Over the past two decades, the global commercial real
estate sector has seen a dramatic shift from private sector to public
markets. The Indian real estate industry’s growing demand for additional
sources of funds and the success story of global real estate investment
trusts (Reits) is compelling enough to encourage the implementation of a
similar regime in India with requisite adjustments. Typically, Reits
invest in completed, revenue generating commercial properties and
distribute a major portion of the earnings among investors. They have
proven to be an attractive investment option for retail investors as
well as for long-term pools of capital such as pension funds and
insurance companies who prefer to have a regular income stream.
Historically, global Reits have been able to generate significant market
traction. The US Reit industry’s market capital, for example, has grown
at an average annual rate of nearly 23% in the past 20 years.
Besides other advantages, Reits bring in increased transparency in
the sector by adopting better corporate governance, disclosures and
financial transparency practices. Being required to comply with the
corporate governance, information disclosure and financial reporting
standards laid down by the regulator, Reits will bring in a regular
information exchange and availability in the public domain. This will
result in higher professionalism with a clear emphasis on issues such as
risks attached to titles and transaction costs.
Equity financing would certainly improve the debt-equity
balance in the market. Reits will also provide a vehicle for addressing
non-performing assets (NPAs) including sick or defunct companies holding
large land banks. Sale of such NPAs to Reits will have a twofold
effect—realization of the real estate’s true value and ease in
liquidating the NPA once the high value of the real estate is removed
from its books. This will help financial institutions regain strong
profitability, which is currently hampered due to the large NPAs booked
by them.
It is a well recognized fact that Indian real estate is
seeing rising demand due to changing demographies and growing
urbanization. As per estimates by the United Nations, India has the
highest rate of change for urban population among the BRIC nations
(Brazil, Russia, India and China). An estimated 843 million people will
reside in Indian cities by 2050, equal to the combined population of the
US, Brazil, Russia, Japan and Germany. More than 300 million are
expected to be added to India’s working age population by the same year.
The capital intensive sector faces a severe constraint in
terms of adequate and structured financing options. It’s time that the
economy experiments with advanced funding options such as Reits and
provide the industry a globally competitive edge.
Apart from making the real estate sector financially and
economically mature, Reits will give common investors a huge opportunity
to share in the gains of this asset class.
Providing the investors with an investment avenue that is
less risky than investing in under-construction properties, it will
also provide an income source in form of rentals, which, in turn, could
be a good hedge against inflation as the underlying income will adjust
itself to the cost of living.
Moreover, being a more liquid instrument among the
current range of property investment vehicles, Reits hold the potential
of improving investors’ investment profile through diversification of
investment base and increasing stability of income source. The latest
release of draft regulations for setting up Reits in India is one big
effort by the market regulator Securities and Exchange Board of India to
bring in a high level of maturity into the Indian real estate sector.
It is expected that with the opening of the sector to Reits, there will
be increased capital inflows from overseas markets, and while most
investors will enter into joint ventures with local developers to
leverage local expertise, there would still be a large section of
investors who would prefer to invest in tax-efficient vehicles, which
provide them stability in returns and at the same time offer diversity
in projects in which investments are channelled.
The draft guidelines are a welcome step and should
provide the much needed fillip to the sentiment in the sector. Our
experience suggests that the success of a Reit structure depends largely
on participation by households. Therefore, it is important to make the
participation levels and taxation structures attractive. The subject is
more relevant today since any investment opportunity with a visibility
of cash flow is always an attraction. With this in view, we would
encourage the regulators to address these issues while shaping the
structure of Reits in the country.
Introduction of Reits is going to provide a timely
opportunity to both investors and the real estate industry to develop a
mature and transparent market. Over a period of time, it will also help
in developing a price discovery mechanism for the commercial property
market in select cities.
