Reits India

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Moving towards the REIT1Development.

By Arijita Kakati2Think back to China a decade ago, and a prosperous India is not such an impossible

dream.- The Economist.

The Indian property market is characterized by volatility, fragmentation, segmented

development, administrative and political complexities. As the 11 th largest economy in the

world and projected 3rdlargest economy by 2028, the Indian market is a lucrative prospect for

investorsworld-over. Therefore, the introduction of REITS in India is a natural outcome of

globalisation aimed at transforming the patterns of ownership in the real estate market 3.

In October 2013, SEBI (Securities Exchange Board of India) came up with the draft

regulations on REITs in India. The increased relevance of REITs can be attributed to the

demand for satisfying the appetite of a growing middle class eager to gain exposure in the

booming property markets. Prior to this, investment in real estate in India for small time

investors was possible only through the Securities Exchange Board of India (Collective

Investment Scheme) Regulations, 1999. Under Section 11 AA of the SEBI Act, a Collective

Investment Scheme is defined as any scheme of arrangement made or offered by any

company which pools and utilizes the contributions or payments made by investors for the

sole purpose of the scheme, in return for such payments and contributions, the investors

receive profits, income, produce movable or immovable property. The investors are not

involved in the day to day management of the affairs on the operation of the scheme. Section

16 (1) of the regulations states that, the scheme shall be in the nature of a trust, formed by a

duly registered Trust Deed executed by a collective investment management company, the

assets of the trust would be held by a trustee appointed by the collective investment

management company for the benefit of the unit holders.

Considering the wide spread success of REITs in developed economies, the first draft

regulations on REITs was circulated for public comments by SEBI in 2008.

1Real Estate Investment Trusts

2LL.M Corporate and Financial Services, 2014, The National University of Singapore. Currently working as a

Graduate Research Assistant to Professor Kishore Mahbubani, Dean, Lee Kuan Yew School of Public Policy,National University of Singapore.3Consultation paper on draft SEBI (Real Estate Investment Trusts) Regulations, 2013


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On why REITs are important to India

1. India realised the absence of securitized or liquid market that would not only grant anexposure to small time investors to the real estate market but also enable foreign

investors to invest in properties in India, this coupled with transparency, simplicity

and convenience.

2. REITs act as a one stop shop, managing a diverse portfolio of properties across Indiafor the benefit of domestic and foreign investors.

3. REITs provide an opportunity for developers to raise capital for new projects as wellas revive old projects, which in turn would help in the development of the Indian real

estate market which till date largely comprises of rural and agricultural lands.

Highlights

REITs in India would follow the structure of a trust as provided under the Indian

Trusts Act, 1882, arising out of a Trust Deed registered under the provisions of the

Registration Act, 1908, as well as the provisions of the Securities and Exchange

Board of India (Real Estate Investment Trusts) Regulations, 2013.

The parties to the REIT would include a Sponsor, Manager- which will be a Company

incorporated under the provisions of the companies Act, 2013, a Trustee and a

Principle Valuer.

A designated REIT must make investments only in securities or properties in India the

term property does not include mortgage and Transferable Development Rights. The

assets which includes the assets held by the REIT whether directly or through an

Special Purpose Vehicle will be held by an independent Trustee who is entrusted with

the responsibility of holding the REIT assets for the benefit of the unit holders as well

as fulfilling his/her obligations under the Trust Deed, ensuring the authenticity of the

real estate transaction entered into by the REIT, supervising the activities of the

manager in terms of reporting and disclosures, redressing the unit holders grievances,

ensuring that the unit holders get their payments in a timely manner.

The trustee shall make sure that the money of the REIT is utilized according to the

regulations. A reading of the draft regulations makes it apparent that independence of

the main parties to the REIT is of paramount concern, also the existence of a tiered

system of checks and balances where the ultimate decisions of the REIT would lie in

the hands of the unit holders.


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Apart from this Indian REIT regulations set stringent conditions on the qualification

of the sponsor and manager in terms of their net worth and experience in the real

estate market.

To keep away small operators from entering the market SEBI has set the minimum

value of the REIT assets at Rs.1000 cr. to be eligible for listing. This is done with an

intention of attracting experienced investors and individuals with high net worth

initially, until the Indian realty market matures and the concept of REITs popularizes.

There is a minimum subscription size is Rs.2 lakhs.

Other regulations geared at achieving diversification, growth and investor protection

include restrictions on investment in developmental properties, vacant land, MBS, and

schemes. It is expected that the REITs would generate not less than three fourths of

their revenues from rental, leasing and letting of real assets. REITs are expected to

invest 90% of their investment only in completed income generating properties.

Again, Section 18 (12) states that not less than 90% of the net distributable income,

after tax, shall be distributed as dividend among unit holders. This provision is in

consonance with the global popularity of REITs as a tax transparent and tax efficient

system. The income so distributed is eventually taxable in the hands of the investors

making the system transparent while entailing the REIT a deduction in its taxable

income.

Legislative Progress.

Despite SEBI paving the way for REITs in India there are other ancillary changes that

needs to be brought about in legislations like the Securities Contract (Regulation) Act,

1956, which defines securitiesas shares, scrips, bonds, debentures, debenture stock

or other marketable securities of a like nature in or of any incorporated company,

derivative, units issued by any CIS, units under mutual fund etc. SEBI would require

amending the definition of securities to include units of REITs.

The other concern raised by experts is with regard to the rationalization of stamp

duty.Stamp duty is the tax payable to the state government on the conveyance deed

through which the property to the trust is conveyed by the sponsor. The stamp duty

varies from anywhere between 3.88% in Mumbai to 13% in Delhi of the property

value, this duty is payable by the sponsor upfront prior to listing of the REIT, thus

raising concerns regarding the non recovery of money in case of unsuccessful listing

under bad market conditions.


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Amendments in the Foreign Exchange Management (Permissible Capital Account

Transactions) Regulations, 2000 have to be made, currently Regulation 4(b) (iv)

prohibits investment through all routes by any person resident outside India into real

estate business which would include through REITs but does not include development

of townships, construction of residential/commercial premises, roads and bridges.

Governance

Though section 2(i) of the draft defines change in control in terms of section 2 (e) of

the SEBI (Takeover and Acquisitions) Regulations, to mean the right to appoint

majority of the directors or to control the management or policy decisions exercisable

by a person by virtue of their shareholding, management rights or shareholders

agreement or voting agreement or in any other manner. However the draft regulations

make no mention of mergers of REITS nor does it provide any form of recourse or

reddressal to minority shareholders against the majority in situations of hostile take

overs.

Regulation 22 makes it mandatory for unit holders to hold an annual meeting not less

than once a year. Some of the matters that requires a consensus among majority of theshareholders are

Matters related to party transactions. REIT entering transactions valued at 15% or above of the REIT assets. Further borrowings in excess of 25% of the value of the REIT assets, Change or removal of the manager Delisting of units In case of shares held persons excluding the sponsor above of 50% of the

value of outstanding REIT units, approval has to be sought for further

acquisition of units.

In the above Annual meetings have been made mandatory which is in line with the

regulations for enforcing a strong mechanism of corporate governance, increasing

investor participation and providing a platform for reddressal of investor grievances

however such meetings may result in incurring high additional expenditure. One of

the concerns raised here would be the ordinary nature of the meetings; the regulations


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make no distinction in terms of priority to matters, filtering matters of special concern

from ordinary ones. Moreover rather than making the meetings mandatory the

regulations must consider the option of conducting these meetings at times where the

shareholders come together and unanimously decide on issues of concern and raise a

meeting, this can be done by inserting a clause that allows a certain percentage of

investors requesting for meeting this in turn would help reach consensus on the

requirement of a meeting as well as create a platform where common interests may be

represented. For example in Singapore upon popular public demand a provision was

made wherein 10% of the unit holders could convene a meeting to bring forth their

grievances or discuss matters of importance. This brings in unanimity in setting the

agenda for the meeting, helps redress popular concerns and encourages active

participation.

The other concern that may be raised which is unique to the Indian real estate market,

is with regard to the immaturity and instability of the market which is why issues of

refinancing and recapitalisation must be considered. Going back to the time of the

global financial crises India witnessed a sudden drop in the tapering prices of real

estate from Rs. 260/sq/ft to 160 /sq/ft, in this light it is essential that Indian REITmust consider moulding a structure that is consistent with her needs and concern

rather than blindly following REIT structures from developed economies. A thought

must be put into conserving capital to overcome times of crises. This preposition may

defy the logic behind the tax transparency attached to REITs however it a condition

unique to the Indian market as well as essential to the Indian market.

As mentioned earlier, Regulation 14 (b) lays down the pre condition to listing of the

REIT with a minimum value of assets to be Rs.1000 cr. Though this condition keeps

the small players at bay and permits the larger and experienced developers to take

over the market however in time to come this limitation must be amended to allow

medium sized property developers an exit for their commercial properties, also this

pre condition may limit the number of REITs in India with increased concentration on

select properties. Thus we may never be able to realise the desired benefits in terms of

maintaining a diverse portfolio of real estates.


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Conclusion

Though the draft regulations tries to create a thin balance between investor protection

and industry development, it is too early to predict the future of the REIT movement

in India, it is through practice that this law will help us evolve stronger and industry

specific legislations over time. Today we have inculcated as much as we can from

developed and stronger economies. This is a forthcoming move on behalf of the

regulators but in order to meet the objectives of the REIT i.e attract capital from

domestic and overseas investors it is essential that the regulators not only bring this

legislation into force as soon as possible but also at the same time work on various

amendments and modifications. In the ever expanding global arena along with

regulations you require quick action to tap on opportunities because investors tend to

move fast between efficient market options.

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