Indian real estate investment trusts: Impending growth

Transcription

1 Indian real estate investment trusts: Impending growth

2 Introduction: The story so far Real estate is one of the most critical sectors of any economy. A robust real estate sector, comprising subsegments such as housing, retail, hospitality and commercial properties, helps several other sectors develop simultaneously through the ripple effect. Recognising this, as well as the need for substantial investment on account of the capital-intensive nature of the real estate sector, in 2014, the Government of India put in place a regulatory framework for setting up of real estate investment trusts (REITs) in the country in order to encourage investment in this sector. REITs in India are regulated by the Securities and Exchange Board of India (Real Estate Investment Trusts) Regulations, 2014 (REIT Regulations). The Securities and Exchange Board of India (SEBI), through its consultative and pragmatic approach, has laid out a sturdy platform for the REITs market in India, which is not only customised in conformity with the domestic market conditions but also rationalised in light of the prevailing economic conditions. Further, other regulators such as the Reserve Bank of India, Pension Fund Regulatory and Development Authority and Insurance Regulatory Development Authority have taken cognisance of REITs as an investment product and have actioned enabling provisions in order to widen the institutional and retail investor base of REITs in India. A bold and clear tax regime has also been set out for REITs and their. The regulatory changes, coupled with clarity on taxation aspects, have put in place an all encompassing framework for successful REIT implementation in India. However, these efforts by policymakers are yet to be complemented by a forthcoming stakeholder class and, therefore, India is yet to witness its first REIT listing. While there is a visible interest amongst many of the marquee players to set up the REIT platform for providing exits to as well as monetisation, there are several apprehensions surrounding this new investment product. Thus, actual action has been slow and, in many cases, put in abeyance in favour of a wait and watch strategy. What are the potential reasons for this inertia? A steady start, although with minor hiccups While the Indian REIT Regulations seem near perfect, a deep dive reveals possible reasons for stakeholder apprehensions. A few of these issues are discussed below: One notable feature of the REIT Regulations is the mandatory listing of REIT units. While this requirement seems justified for developing a broad-based investor class, the flip side is that developers must compromise their majority control on projects in favour of retail. This and other related conditions regarding minimum offer size, minimum number of public unitholders and minimum public subscription threshold could be potential deterrents for certain developers, since they demand a shift from conventional ways. SEBI, as we know, is considered to be a progressive regulator. Notwithstanding its efforts, there is always some level of resistance within the business community for venturing into a regulated and compliance-heavy environment. Some of the small and mid-size developers teams may not have adequate bandwidth to meet such high-level of documentation and compliance needs, and the REIT Regulations, in most aspects, do not provide any lower compliance relative to a normal offering/listing. Yield expectations are another reason why developers are sceptical about taking their projects to a REIT. Government of India taxable bonds return around 8 percent on an annual basis. 1 The result being, that the developers are wary that there might not be many takers for their product unless the return provided matches or surpasses this threshold. Further, if post-reit, there is a slump in the market and the REIT yield drops on account of temporary high vacancy levels, the REIT units may start trading at a significant discount to the market value of the property. Given this, managing investor expectations and maintaining a consistent delta between the fixed income generating products and cap rates is essential for the success of REITs.

3 Notably, real estate deals continue to have traction in the private space. Private equity investments in the real estate sector touched a nine year high of nearly 6.01 billion USD in despite stakeholders not having actively started considering REITs as an investment option. In India, real estate projects are typically held through a special purpose vehicle (SPV) model. Under this model, a specific SPV is created for each project, which is either held solely by the developer group or as a joint venture with the owner of a land parcel. Some of these structures may not be REIT-ready and, therefore, a considerable amount of restructuring effort could be needed before the REIT model can be explored in such cases. Now, restructuring not only requires multiple stakeholder consents, but also has associated compliance requirements. Income tax and stamp duty implications could at times outrun the estimated benefits that the restructuring exercise could bring. In contrast, private share deals could be far less complex and easier to implement on account of the fewer parties involved and the limited objectives to be achieved. Brand perception could play an important role in defining the success of a particular REIT. It is believed to be fairly easy for big developers with considerable brand recall to raise public moneys through a REIT listing. On the other hand, for small developers with a limited brand and corporate image, generating a similar sort of interest in the markets could be a challenge, even if their projects are comparatively superior or strategically located. To counter this, we may see some consolidation activity wherein small players join hands before they take their products to a REIT market where it can potentially compete with real estate giants. While the onset and further success of the REIT era in India cannot be predicted with any level of certainty, the concerns discussed above can be explained as the normal gestation for any new investment product as stakeholders, and markets make a shift from conventional unregulated environments to a structured regimebased environment. An immediate and obvious example of this is the Singapore REIT market, which is also one of Asia s largest REIT markets. REITs were launched in Singapore in 1999 and the first Singaporean REIT listing was made only in Given that the Indian market is more complex and highly unstructured at present, clearly, it will take its incumbent time to pave the way for REITs. 1 8% savings (Taxable) Bonds, 2003 launched vide notification dated 03 April 2003, Ref no. CO. DT /H-3836/ As per the June 2017 edition of Indian Brand Equity Foundation report

4 Migration to REITs What are the ideal structures which could be set up as a precursor to the REIT structure? What issues could crop up during migration to the REIT structure? REITs in India are modelled as a yield-generating platform. The REIT Regulations require that at least 80% of REIT assets should comprise completed and rent-generating properties. This condition makes it inevitable for developers to first construct the projects under a development platform and, once the project is ready and rent-generating, migrate it to a REIT. REITs could be an ideal exit option, especially for developers stuck with huge projects in the absence of institutional who are ready to invest the requisite funds. From a sponsor holding perspective, while the REIT Regulations prescribe that the sponsor and sponsor group are to hold at least 15% of the outstanding units of the REIT at all times (individual holding of each sponsor not being less than 5% of the outstanding units of the REIT), divestment of such continued holding is possible post three years from the date of listing of the REIT units. Alternative investment funds (AIFs), which are privately pooled investment vehicles that collect funds from domestic and foreign in accordance with a defined investment policy, have become a preferred structure for undertaking real estate development. Thus, an eventual REIT plan could be initiated by first pooling moneys from private under an AIF model for the development phase. Development could then be undertaken under the SPV structure. As and when the projects are completed, the AIF could sell the stake in the SPV to a REIT, thereby giving exit to the private. While various structures can be explored for migration from the AIF to REIT structure, the glaring issue continues to be the tax implications of such a migration. If the exit timing for all projects developed under a single AIF coincide, a simple structure like cancellation of AIF license and obtaining registration as a REIT (in the case of AIFs constituted as a trust) could be considered. Though the actual impact of such re-registration of an AIF as a REIT from a taxation and stamp duty standpoint would need to be evaluated, there could be a strong case for nil capital gains tax and stamp duties, which could otherwise be associated with migration to a REIT structure.

5 Domestic Foreign AIF Development of assets in an SPV under an AIF model. Once the assets are ready: Transfer stake in the SPV to a REIT Explore possibility of conversion of the AIF licence to a REIT licence SPV Also, the REIT Regulations provide that REITs are required to make their initial offer within three years from the date of registration with SEBI. This three-year window could help the developer/ to transfer all projects from which an exit is needed and also build a reputation to encourage demand for their units when listed. Domestic Foreign AIF Development of assets in SPV under REIT; however, the REIT is not listed until 3 years or the time that the assets are ready, whichever is earlier. Developer/private could be allowed an exit (partial or complete) prior to listing. SPV It is also to be noted that currently, only swap of shares in SPVs formed as companies with units of REITs is treated as a tax-neutral event; property transfers from SPVs or property holding companies to REITs are subjected to levy of income tax as well as stamp duty. A positive outlook Acknowledging the significance of REITs in India, the scope of institutions eligible to invest in REITs is being widened by the government so as to boost the availability of funds to REITs. This is evident from the recent circulars enabling the participation of banks, pension funds and insurance companies in REIT units. Further, SEBI has classified investment in REIT units as hybrid instruments, thus enabling mutual funds to invest in REIT units. This is expected to encourage participation by domestic players in REITs. The eligibility of large institutional to invest in REIT units will no doubt attract domestic developers to this opportunity. However, the fact remains that liquidity of REIT units once listed could be low as a result of the minimum trading lot requirements. Also, units that are not frequently traded on the stock exchange could trade at a substantial discount, thus further affecting the public demand for these units.

6 Conclusion The REIT model has been effectively implemented in several countries. Further, in many of these countries, the REIT market has grown exponentially in terms of market capitalisation. Understanding the domestic real estate sector conditions and accordingly moulding the regulatory framework for REITs have been recognised as the prerequisites for establishing a thriving market for REIT units in India. The REIT Regulations have made the intention of SEBI to go this extra mile clear. In the near future, we could expect Indian REITs to increase the depth of the Indian property market with higher transparency and governance standards. While the market for REITs is still at a nascent stage in India, infrastructure investment trusts (InvITs) being the REIT counterpart in infrastructure sector, are relatively ahead of the curve. Though the first REIT if yet to be listed, we have already seen a few InvIT listings, with a few more in the pipeline. However, with various enabling factors such as the growth of the economy and increasing financial literacy, along with the government push to the real estate sector, the future of the Indian REIT market is no doubt bright. Contacts Abhishek Goenka Partner and Leader, Real Estate Tax abhishek.goenka@in.pwc.com Bhairav Dalal Partner, Tax and Regulatory bhairav.dalal@in.pwc.com About PwC At PwC, our purpose is to build trust in society and solve important problems. We re a network of firms in 157 countries with more than 2,23,000 people who are committed to delivering quality in assurance, advisory and tax services. Find out more and tell us what matters to you by visiting us at In India, PwC has offices in these cities: Ahmedabad, Bengaluru, Chennai, Delhi NCR, Hyderabad, Kolkata, Mumbai and Pune. For more information about PwC India s service offerings, visit com/in PwC refers to the PwC International network and/or one or more of its member firms, each of which is a separate, independent and distinct legal entity. Please see structure for further details PwC. All rights reserved About GRI Club The GRI Club is a global fraternity of real estate leaders. Members find the club a useful way to maintain valuable relationships, find new business partners, and strengthen their global networks. GRI Club India organises Club Meetings in Mumbai, Delhi and Bangalore to cover a specific theme, sub-sector or micro-market and are exclusive to members. In addition, Open Events bring nonmembers and members together for high level debates with global. The relaxed and collegial environment helps members build personal friendships with like-minded business partners. Data Classification: DC0 This document does not constitute professional advice. The information in this document has been obtained or derived from sources believed by PricewaterhouseCoopers Private Limited (PwCPL) to be reliable but PwCPL does not represent that this information is accurate or complete. Any opinions or estimates contained in this document represent the judgment of PwCPL at this time and are subject to change without notice. Readers of this publication are advised to seek their own professional advice before taking any course of action or decision, for which they are entirely responsible, based on the contents of this publication. PwCPL neither accepts or assumes any responsibility or liability to any reader of this publication in respect of the information contained within it or for any decisions readers may take or decide not to or fail to take PricewaterhouseCoopers Private Limited. All rights reserved. In this document, PwC refers to PricewaterhouseCoopers Private Limited (a limited liability company in India having Corporate Identity Number or CIN : U74140WB1983PTC036093), which is a member firm of PricewaterhouseCoopers International Limited (PwCIL), each member firm of which is a separate legal entity. PD/June