The real estate investment trusts, or REITs, as they are commonly known, supposedly serves two purposes. One REIT allows real estate developers and the business houses to unlock the value of “income or rent yielding real estate assets” through a sale of such assets to a REIT; and second a RIET presents a rather low risk investment opportunity to investors whether HNIs or corporates or endowments or pension fund etc.

As regards the first purpose, if a real estate developer develops and constructs a commercial or retail or office real estate building; and thereafter leases out such commercial, office or retail building, without selling any areas in such building complex, then the developer will have an asset which will be fully built and will also be yielding income through rents from such asset. There may be additional income in the asset from margins on common area maintenance or parking etc. The developer will have the option to unlock the value of such rent/ income yielding assets through a sale of such assets to a REIT. Such sale will occur at a capitalization rate linked to net operating income (rent and other income) from such asset. The developer will in return get the value for the assets from the investors acquiring the units of the REIT and may also continue to hold units in REIT ensuring a long term return.

Also, if any business house owns the building in which it is operating, then it can sell such building and land or significant majority in them to a REIT and have the same “lease back” to itself for its business and operations. In the bargain, while the primary business of the company will remain uninterrupted through the same real estate assets that it created and were using, at the same time such company will be able to garner significant cash flows on sale of the real estate assets that it had created by selling them to a REIT. In some of the cases, if the promoters of such company also own significant minority stake in the REIT and also have some participation in the asset management company, then they will have some assurance that the leasing contracts will not be reneged by REIT if the market rentals go north in future.

Like most countries where REITs have been functioning since many years, in India too, the primary objective of introducing REITs is twofold, viz., to provide a new avenue to investors to invest in low-risk real estate assets (as 80% of the assets of the REIT have to be completed and rent generating) with a flexibility on the investment size (so anyone with an investment size of Rs.2 lakh can also subscribe to a unit in the REIT, although the limit is reduced for a secondary transaction on the stock exchange); and the other objective of REITs is to provide an exit opportunity to sponsors (who could be developers/ foreign investment funds etc.) thus providing liquidity. REITs may also lead to allowing foreign investors to access the till now forbidden developed property market in India.

Even though REITs may seem like a win-win situation for both the developers and the investors, there has however not been even a single REIT listing in India since the time the regulations were notified in September last year. While the limited tax breaks and tax leakages were the main causes that had dampened the interest of developers/ sponsors in REITs, now there seems greater clarity on such taxes and therefore we might not find that as a major obstacle for REITs to take-off.

The REIT Regulations do mention that the REIT may invite subscription from both residents and foreigner and that foreign investments in REITs shall be subject to guidelines specified by RBI, however at the time of the REIT Regulations coming into force, REITs were inaccessible to foreign investors under the Foreign Exchange Management Act, 1999 (“FEMA”) and the regulations/ policies thereunder ,.Although, very recently (and after almost 7 months of the REIT regulations coming into force), the Union Cabinet has accorded its approval to treat REITs as “an eligible financial instrument/ structure” under FEMA, the policy framework, which will hopefully come into existence soon, will need to address many issues to make REITs a more lucrative structure for the non-residents.

Another challenge that REITs may face, unless specifically addressed by the State Government’s, would be with respect to stamp duty implications. For any transfer of the assets into the REIT, stamp duty would be payable on the sale deeds at the rates prescribed by respective State Governments, which are fairly high. Also, while both freehold and leasehold properties are permitted to be included in the REIT assets, the REIT Regulations do not specifically include properties over which the SPV only has development rights, which is a commonly used model in the real estate market in India. Since REIT and, or the SPV is required to own the asset, in situations where the asset is ready and built-up, these properties may still be considered as freehold in favour of the developer/ SPV, however, this does not appear to be the case for under-construction properties.

As the case is with introduction of any new regulation/ instrument, REITs too are just at their nascent stage in India and one can only hope that the REITs market along with the applicable regulations will evolve and grow as the time comes and unlock the value that it promises to.