Dr. Arun Draviam’s

Devendra Mishra; Prabhakar Pandey; Saman Rizvi; Aditya Arya;

Arnab Bhattacharya; Shreeharsha TV; Ankit Karmakar;

AIM, New Delhi

3rd Mar, 2014

REIT Prospects In India

Real Estate Investment Trusts A Real Estate Investment

Trust or REIT is a company that owns and operates income-producing real estate

REITs are also known as Real Estate Stocks

Some REITs not only operate, but also finance real estate

REITs provide an alternative way of holding Real Estate properties without physically possessing them.

History

REITs were first created in the US in 1960’s to give anyone and everyone the ability to invest in large-scale commercial properties.

Legalized in 2001 in the USA and 2007 in UKREIT Law Passed in India in 2013.

REIT Basics…The shares of most REITs are publicly traded on major stock exchanges

The US Congress created the legislative framework for REITs in 1960 to enable the investing public to benefit from investments in large scale real-estate enterprises

REITs provide ongoing dividend income along with the potential for long-term capital gains through share price appreciation

It is also a powerful tool for long-term portfolio diversification

Categories of REITs…

Equity REITs own and operate income-producing real estate

Mortgage REITs lend money directly to real estate owners and their operators, or indirectly through acquisition of loans or mortgage backed securities

Hybrid REITs are companies that both own properties and make loans to owners and operators

REIT sectors… REIT offers investors alternatives across a

broad range of real-estate properties:-

Benefits Ownership of REIT increases investors’

total return and / or lowers the overall risk in both equity and fixed income portfolios due to diversification.

Dividend growth rates for REIT shares can outpace inflation.

REIT business enterprise is based in large part; on the value of tangible and quantifiable assets, namely large scale commercial real state.

REIT Is Like Any Other InvestmentLiquidity – REITs are traded on all major stock exchanges like any other publicly traded company.

Shareholder Value – REIT shareholders receive value in form of both dividends and price appreciation

Active Management – REITs are professionally managed and adhere to corporate governance principles

Disclosure Obligations – REITs are required to provide regular financial disclosures and audited financial statements

Limited Liability – Shareholders have no personal liability for debts incurred by REITs

Investor Participation…Individual investors can participate broadly in opportunities available in the REIT industry through REIT mutual funds.

These REIT mutual funds are managed by portfolio managers with a high degree of expertise in the real estate industry.

REIT mutual funds provide investors with a cost-effective opportunity to add to a balanced investment portfolio .

REIT mutual funds offer diversified exposure to the real estate asset class

Valuation of REIT’sNAV calculation – The REITs’ total

assets minus all liabilities, divided by all outstanding equity shares of the REIT yields the NAV

Value of a REITs’ property assets can be enhanced through capital expenditures. This is significant because these expenditures, either for development or maintenance of property, can maintain or increase NAVs

REIT was introduced in Singapore in the year 2002.

REITs distribute at least 90% of their income to unit holders in return for tax concessions from the Singapore Government.

The majority of REITs listed on the SGX invest in property assets pertaining to hotels & lodging, industrial & office, residential, retail and healthcare.

REIT Singapore

SGX provides retail investors with a compendium of different REITs specializing in different sectors, hereby providing inherent diversification of portfolio.

Subject to strict regulations imposed by the Monetary Authority of Singapore, S-REITs offer better transparency and corporate governance that many other corporate sectors.

dividends, derived in part from rental income are strongly correlated with the high occupancy rates of assets, renewal of leases and better valuations of property in land-scarce Singapore

More REIT Singapore

The type and quality of a REIT’s assets is an important factor affecting generated income.

Categorizing of REITs by the type of property assets is done because REITs are pro-cyclical investments.

Many of the S-REITs rely substantially on debt to finance property acquisitions.

Rising interest rates adversely affect REITs laden with high debt to equity ratios However, with expansionary monetary policy and strong repository of foreign reserves, Singapore is well fortified against such radical changes in the economy.

Evaluation in Singapore

The biggest challenge in Singapore is the shortage of land.

The high gearing REIT of Singapore may find difficulty in debt refinancing and may therefore be forced to take measures to depress its price.

In October, 2012 the government introduced further belt-tightening measures in Singapore to curb the speculative residential property market by imposing caps causing a slow down in real estate.

Challenges for Singapore REIT

The UK REIT Industry has been seeking a REIT vehicle for

many years.

Pressure on Government and Treasury for change:

External – SIICs etc.Capital Flow OffshorePensions issues – poor performance of equities etc.

Clear appetite for real estate: buy-to-letUrban Task Force / Barker Report

The UK REIT, January 2007 Company and Listing Rules

Must be a closed ended companyMust be listed on main stock exchange (LSE not AIM)

Must have one class of (voting) sharesMust be resident in UK for tax purposesRestrictions on large share-holdings (10% rule)

Activity RulesDefine a Tax Exempt Business (ring-fenced)75% of firm’s profit from real estate (rents)75% of firm’s assets = real estateMust have three properties (not owner occupied)Development activity OK for portfolio building (3 year rule)

The UK REIT, January 2007 Other Constraints and Rules

Gearing rule: Profit/Finance Costs 1.25Conversion charge 2% of GAV – may be phased

Tax and DistributionTEB not subject to corporation tax90% of profit must be distributed as Property Investment Dividend (PID)

PID subject to withholding tax and treated as property income for shareholders

Capital allowances set against income in profits calculation

Cannot offset losses inside/outside TEB

The UK REIT – Issues and Problems

Establishing a Critical MassConversions of Property CompaniesNew entrants and listing requirementsThe offshore industry and REITs

Specialist or Diversified Vehicles?Professional versus retail investorsInvestor interests versus management interests

Returns and Market ExpectationsREITs as an income vehicleProperty values, yields and distributionsGrowth, retained earnings and distributionsThe state of the market and investor confidence

The REIT shall be set up as a Trust under the provisions of the Indian Trusts Act, 1882. REITs shall not launch any schemes.

The REIT shall have parties such as trustee (registered with SEBI), sponsor, manager and principal valuer.

The Trust shall initially apply for registration with SEBI as a REIT in the specified format. It shall fulfil eligibility criteria as specified in the draft Regulations.

SEBI, on being satisfied that the eligibility conditions are satisfied, shall grant the REIT certificate of registration.

REIT India

In the beginning…After registration, the REIT shall raise funds initially through an

initial offer and once listed, may subsequently raise funds through follow-on offers.

Listing of units shall be mandatory for all REITs. The units of the REIT shall continue to be listed on the exchange unless delisted under the Regulations. Provisions for delisting have also been specified in the Regulations.

For coming out with initial offer, it has been specified that the size of the assets under the REIT shall not be less than Rs. 1000 crore which is expected to ensure that initially only large assets and established players enter the market.

Further, minimum initial offer size of Rs. 250 crore and minimum public float of 25% is specified to ensure adequate public participation and float in the units.

The REIT may raise funds from any investors, resident or foreign. However, initially, till the market develops, it is proposed that the units of the REITs may be offered only to HNIs/institutions and therefore, it is proposed that the minimum subscription size shall be Rs. 2 lakhs and the unit size shall be Rs. 1 lakh.

Why India needs REITS

• Reits will provide an avenue to real estate developers to commercialise developed property, providing an exit avenue.

• It will also provide overleveraged companies an opportunity to deleverage. It will increase the depth of the Indian real estate market and provide additional liquidity.

• Reits would also enable people to channelise their  investments into India's realty sector through a regulated mechanism. Since the investment in Reits is asset-backed, it is ideal for investors wanting to invest in real estate without the hassle of checks on property titles and the plethora of regulatory approvals.

• Considering the current economic slowdown and paucity of funds, Reits are expected to infuse a fresh lease of life into an otherwise choppy market.

Details

The obvious road blocks are taxation of Reits, foreign investments in Reits and stamping of agreements relating to transfer of property to the Reits. In addition to these stumbling blocks, there is a need to fix the following issues to make the Reit regulations workable.

One of the basic premises of the draft Reit regulations is the need to provide an exit avenue and liquidity. However, the definition of "real estate" seems rather constricted. The definition of "real estate" or "property" should be broadened to include all commercial and residential property and completed infrastructure assets such as roads and highways that have a regular income flow.

Challenges

The investors shall have right to remove the manager, auditor, principal valuer, seek delisting of units, apply to SEBI for change in trustee, etc.

An annual meeting of all investors is mandatory to be convened by the Trustee wherein matters such as latest annual accounts, valuation reports, performance of the REIT, approval of auditors & their fees, appointment of principal valuer, etc. shall be discussed.

Approval of investors has been made mandatory in special cases such as certain related party transactions, any transaction with value exceeding 15% of the REIT assets, borrowing exceeding 25%, change in manager/ sponsor, change in investment strategy, delisting of units, etc.

In order to ensure that a related party does not influence the decision, it has been specified that any person who is a party to any transaction as well as associates of such person(s) shall not participate in voting on the specific issue.

Rights of Investors

Keeping in mind that transparency has been a cornerstone of the REIT industry globally, detailed disclosure requirements have been specified in the proposed Regulations.

Minimum disclosure requirements in the offer document/follow-on offer document have been specified in the proposed Regulations. Further, minimum disclosures have also been specified for the annual and half-yearly reports to be sent to the investors.

Certain event-based disclosures have also been specified. Further, the REIT shall additionally be bound by periodical disclosure requirements required under the listing agreement with the exchanges

Disclosures

Investment conditions and

dividend policy 90% of the REIT value should be invested in revenue

generating properties and 10% in other assets as specified in the proposed Regulations.

To ensure regular income to the investors, it has been mandated to distribute at least 90% of the net distributable income after tax of the REIT to the investors.

The REIT shall not invest in vacant land or agricultural land or mortgages other than mortgage backed securities. Further, the REIT shall only invest in assets based in India.

Investment up to 100% of the corpus of the REIT has been permitted in one project subject to the condition that minimum size of such asset is not less than Rs. 1000 crore.

To ensure that the underlying assets of REIT are valued accurately, requirement of a full valuation including a physical inspection of the properties has been specified at least once a year.

A six monthly updating in the valuation capturing key changes in the last six months has also been specified.

The NAV shall be declared at least twice in a year. Provisions have also been specified for valuation in case of any material development.

Any purchase of a new property or sale of an existing property, it has been required that a full valuation be undertaken and the value of the transaction shall be not less than 90% and not more than 110% of the assessed value of the property for sale/purchase of assets respectively.

Valuation of assets

Real Estate Holding

House LandCommer-cial Build-ings

Other

Market Survey Investment In Real Estate

Yes No6.5

7

7.5

8

8.5

Do you hold RE investments?

Do you hold RE invest-ments?

Investment In Real Estate

38%

17%

17%

29%

Why Invest in RE?

Security Security

Social Status

diversify portfolio

Normal Course of Life

Other

57%19%

19%

5%

Why Not Invest in RE?

Cost

Upkeep

Non-Current

Other

86%

14%

Are You Aware of REIT?

NoYes

Market Survey REIT Awareness

47%

27%

27%

Would You Invest in Demateialised RealEstate?

YesNoSkeptic

Market SurveyOpeness to REIT

20%

7%

73%

Do You Think De-materialised RE is a

Good Idea?

YesNoI Don’t Know

Homes are the most held Real Estate property among in Indian Individual Investors.

Cost is the biggest reason for not being able to invest in real estate.

Awareness of holding real estate in portfolio is good.Dematerialized form of Real Estate is a new concept in India and

awareness about REIT is poor. Investors are aware that dematerialized form of property

provides opportunity for holding real estate units at affordable price.

REIT promises to make real estate more affordable and with in reach of an average investor.

With enough awareness and proper regulatory guidelines, REIT can prove to become a promising avenue for investors of India.

Results, Interpretation & Conclusion

Q&A

Referenceswww.investopedia.comwww.reita.orgIntroTo Singapore REITS – NUS Students’ Investment SocietyConsultation paper on draft SEBI (Real Estate Investment Trusts) Regulations, 2013