SEBI (Securities and Exchange Board of India) is redrafting the guidelines for REITs (Real Estate Investment Trust). They plan to release the guidelines ahead of the 2014 general elections. REITs fall under the ambit of Alternative Investments category. REITs are real estate investment companies or trusts which invest in real estate. Equity REITs invest in shopping malls and healthcare avenues and offices and commercial real estate. They rent out the commercial space they own and whatever rental income is generated is the income of the Equity REIT. An equity REIT is required under the US laws to distribute at least 90% of its rental income as dividends to the unitholders.
SEBI may initially allow only financial institutions (FIs) and high networth individuals (HNIs) to invest in Equity REITs. The retail investors may be allowed after successful running of the REIT for at least three years. Mortgage REITs on the other hand fund mortgages by loans or by buying mortgage backed securities. They have interest income. In the USA, 90% of the REITs are Equity REITs and 10% of the REITs are Mortgage REITs. It seems SEBI will be allowing Equity REITs in India.
The introduction of REITs in India is a welcome step. SEBI has mandated that at least 90% of the income of REITs in India needs to be distributed as dividend income amongst the REIT unitholders. This is in line with international best practices. For investors seeking good regular income, this would be welcome news. The US experience has been that Equity REIT returns (capital appreciation) are less than the returns (capital appreciation) on high growth stocks but more than that of corporate bonds.
So an investor who prefers regular income with capital appreciation which is more than that offered by corporate bonds could opt for this vehicle of investment. In 2012, REITs paid US$ 29 billion to investors. This also serves the purpose of portfolio diversification. Having only equity in the portfolio can be extremely risky and volatile. Stock market gyrations are a well documented phenomenon and India is particularly vulnerable as FIIs (Foreign Institutional Investors) chase returns all across the globe, pulling out money from economies where growth is slowing to economies where growth is promising.
The recent phenomenon has been that FIIs have been pulling out money from the Indian stock markets and other poorly performing markets and investing in Japan, Pakistan etc. Thailand has also seen FII outflows along with Indonesia. Secondly, the dividends which REITs pay are a tax deductible expense for the Equity REITs. There are many REITs in the USA which distribute 100% of their income as dividends and do not pay any corporate tax.
REITs also provide an investor to be a part of the fast growing real estate market. There would be many investors particularly retail investors who, at the most, can afford a house and maybe a commercial shop or office space. But these investors would certainly like to be a part of the real estate boom and benefit from it. Equity REITs enable them to participate in the real estate boom. For example, in business areas or commercial areas of metros (for example Delhi or Mumbai or Bangalore or Chennai or Hyderabad) the appreciation in value of the commercial office space or shops is astronomical and at mind boggling rates but what appears on paper is, at best, 10% to 15% of the actual appreciation.
This means that the government of India receives at best 10% capital gains tax. This also leads to the next conclusion that deals are done with a fraction of the sale price in white money and a lion’s share in black money. This adversely impacts both the buyer and the seller and of course the Government. The buyer has to arrange to pay for a major portion of the cost price of his purchase in kuchha or black money. I don’t think that all buyers want to do this but they have no option. It is estimated that shadow economy or black money circulating in the economy is equal to white money.
While there is no accurate estimate of black money in circulation, it is nevertheless, a huge menace. The government should come out with amnesty schemes whereby by paying a token one time tax or penalty the black money is allowed to be converted into white by declaring it with the authorities. There should not be any witch hunt thereafter and the authorities should not penalize those who voluntarily come forward. This will cleanse the system and lead to enhanced tax collections. On every sale of real estate the government loses out a lot of money as sales is shown at a much reduced figure in white money. REITs in India will find it difficult to operate smoothly in the kuccha-pucca system of acquiring properties. REITs seek to broaden and deepen the real estate market but the black money menace will rear its head. The idea is to remove this ill by giving avenues to people to come forward and convert their black money into white money and to incentivize this process.
When a person wants to purchase a house property, the rule is that he has to be given a car parking space with it. Many times the actual practise is to quote a separate price for the garage and to take the money in kuchha.
When a person wants to rent an office space in metros like Delhi or Mumbai or Hyderabad or Chennai or Bangalore, the general practice is to recover pugri or salaami which is an upfront huge one time payment. The balance is collected as rent, which is extremely low. Why cannot the government legalise salaami or pugri and create quasi ownership of the tenant? This means that the tenant of the office space will have a legal asset which will grow in value. When he vacates this office space, if pugri is legalized, he gets back his money on present valuations which is greatly enhanced and with the government collecting tax. Not only that, it becomes a tangible asset in the balance sheet of the tenant against which he can take a bank loan. This is not the case as of now, leading to under reporting of rentals and under recovery of tax.
These are some of the ground realities in real estate as of now and these need to be sorted out so that REITs become successful in India. These problems make real estate illiquid and opaque. What is needed is liquidity and transparency in the entire real estate system.
If these issues are sorted out, the government will collect more tax and the entire process will be legal. The current tax regime is too high and it is a well known and well documented fact that such high rates of taxes lead to tax evasion and tax avoidance, thus defeating the very spirit and purpose of taxation. A benign tax regime with avenues to do away with shadow economy will do a whole lot of good to the entire economy.
REITs provide diversification to one’s portfolio and are a hedge against inflation. For an economy like India which has been battling high inflation for the past so many years, this could prove to be an alternative to gold. Skeptics would be quick to point out that India is the largest importer of gold and Indian love for gold has no parallel in the entire world. Indian temples have huge hoards of gold. Indian love for gold is a psychological thing but this is sure to break down when investors have alternative better investment avenues.
REITs will also provide an investment avenue for people with limited resources and people with less financial acumen and financial awareness. These investors will get a scheme which is SEBI regulated. REITs are like mutual funds. Mutual funds are an investment avenue wherein investors pool their money and depend on the expertise of the Mutual Fund manager who will invest the pool of money into stocks and bonds. REITs are like mutual funds which invest in real estate. Retail investors will have an investment avenue which is far superior to the unregulated chit funds and ponzi schemes where crores get defrauded and poor lose their life savings.
The experience in USA has shown that there is no correlation between REITs and the S&P 500 (one of the index of listed stocks in the USA). This means that if an investor is investing in equities and in REITs he has successfully diversified his or her risk. When the stock markets are performing well he gets good returns (capital appreciation) from the stock markets and when the stock markets are not performing well, it does not adversely impact the returns from the REITs. This means that the investor is in a win-win situation.
REITs can be both listed on the stock exchange or unlisted. In case the REIT is listed on the stock exchanges, it is an even better situation as it provides an exit route in case the REIT is not performing well. It also provides liquidity to the investor who can sell his REIT in case he needs money or the REIT is under performing.
REITs are managed by professional real estate professionals. This lends credibility to this investment avenue.
REITs would be monitored by independent statutory auditors and regulated by SEBI. Moreover, their performance would be carefully scrutinized by business analysts and their performance would be continuously reported in the media- This means that an investor will have transparency and could also compare different REITs and also compare across investment avenues.
REITs will provide funds to the cash starved, funds starved realty space. Promoters and builders need funds to build their projects which take a year to two years to complete and commercial real estate like shopping malls etc need more funds. REITs provide funds to give a fillip to the real estate sector. This in turn gives a boost to the cement and the steel industries and create employment. This will give a push to the GDP growth and at a time like this, it should be a shot in the arm.
There are nearly 30 countries in the world today which have REITs as one of the investment avenues for their citizens.
Today one can invest across countries and take advantage of the real estate scenario in different countries. We will have to wait and see whether SEBI and RBI (Reserve Bank of India) allow investors to invest in REITs which invest in properties outside India. There would be limits to which a person may invest. While investing in different geographies diversifies risk, but a REIT professional manager will need to be very nimble to take advantage of changing real estate in different geographies. For the retail investor, maybe sticking to India may be less risky as he would be more tuned in to the developments back home in India.
