Realty investment trusts: Regulation key to success

With the floating of draft norms for listing real estate investment trusts (REITs), markets regulator Securities and Exchange Board of India (SEBI) has revived the 5-year-old proposal, paving the way for opening new avenues for retail investors for safe and transparent investment in real estate while providing a life-line to fund-starved developers.

Currently, because of the prohibitive property prices, a large number of retail investors can not afford to invest in real estate. Even the close-ended real estate funds presently in operation with an investment cap of Rs one crore are beyond the reach of majority of ordinary investors.

Moreover they are apprehensive of investing in real estate due to low transparency and fears about the safety of investment in view of increasingly large number of delivery defaults. Retail investors are highly conscious about the safety of their capital over capital appreciation and attractive returns.

However, with REITs, the safety of investment could be ensured as unlike physical real estate transactions, those under this new scheme will be regulated. Also, the REIT rules that prescribe 90 percent investment in completed projects and 75 percent in leased income-generating properties provide a safety net to investors who will be insulated from the malpractices associated with real estate transactions.

And REITs are investor- friendly as unlike physical real estate which lacks liquidity, investment in REITs is liquid and exit is as easy as in the stock market.

The realty trusts, which are an extension of mutual funds, will facilitate retail investors to buy listed units like stock market shares. They will be investing directly in income-generating assets or through special purpose vehicles and investors can reap the benefit of regular return on investment.

Besides investors, REITs are equally beneficial for real estate developers as they provide an excellent platform to cash-strapped developers to generate funds without development risks, especially those developers who are sitting over good income-generating assets.

The extent of business opportunity can be gauged from the fact that 400 msf of commercial office and mall properties are currently available in the market. And to make most of this opportunity, developers like Parsvnath have already announced their plans to list their income-generating assets as REITs to raise money.

Due to their high liquidity and easy exit options, REITs come as a good business opportunity for PE funds who are sitting over huge funds but are reluctant to deploy them as exits are difficult. But now with REITs, they will be putting in more money, in turn helping developers who are struggling to cope with a liquidity crunch.

Already leading PE funds like Blackstone, Xander, Tata Realty and Infrastructure and Kotak Realty have made public their plans to launch REITs. It is an equally big opportunity for funds-turned-developers.

But then the high tax structure in the form of capital gains tax, tax on rental income and price appreciation, division and distribution tax and securities transaction tax, casts its shadow over REITs which in their present form lose much of their sheen as an attractive investment option.

SEBI has however proposed to amend norms to make REITs more tax-friendly. Industry bodies are also demanding a single-point tax structure - be it at the asset level or at the distribution level. But in view of the upcoming parliamentary elections, the final guidelines of REITs may not come before the second quarter of 2014 and it may take more than a year before REITs become operational.

Along with tax-related issues, the regulatory concerns also need to be addressed before REITs are launched. In the past, several companies that raised funds through REITs on the London Stock Exchange, saw their stock prices crashing due to defaults in the delivery of real estate projects and investment mismatches.

So, considering the risks involved in real estate investment due to lack of transparency and regulatory mechanism, the government needs to come up with all necessary safeguards to ensure safety of investment. And it will be a wise move if Real Estate Regulatory Bill is implemented before the launch of REITs to realize their full potential in spurring capital inflows and investor confidence for the speedier and sustained growth of real estate.