REITs (Real Estate Investment Trusts) are soon going to be a reality in India. The Securities & Exchange Board of India (Sebi) has issued final guidelines for Real Estate Investment Trusts (REITs). While the concept of REITs been in existence in developed markets for several years now, it is a new concept in India.
In this post, let us understand about – What is REIT?, How it works?, Benefits of investing in REIT and Tax implications for investors.
What is a REIT?
Real Estate Investment Trust, is a type of real estate company which operates like a mutual fund. Mutual funds pool money from different investors and use it to purchase financial securities like stocks,government bonds etc.,
Whereas, REITs raise money from different investors to invest in income producing real estate properties. REITs provide great opportunity for small investors to participate in real estate market without directly investing in large scale properties.
The basic idea behind the creation of REIT is simple and noble – allow small investors to participate and gain from income producing real estate investment.
How does a REIT work?
- REIT collects the money from the investors. These monies are invested mostly in rent generating properties.
- Properties generate rental income every month (periodic).
- REIT will distribute the rental income monies among the investors
- The capital values of the properties may also raise over a period of time.
- The Net Asset Value of the REIT units may raise depending on the capital appreciation
- The investors can sell the units for gain/loss in secondary market
SEBI’s Final Guidelines for REITs:
- Minimum size of REIT should be Rs 500 crore
- The Initial Public Offer size should be of minimum Rs 250 crore
- The minimum subscription amount to an IPO is Rs 2 Lakh for a retail investor
- The market lot is fixed (1 unit) at Rs 1 Lakh. This limit is for trading in secondary market.
- The minimum public holding should be 25% in a REIT
- Initially REITs are allowed to invest only in commercial properties and 80% of the amount should be invested in rent generating properties.
- The remaining 20% of the REIT amount can be invested in under construction projects,cash,real estate companies’ stocks etc.,
- Atleast 90% of the distributable cash flows must be distributed with the unitholders.
- NAV (Net Asset Value) must be declared within 15 days of valuation.
Benefits of REITs:
- Transparency– REITs will be regulated by Securities Exchange Board of India (SEBI). Like Mutual Funds, REITs will be managed by professional managers.
- Hassel free – A retail investor can hold a small piece of a rental income producing real estate asset without going through the hassels of property buying and registration.
- Diversification – REITs provide a new opportunity to invest in different kind of real estate projects which spread across different geographies or locations. Also, investors can consider this as a new asset class in their investment planning.
- Liquidity – REITs will be listed on stock exchanges. The shares/units of listed REITs can be easily bought and sold.
- Industry growth – REITs can extend credit and financing options to developers and real estate companies. They provide an exit option to developers. REITs can buy properties from the developers and operate them. It will increase the depth of Indian real estate market. REITS will increase the flow of funds to cash-starved real estate industry.
- 90% of distributable cash flows have to distributed with the unitholders. This may ensure regular income to the investors in the form of Dividends.
- The value of the properties held by REIT can go up leading to capital appreciation. This will increase the NAV of the REIT units.
- SEBI has set the minimum subscription amount for a retail investor at Rs 2 Lakh. This is an entry barrier to small investors. It has clearly stated that the minimum subscription amount will soon be reduced. SEBI initially wants to test the waters. The cautious approach adopted by SEBI can be acceptable.
- Real estate industry itself is not a very well regulated market in India. This may pose a big challenge to REITs. Central Government has to implement the Real Estate Regulations bill very soon.
- As any other industry, real estate sector can get into a slump and you may not get regular income on the expected lines.
- The main selling point in case of REIT is the steady flow of rental income from the properties. The current average rental yield for commercial properties in India is around 6 to 8%. The investors will compare these returns with other fixed income products. If the rental yield do not increase then the attractiveness of REITs as an investment option may fade away.
- Another key challenge would be, ‘the property valuation process.’ There are no proper standards,procedures or benchmarks in India for property valuations.
Taxation – REIT Unitholders
- The dividends distributed by REITs are tax free in the investors’ hands. REITs will pay the dividend distribution tax.
- REITs will be listed on the stock exchanges. The tax on Long Term Capital Gains incurred by the investors when they sell the units (REIT units) after 3 years of holding is NIL.
- The Short Term Capital Gains on the sale of units held for less than 1 year will be taxed at 15%.
REITs – Market capitalization in developed markets:
The real estate investment in India is a costly affair. The average ticket size is around Rs30 Lakh to Rs 50 Lakh in major cities. Also, it is not a well regulated industry. In most of the situations the buyers are at the receiving end. In such a scenario, will REITs turn out to be a boon to Indian retail investor who wants to participate in India’s growth story? We may have to wait for some more time to get the answers. Kindly share your comments.
(Chart source : E & Y- REIT report)