The Real Estate Investment Trusts (REITs) in India have been in the news for some time and generally pledge high yield to investors. They receive favourable tax considerations and are more liquid than direct investments made in the property. REITs were created back in 1960 in the US and in the year 1965 the first REIT got listed on the New York Stock Exchange (NYSE). There main motto was to provide the average investors with an easy, affordable way to invest in various real estate markets. Since then more than 30 countries worldwide like Australia, Singapore, Japan, France, UK, etc. have established the REIT regimes thereby leading to an increase in awareness and acceptance of investing in global real estate securities which has given more and more options to the investors.
REIT is generally described as an instrument that owns and manages income producing real estate assets such as office buildings, shopping malls, apartments, hotels, warehouses, mortgages or loans. The underlying objective behind investment in REIT is to provide investors with dividend income from the profitable sale of real estate assets without actually having to go out and buy or finance properties. A REIT must pay at least 90% of its taxable income as a dividend to shareholders annually and must derive at least 75% of its gross income from real estate-related sources. These income producing instruments can be classified into three categories that are as follows: –
Equity REITs – They account for a vast majority of REITS’s and mostly own and operate income producing real estate. By engaging themselves in real estate activities such as leasing, maintenance, and development of real property and tenant services, these REITs generate their earnings which is then distributed as dividend to investors.
Mortgage REITs – These REITs either directly lend money to real estate owners and operators or indirectly extend credit through the acquisition of loans or mortgage backed securities. Primarily, there earnings are generated by the net interest margin i.e. the cost of lending capital to borrower versus the cost of raising the capital to lend.
Hybrid REITs – Companies that uses the investment strategies of both equity and mortgage REITs are termed as hybrid REIT.
REITs can be a reasonable choice for a financial plan for those who wish exposure to real estate but don’t have the sufficient capital for direct investment. Also, there are REITs that provide you with the ability to diversify across property type, geographic location and more. Unlike, direct real estate which can be difficult to sell quickly, traded REITs can be bought and sold like stocks as they are fairly liquid. In case of REIT the regular dividend received by the REITs unitholder is tax exempt whereas regular rent received by owners of real estate property is taxable. No substantial maintenance and effort is required to hold a REIT apart from occasionally checking on the investment which is not the case with direct investment where continuous maintenance is needed.
Despite REITs being a good option for investors, one has to take into account certain things such as: –
High Fees – Huge fees are charged by private REITs. This could include sales commission, dealer manager fees, organization and offering expenses, acquisition fees and acquisition expenses.
Lower Average Returns – In comparison with average returns from direct commercial realty ownership, average REITs dividend may be significantly lower.
Lack of Control – There is lack of control over the assets which are purchased in spite of there being diversity.
Volatility – REITs shares are subjected to high volatility and market shifts of the stock market as they are traded on a stock exchange.
The success and growth of REITs have not been the same across countries in spite of the REIT structure having many similarities. In order to analyse the future of REIT in India, a study of history of REIT structures in overseas countries could be relevant. We shall now take into account a synopsis of U.S and U.K. which is as follows:
In the year 1960, REIT market journey began in the USA and got into a rigorous phase by 1980s. The sector achieved a substantial growth amongst the investors in 1990s due to positive changes in the U.S. tax and regulatory laws which led to its increasing acceptance as an alternative mode of investment in real estate properties. The two important tax and regulatory breakthroughs for the US REITs have been the Tax Reform Act, 1986 (TRA) and the REIT Modernisation Act (RMA) effective from 2001. Tax transparency and integration of REITs with ancillary real estate business, like property management, leasing or development increased with the implementation of TRA thereby facilitating more effective management of REITs. On the other hand, RMA made way for taxable REIT subsidiaries (TRS) which can independently engage in such ancillary business activities. The US market in its 55 years of REIT history has gone through a roller coaster ride of success, failure, development and change thereby transforming today’s REIT into an important vehicle for investment in real estate properties across the world.
In comparison with the U.S., the REIT structure came decades later in U.K. with effect from 1st January 2007 by the Finance Act 2006. In its first year of inception itself the number of registered REITs grew significantly, but since then the growth has been sluggish. The REIT regime in U.K. operates through a combination of legislation (primary and secondary) plus guidance. In order to simplify U.K.’s tax legislation which forms part of the Corporation Tax Act 2010, the primary legislation has been reworked. Now the legislation separates the property rental business from other business activities termed as residual business for taxation purposes. The U.K. REIT regime has evolved with a number of changes in its seven years from launch resulting in a more attractive REIT regime. Few changes to be worth noting are the relaxation of listing requirement to allow listing on secondary markets, abolition of flat 2% tax charged on value of properties group entering the REIT market, modification of stamp duty on bulk purchases of residential property. These were especially aimed at motivating small real estate players seeking to startup REITs and boosting the residential property markets.
Considering the challenging economic situation currently India is facing and in order to be competitive, the Indian real estate sector must introduce reforms in the form of introduction of the concept of Real Estate Investment trust. Mainly because of the lack of an existing regulatory framework, India has been unable to take advantage of this funding opportunity. Taxation and regulatory incentives which was a major impediment need to be made conducive for the REITs model to be successful in India. Towards addressing the above taxation issue, the recent union budget proposes relief in the form of exemption from DDT. Also, the recently passed Real Estate Bill 2016, is set to ease the home buying process by bringing in transparency and accountability in the real estate sector, thus increasing consumer confidence and benefitting the sector as a whole. Capital gains tax is the second biggest hurdle after DDT. The government announced capital gains tax exemption at the hands of the sponsor in the previous budget of 2015 but still it remains an issue at the REIT where it is still applicable. Suitable exemption should be provided from the capital gains incidence.
Real estate PE fund has been the only operational real estate investment structure so far in India, enabled by SEBI in 2004. This has been the largest contributor to real estate asset class ever since the regulator empowered the venture capital financing regime to participate in real estate. Since it allows fund to invest in developed assets, it is possible for the PE structure to assume the nature of a REIT in some form.
REITs could provide an additional exit route for investors and enable retail money to be channelled into India’s reality sector through a regulated network, one the Government fast track taxation and other regulatory amendments and reforms. The introduction of REITs would have a desired effect on the economy by spurring capital inflows and fostering institutional credibility
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