or mortgages, and like stocks it can be traded. The property is securitized by means of dividing the ownership of an asset (property) into multiple units and then selling the units. The rent that is collected from the property is paid to the investors as dividend. REITs receive special tax considerations and typically offer investors high yields as well as a highly liquid method of investing in real estate. Presently, a REIT is a company that buys, develops, manages and sells real estate assets and allows participants to invest in a professionally managed portfolio of properties. Some REITs are also engaged in financing real estate. The REIT structure, like that of Mutual Funds, involves the sponsors, REIT, trustees, a real estate asset management company and the unit holders. Since REITs are required to distribute a large majority of their income as dividends, which may be taxable in the hands of the investors, they are a means of reducing or eliminating corporate income taxes. •
•
•
•
specific REIT, diversification could also be seen in asset quality, geographical location and tenant base. Low Volatility: Generally physical property has a negative correlation with stocks, so investing in REITs becomes more attractive. Thus, reducing the volatility linked with traditional stocks. Transparency in Working and Reporting: The traditional route of investment has lot of scope for misappropriation or manipulation. The REIT does away with such a system and induces greater transparency and order in the real estate market in India, because trusts are obliged to supply a flow of information about rents and capital values to their investors. Professional Management: REITs in general are valued higher than their property is actually worth. This is because REIT units are more predictable, less risky and easily traded. Convenience: No legal hassles related to the authenticity of the title, etc.
How REITs make money?
• Buying and selling property, thus pocketing gains from any appreciation in value. Developing commercial space Renting and leasing commercial space, and Financing mortgages and loans on property
Advantage to investors
• Stable Dividend Growth: REITs pass a major portion of the profits on to investors since the REITs business activity is generally restricted to generation of property rental income (In USA, a REIT must distribute 90% of its annual taxable income to shareholders as dividends) Diversification: Diversification of investment in real estate sector as more choice is offered to the investor in terms of class of asset: retail, office, residential, industrial, etc. In a sector • • •
Types of REIT
REITs are classified in the following categories: • Equity REITs own and operate incomeproducing real estate. They focus on the ‘hard asset’ business of real estate operation. They tend to specialize in
•
•
•
owning certain types building such as apartments, regional malls, office buildings or lodging facilities. Some are diversified and some are specialized, for example a REIT that owns golf courses. Mortgage REITs lend money directly to real estate owners and their operators, or indirectly through acquisition of loans or mortgage-backed securities. They are mainly finance companies that use several hedging instruments to manage their interest rate exposure. Hybrid REITs are companies that both own properties and make loans to owners and operators.
•
liquid methods of investing in real estate. REIT structure also offers a better chance for companies to release property assets from corporate balance sheets into professionally managed firms. They would also usher in a greater professionalism in the real estate sector and the association of dividend reinvestment plans, resulting in higher capital flow to the market.
Launching REITs in India
Presently, the introduction and facilitation of the REIT concept is still in the planning stages with the securities exchange bureau of India (SEBI), Reserve Bank of India (RBI) and the Finance Ministry evolving a blue print for customizing REITs for the Indian marketplace and formulating the changes in regulations required to enable this structure. The Satwalekar Committee, formed as a Sub-Committee of Association of Mutual Funds of India (AMFI), conducted a detailed study and prepared an exhaustive report on the above subject and formulated a working plan for launching Real Estate Investment Schemes (REIS). The Sub-committee deliberated on the appropriate structure to be recommended for the introduction of the real estate funds in the country which focused on two different models: • Real Estate Investment Trust of USA, which have been in operation since 1962, and The Mutual Fund Structure prevalent in UK.
Advantages introduced
•
to
India
if
REITs
are
•
•
•
The establishment of a REIT industry would provide a much-needed capital infusion (also in terms of increasing foreign capital) to the Indian real estate market. Real estate developers presently have limited means of financing, few developers have tapped capital markets for fund raising, and there is too much dependence on debt. The introduction of REITs in India would provide a further boost to the real estate industry. This would result in increased rental housing generation and also raise cheaper funds for this sector. REITs would also provide an opportunity for small investors to access commercial property returns that are now unavailable without significant capital outlays. REITs could also foster improvement in investors' portfolios by diversifying the investment base and increasing the stability of income sources. Instruments like equity, mortgage and hybrid REITs can offer investors high yields as well as
•
The favoured model for India was found to be the one prevalent in UK where real estate investments are done through pooled managed vehicles (PMV).
SEBI is a also working with various central and d state gove ernment agen ncies includin income tax ng x authorities, representat tives from th real estate he e industry and local governments on issues s s relating t stamp dut to ties, registrat tion charges, , property taxes, etc. (w which vary f from state to o state). , nching a REM all Real MF, l However, before laun Estate In nvestment Sc chemes wou uld need the e
roval of SEBI and will als have to file the I so appr Offe Document as per th existing SEBI er t he (Mut tual Fund) Regulatio ) ons. An asset Man nagement co ompany cou uld launch these Sche emes if it has the appro opriate investment management skill and if not then it can us the ls se ices of an adv visor. servi
Is India ready for REIT? n
Befo one could even think of introducing a ore f
Map pping the gene REIT stru eric ucture to the I Indian Real E Estate Market
product as REIT to the investment community, many aspects of real estate in India must be addressed. The dual nature of REITs emphasizes their dependence on the real estate asset/physical space market. Without an organized real estate market, REITs can’t deploy the funds they raise. The model below shows the various components of an efficient REIT market and what India is lacking. The absence of even one of these elements could lead to an inefficient REIT market and trigger a collapse in the entire system.
Figure: Mapping the generic REIT structure to the Indian Real Estate Market
How REITs can be improved in India?
Introducing REITs to the Indian market place requires a favorable legal, regulatory, accounting and tax system and environment. To make the REITs a success in India, a more relaxed regulatory and tax regime needs to be created. As in other countries, incentives should be provided like exemption from the payment of corporate tax. Also in some nations, no capital gains tax is levied on the investors, or no tax is paid on dividends paid to investors. India’s real estate market is particularly hampered by tedious registration processes and burdensome stamp duties that vary across states. This can be done away with, as is done in Singapore for a 5 years period (to promote REITs). Along with the regulatory issues, there are some legal issues that are caused by our antiquated laws and which will hamper the smooth and profitable functioning of REITS. Thus these laws need to be reformed since they also increase the risk level of a Real Estate Investment: • Stamp Duty - is recommended that either there should be no stamp duty for a SEBI registered REMF or even if a minor stamp duty is imposed it should take the form of value added stamp duty structure and thus double stamp duty will be avoided in case of frequent transfer of the properties Property Taxes - It recommended that the relevant authorities provide exemption from annual property taxes to real estate investment schemes. This would help real estate investment schemes to provide better returns to investors. Rent Control Act - It is one of the main reasons why people are not very enthusiastic in building a house and
Restrictions on REITs
SEBI and other regulatory authorities intend to impose certain restrictions on REIT/REMFs for proper control and management of these bodies. Some of them are: • All units under the REIT scheme must be listed on a recognized stock exchange within six weeks of the closure of the REIT scheme. A REIT scheme shall be close-ended. A REIT must not have exposure to more than 15% of any single real estate project. A REIT must not invest more than 25% in real estate projects developed, marketed, owned or financed by a group of companies. The REIT scheme must distribute at least 90% of its annual net income after tax each year as dividends to unit holders. REITs may invest in real estate involving encumbrances.
• •
•
•
•
•
•
•
•
giving it on rent. The provisions of the act have been amended in some of the states, however several states still continue with the ancient Rent Control provisions. Urban Land Ceilings and Regulations Act – It is recommended that if the REIT has to come to any meaningful existence, this law has to be scrapped. Records - It would be very helpful to the REMF if all the property records are computerized and the properties be transacted in a dematerialized format
References:
• Real estate investment trusts: A ‘REIT’ choice for the economy, Kaushik Rajan, IIM Indore, 2008. Is India ready for REITs?, Vivek Sah, ICA Institute.
•
Also, Pension funds are currently not allowed to invest in equity markets and real estate. As pension reform takes place it is expected that this long-term money will flow into the capital markets, making REITs or real estate-dedicated funds a desirable investment option.
doc_368128920.pdf