REITs in India: Decrypted

Recent actions by Indian regulatory bodies are bringing REITs (Real Estate Investment Trusts) closer to reality. REITs are expected to bring in a landscape change to real estate development in India – most importantly from a corporate governance perspective, enhancing greater participation from institutional players, both global and domestic. The changes will positively affect the real estate industry in India – CRE (commercial real estate), more specifically.

REITs will essentially help large developers (owners and operators) and funds with assets size more than INR 5 bn list their rent yielding properties on an exchange. These listings will provide the necessary capital inflow to cash strapped developers – who will now be able to infuse fresh funds to complete under-constructed projects. It’s a win-win scenario, as REITs open up investment opportunities in CRE for an average retail investor - with ticket sizes down from INR 10 mn (through PERE investments (Private Equity Real Estate) to INR 0.1-0.2 mn. Further, liquidity is no longer an issue as REIT units can be traded like shares on stock exchanges.

While REIT listings are yet to take off as the market is on a wait-and-watch mode, SEBI (Securities and Exchange Board of India) and the Finance Ministry are taking progressive steps to improve interest levels:

• The union budget in February 2016 recently waived-off of the dividend distribution tax of 17.6% on any income from SPV (Special Purpose Vehicle) to REITs – this makes investments more attractive as 90% of rental/ capital income accrued mandatorily needs to be distributed to investors every 6 months.

• REITs can now make investments upto 20% in under-constructed properties from the erstwhile limit of 10%. Potentially, this can help sponsors unlock significant value in such projects as it tends to completion with fresh capital infusion.

The total commercial stock across the top six cities (National Capital Region includes Delhi, Gurgaon & Noida) in India is approximately 600 million square feet (msf). The investable Grade stock estimates are pegged to be around 400 msf. Considering, non strata-sold quality investment assets across these cities, the REITable office stock is 177 – 200 msf. That means only 1/3rd of the total cost is currently REITable. In India, quality commercial developments started springing up after the IT boom in the 2000s. Most of these REITable assets are the crème of the market, owned by reputed developers or funds or a JV between these having an average age of less than 8 years. Thus, the major chunk of the CRE market having REIT potential is recently developed.

Monthly rental returns from these REITable office assets are INR 12.45 bn (USD 186 mn) to INR 14.02 bn (USD 209 mn) – once listed can potentially provide dividend income of the same number to investors. These properties are currently holding a total valuation of INR 1,690 -1,890 bn (USD 25.2 to 28.2 bn). Majority of these projects are already owned by potential REIT listing entities having up to three sponsors and an asset corpus of over INR 5 bn. However, considering many quality non-strata sold rentable developments are under scrutiny for acquisition by the bigger players, we have accordingly accounted for them in the above numbers.

Our numbers suggest that given a rental yield of 9-11% and capital appreciation of 2-3% annually, REIT investors in Indian assets can expect gross returns of 11-13%. Globally, the returns across various REIT countries have even peaked to 23% as outlined in the table below. In Asia, the returns vary significantly from 10%-22% depending on developing versus mature markets.

Other countries have a large quantum of residential and warehousing stock also listed under REITs. For India, with the first listing scheduled latest by 2017, and its success, many entities will now also look at development of ‘Rental Housing’, which has not yet caught up as a trend, but seems to have tremendous potential in India. This will also benefit the residents of these metros, with large organized well managed housing set-up having little capital investment.

The e-commerce boom has led to large PE funds scouting to acquire quality warehousing spaces. Many of the planned projects in both these segments might be considered for a REIT listing. Thus, introduction of REITs will help in setting higher standards for real estate developments across sectors along with greater transparency.

Traditionally, Real Estate in India has been dominated by a few large players. It has always been a rich-man’s investment and not a level playing field. In a country where the ‘common man’ or the ‘aam aadmi’ always looks up to fulfil the three basic necessities of ‘food, clothing and shelter’ and investments are limited to gold, stocks and buying a home (only for the select few), REITs will potentially open up a great avenue for earning from investing in real estate with a unit size of just INR 200,000. Also, for the developers who have been facing the challenge of higher borrowing costs, capital inflows would now improve, with public money pouring in. Thus, it benefits both the public in general and REIT aspiring developers in particular. Increase in transparency in real estate will follow due to transparent listing mechanisms.

*Considering 1 USD = INR 67