Reits: A solution to many problems in Indian real estate

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.