REAL ESTATE INVESTMENT TRUSTS (REIT) New Regulations BFSI & Capital Market Study Group November 29, 2014 CA. Gaurav R. Shah 1
REIT REAL ESTATE INVESTMENT TRUST
REIT STRUCTURE What is a REIT? A Legal entity that owns, and in most cases, operates income-producing real estate and in some cases finance also Generally REITs must distribute most portion of its after tax income to shareholders annually in the form of dividends. (e.g. As per proposed SEBI regulations, not less than 90% of its annual net income after tax shall be distributed in the form of dividends) The REIT structure was designed to provide a similar structure for investment in real estate which mutual funds provides for investment in stocks Types of REIT EQUITY generates income from property ownership and operation MORTGAGE provide a source of loan to property owners and operators directly or via collateral bonds HYBRID a mixture of the above two types 3
CHARACTERISTICS OF A REIT Tax Concession Minimum Payout Ratio Better Investor Protection (Limit on Leverage, restriction on development activites etc) Relatively stable income High Liquidity Management Expertise Access to large and high quality projects / properties Diversification Economy of Scale Low Transaction Cost Focus on Property Investment but without becoming a landlord 4
ADVANTAGES OF A REIT High liquidity Transparency Tax benefit High dividend yield Inflation hedge Portfolio diversification Lower risk 5
Risks of REIT 6
RISKS OF A REIT Market Risk REITs are traded as stock in trading exchange, prices are subject to demand supply Income Risk Dividends may not be paid if REIT incurs operating loss Higher cost of debt, Renewal of tenant at lower rent Concentration Risk Substantial portion of investments from one or few properties Liquidity Risk REIT fund relatively less liquid as compared to funds which invests in Stock and bonds Leverage Risk In case of insolvency debt holders will have preference in repayment Refinancing Risk 7
REIT VS. DIRECT PROPERTY INVESTMENT REIT Properties Revenue Property Income - Interest Payment (depends on leverage) - Landlord's Expenses - Management Expenses Net Income Yield Operating income - Tax Net Income x Payout Ratio Dividend Dividend Yield 8
REIT DEVELOPMENT Satwalekar Committee on Real Estate Funds Venture Capital Funds allowed to Invest in Real Estate in 2004 SEBI issued draft Regulations for REITs and REMF in 2008 Regulations shelved post Global Financial Crisis SEBI issued revised draft Regulations in October, 2013 Government gives Pass through status for REITs in July, 2014 SEBI Notifies final regulations in September, 2014 9
REIT Regulations, 2014 10
REIT LEGISLATIVE MODEL Minimum Public Float > 25% REIT Units Sponsor ** **Minimum Sponsor Investments >=25% first 3 Years Lock In >=15% Post Lock In Real Estate Properties REIT Holders* SPV >=80% REIT Trustees >=50% Real Estate Properties Banks <49% of value of REIT Manager 11
REIT REGULATIONS, 2014 Eligibility of Manager Net worth of 10 Crores Manager and two key personnel should have relevant experience of 5 At least half of the members of Investment committee should be Independent and not related parties Eligibility of Sponsor Net worth of at least 100 Crores on collective basis At least 20 crore Net worth on Individual basis At least 5 years of experience in the Real Estate Industry 12
REIT REGULATIONS, 2014 Eligibility of Trust/Trustee Registered trust and trust deed with main objective as undertaking the activity of REIT No Preferential voting rights, no multiple class of units The trustee to REIT should be registered with SEBI under SEBI (Debenture Trustees) Regulations, 1993, 50% of its directors are Independent and not related parties to the REIT Eligibility of Principal Valuer Not an Associate of parties to REIT At least 5 years of experience in valuation of Real Estate 13
REIT REGULATIONS, 2014 Rights and Responsibility of Trustee Not allowed to invest in REITs Cannot be an associate to the Sponsor, Manager or Principal Valuer Responsibility for supervision, appointment, removal of the Manager. Obligation to ensure that the REIT is operating in accordance with the provisions of the trust deed, the offer document and the Regulations. Rights and Responsibility of Manager Identifies, recommend investment and manage the REIT assets, manage either directly or through the appointment and supervision of appropriate agents. Ensure that REIT Assets have legal and marketable titles and all the material contracts are legal, valid, binding and enforceable. Shall appoint the principal valuer, any other valuer(s),auditor, registrar and transfer agent, merchant banker, custodian and any other intermediary/service provider/agent for managing the assets of the REIT Ensure Computation of NAV as per Valuer and declares REIT NAV once every six month. 14
REIT REGULATIONS, 2014 Rights and Responsibility of Principal Valuer Principal Valuer is a "registered valuer" under Section 247 of the Companies Act, 2013. Shall not invest in units of REIT. High standards of service, exercise due diligence, ensure proper care and exercise independent professional judgment Principal Valuer shall be changed not less than every 2 years Cannot do valuation of same property for more than 4 years Rights and Responsibility of Sponsor Shall set up the REIT and appoint the trustee of the REIT Shall hold 25% of the total units prior to initial public offer with a lock in of 3 years from the date of the listing of such units. Units exceeding 25% shall be locked in for a period of 1 year from the date of listing of such units. Minimum holding shall not fall below 15% of the outstanding REIT units at all times. After 3 years from the listing, sponsor can to sell units below minimum holding by arranging another person/entity to act as a Sponsor and obtain approval from unit holders. 15
REIT REGULATIONS, 2014 LISTING CONDITIONS:- Registered REIT with Minimum assets of 500 crore. Offer size is of 250 Crore and minimum public float of 25% of the value of the REIT Face value of one unit of the REIT shall be rupees one lakh and Minimum application for public offer is two lakhs. Initial offer and follow-on offer will be open for subscription for a period of 45 days and 30 days respectively. 16
REIT REGULATIONS, 2014 LISTING CONDITIONS:- Money collected from all applicants shall be refunded within 15 days In case REIT Issue is not subscribed at least 75% of the issue size, or subscribers to the issue are less than 200 in numbers. REIT can retain oversubscription to the extent of 25% of the issue size. REIT shall be mandatory to be listed on stock exchange in 15 days No. of Unit holders should be more than 200 17
REIT REGULATIONS, 2014 INVESTMENT CONDITIONS:- Not less than 80% of value of the REIT assets shall be invested in completed and rent generating properties. Not more than 20% of value of the REIT assets shall be invested in:- Developmental properties and non rent generating completed property (Restricted to 10%) Listed or unlisted debt of companies Mortgage backed securities Equity shares of Listed Real Estate companies Government securities Money market instruments or Cash equivalents 18
REIT REGULATIONS, 2014 INVESTMENT CONDITIONS:- Shall hold at least two projects, not more than 60% of the value in one asset At least 75% of the revenue other than capital gain on disposal of assets shall be from rental, leasing of real estate Shall not invest in the units of other REITs At least 75% of the value of REIT should be rent generating SPV shall hold 80% in property directly and shall not invest in other SPV Shall not invest in vacant land or agricultural land or mortgages other than mortgage backed securities. 19
REIT REGULATIONS, 2014 INVESTMENT CONDITIONS:- Shall not undertake any lending to any person (Investment in Debt Security is not considered lending) 90% of net distributable cash flow of the REIT shall be distributed to the unit holders Distribution once every six months In case of sale of property, if the proceeds reinvested than no requirement of distributing it to unit holders No schemes to be launched under REIT REIT should have controlling interest in SPV (i.e. more than 50%) 20
REIT REGULATIONS, 2014 BORROWINGS AND DEFERRED PAYMENTS: Aggregate consolidated borrowings and deferred payments of the REIT shall never exceed 49% of the value REIT assets. For any further borrowing above 25% of the value of the REIT asset approval of Unit holders and credit rating from credit rating agency shall be obtained. VALUATION: To be conducted by Registered Valuer Property shall not be purchased at 110% of the value and shall not sell at 90% of value as assessed by Valuer. No valuer shall undertake valuation of the same property for more than four years. 21
22 TAXATION
TAXATION REITs accorded pass through structure to avoid double taxation in Finance Bill, 2014 Tax treatment for Investors: Treatment of listed REITs unit akin to listed shares Long term capital gain (if units held for more than 36 months) would be exempt Short term capital gain would be charged @ 15% Dividend received from trust exempt from tax Interest income received from trust subject to 10% witholding tax (5% for Non Residents) Tax treatment for Sponsor: Transfer of shares of the SPV in exchange for issue of units of the REIT exempt from capital gain tax Capital gain tax on the disposal of units No benefit of exemption from LTCG and special rate of 15% for STCG Holding period of the shares in SPV would also be included in reckoning the holding period of the units Shall deduct 15% Dividend Distribution Tax on any Dividend distribution 23
TAXATION Tax treatment for REIT: Dividend received from SPV exempt (Since the same is subject to Dividend distribution tax) Interest from SPV not taxable as the same is accorded pass through status Capital gain tax on disposal of any asset All other income shall be charged at maximum marginal tax of 30% Shall deduct 10% withholding on the interest income distributed to unit holders and 5% in case of non resident unit holders 24
TAXATION Tax Issues Sponsor has to pay tax on the entire gain including appreciation for holding REIT units Capital gain to be charged to Sponsor when property transferred directly to REIT (Same is Exempt when the share SPV is transferred) Exchange of shares of SPV for REIT units is exempt in the hands of Sponsor, but the sponsor is still liable to MAT Dividend Distribution tax over and above normal corporate taxation of 30% would reduce the Rental yield and make investing in REIT less attractive Holding Period for Units to be classify as Long term is 36 months, as compared to 12 months for Equity Views are to make REIT a complete pass-through Vehicle 25
REFERENCES SEBI Website Finance Bill, 2014 26