REIT or Real Estate Investment Trust is a collective fund which collects funds from various types of investors and then invest the funds on their behalf in Real Estate (either via debenture route or via equity route). They traditionally prefer growing mid-size cities in particular as the multiplication is more. Also, they invest in both residential as well as commercial properties.
Modeled based on mutual funds, REITs provide investors either periodic income or long-term capital appreciation. To qualify as a REIT the company should have 75% or more of their investment in Real Estate; also derive more than 75% of the gross income from Real Estates. Thanks to Piramal group and their brand IndiaReit the “Real Estate Investment Trust” (REIT) was already present in India little more than a decade, yet only after SEBI’s nod for these in late 2014 made this innovative asset class both affordable and catchy at the same time.
Now REITs can also pool in money from investors openly like the Mutual Funds. Also previously REITs were available only through Private Placements, but now they are available for open purchase. According to SEBI, the minimum permitted Asset under management will be 500 Cr, out of which the IPO should not be less than 50% of that figure.
Traditionally in India REITs were investing in two primary and cardinal methods. The first one is through non-convertible debentures, offering high coupons (close to 1.75 times than that of PLR). Secondly REITs in India used to invest in the equity zone of the target companies. However, the profits could then either be through the dividend route or through the capital gain’s route. If we turn our observation to REITs in early 2000 and even mid-2000, we will be able to identify that most of them used to invest bulk of the money (7% and more) through the debenture route.
The debate is whether they are manufactured for risk-averse investors or risk-taking investors. Some believe that as most of the funds came through debenture or fixed income route so this will be a suitable ideally for a low-risk taker. The other school of thought, however, believes that even in that case also, the credit rating of those real estate companies are low, and the coupon offered is quite high compared to the debt instruments available in secondary market for sell makes it a risky affair.
Though IndiaReit and HDFC Realty have stuck to this proven formula of 70-80% debentures others have different ideas as well. Motilal have an existing REIT with 20% equity and 80% Mezzanine funding (could be debt and depending on certain situation it could be converted into equity in no time). Now as the Debt returns are slowly on the verge on a steady decline, and equity prospects look better both in valuation as well as from sentiment terms, all the market players in REIT segment (be it old war horse IndiaReit, HDFC Realty or newbies Motilal and Ask Property) are all shifting gears.
Another interesting way of looking into the problem is that if a continuous fund doesn’t come into the funds, interest payment to unit holders comes under pressure. Under that circumstances, equity seems a safer bet. At the same time, many firms have received funds during the property boom of 2005-07 and as equity too. Currently. those are stuck as there is a negative valuation gap. So, the balance is the call of the day. Union budget of 2015 brought a rising smile to the face of all the participants in REIT business in India.
Long Term Capital Gain while exiting a project as equity in REIT becomes Tax-Free post budget 2015. So now the REIT units are exempt from LTCG completely. Previously the interest earned on debentures held by REITs Government used to Tax twice (once at REIT level and once at investor level). So now with the new rule it would be taxable only once (at the investor level).
However DDT in REIT, while SPV is transferring equity to REIT is still going strong @15%. All these interesting points discussed above signals to the re-birth or rejuvenation of a new category i.e. REIT.
