Monday, October 21, 2013

The Resurgence of REITs


More than 5 years ago (in December 2007), SEBI had issued a consultation paper and draft regulations with a view to paving the way for the introduction of real estate investment trusts (REITs) in the Indian markets (which we had the opportunity to discuss here). However, the plan seemed to have gathered moss for a number of years.

Earlier this month, it was revived when SEBI issued another consultation paper and a draft of the proposed SEBI (Real Estate Investment Trusts) Regulations, 2013, seeking public comments (which are due on October 31, 2013).

REITs are an attractive instrument for financing in the real estate sector. It benefits promoters or sponsors of existing real estate projects by providing an exit option from their investments. It also enables investors who may be interested in investing in real estate as an asset class. Despite the perceived advantages of REITs, and their prominence in developed markets, the idea received limited attention in India. It is also not surprising that a handful of Indian real estate companies sought to list their securities in overseas markets. This is all set to change with the proposed regulations.

According to the consultation paper, REITs would be available primarily for completed, revenue generating real estate projects. In other words, under-construction projects as well as trading in real estate or undeveloped land would not fall within the purview of REITs, primarily due to the uncertainties involved.

In terms of the investment structure, the REITs will have to be set up as a trust, with a trustee, manager, sponsor as well as the valuer. The REIT will have to be registered with the SEBI before it can operate.

REITs’ units shall be initially issued through an initial public offering, following which the listing off the units shall be mandatory. In order to ensure that this facility is available only to large, and well-recognised projects, the minimum asset size is fixed at Rs. 1000 crores.  Similarly, there is also a minimum offer size as well as a minimum public float. At the outset, the idea appears to be to offer the units only to high net worth individuals and institutions. This is to ensure that only sophisticated investors with the requisite capacity to bear the risk are able to invest.

While there are customary responsibilities imposed on the trustee, manager, etc., there is a great emphasis on matters of governance, disclosure and transparency. For example, there is a detailed treatment of related party transactions that the trust may undertake. Moreover, there is a detailed focus on the valuation of the real estate assets held by the trust, and also appropriate disclosures regarding the same. This is important given the levels of fluctuation that real estate assets may experience from time to time. Clearly, the proposed regime seems to contemplate the possible risks in the real estate sector, and seeks to address them to the extent possible.

Overall, the proposed introduction of REITs in the Indian markets is timely. While the proposed regulations are fairly balanced in that they are on the one hand facilitative in nature, but on the other hand they are also protective of investors and markets (implemented through the imposition of several conditions on the establishment and operation of REITs).

At the same time, other issues need to be addressed as well. We have discussed this in our earlier post, and they continue to be relevant at the present moment as well:

There are other issues (that fall outside the direct ambit of the draft Regulations) that need to be ironed out before REITs can be implemented in practice. First, there are several industry-specific problems underlying the real estate sector. One important legal issue is the absence of clear title and the existence of incomplete contracts that plagues several real estate transactions in India. This enhances risks borne by investors in REITs. Therefore, it is imperative that there be stringent disclosure norms for issuance of securities by REITs that make it mandatory for issuers to qualitatively disclose these risks to investors. In other words, the offer document requirements to be prescribed by SEBI for REITs should encompass all industry-specific issues and matters that are associated with the real estate sector.

There is also a need for clarity on the position regarding taxation of REITs themselves as well as their investors, as also any stamp duty implications on the issue and transfer of the REITs securities. This is required to ensure smooth implementation of the regulations.

While SEBI’s announcement of REITs cannot be more timely, there is evidently a need for a comprehensive review of all aspects that have a bearing on REITs transactions before the mechanism can be put in place, so as to make its implementation successful.

Added to this list is the need for streamlining the foreign direct investment (FDI) regime if this sector is to attract foreign capital, which may be necessary given the potentially large sizes of offerings.

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