REIT, no one is excited - Indian Realty (Part 4 final)

Pic. Credit
http://www.moneylife.in/article/reits-coming-is-it-the-right-product-for-you/35003.html

Okay, I just could not help writing about this investment instrument. After close to a million years of debate, in September of 2014, the Securities Exchange Board of India (SEBI) finally launched REITs (Real Estate Investments Trusts) with much fanfare. The real estate industry was elated. It seemed that the then new government was doing everything in its power to infuse life in the lifeless real estate segment by way of foreign direct investment (FDI). The excitement was short lived. The way the REITs Regulation of 2014 was drafted, it was as good as a stillborn. Not only did it have much tax related anomalies, there was a complete lack of clarity from the Reserve Bank of India (RBI) on guidelines for FDI in such instruments, the very capital it was meant to attract.

Little over a year later, in November of 2015, RBI finally came up with the required notifications on FDI in REITs and Alternate Investment Funds (AIFs). The new amendments left everyone more confused on why REITs would make a good investment vehicle. It did make REITs a more attractive option to foreign and non-resident investors, but in the same breath, AIFs look a far better proposition to both domestic and international cheque writers.

Among the major hurdles being faced by would be REIT sponsors, the first one is the issue of the "Dividend Distribution Tax" (DDT). REITs are assumed as pass-through vehicles, but not by our taxman. So REITs cannot claim an exemption. This, in turn, impacts returns. Typically, an REITs investor is a yield searching animal. With limited exits and no real cap-rate story, the non-exemption of DDT puts a lot of pressure on yields, driving away the animal to other favourable pastures.

To add salt to injury, an REITs sponsor has to have a background in development. Why? First, with only ten percent of the raised corpus being allowed to be invested into development, I wonder how a development experience would help? Second, there are several large well-run corporations and Public Sector Units that hold vast tracks of land and owns millions of square feet of built commercial estates who would make perfect sponsors over some large and dubious developers, but a lack of RE development experience rules out the former. Many corporates would be happy to sell and lease back owned space to provide an REIT with a stable and risk-free yield.

Given the complexity of issues associated with REITs, developers continue to raise money by way of listed NonConvertible Debt (NCD) where tax law allows the deduction of interest paid making it more efficient from the borrower's point of view. Most consultants advising the RE space would recommend AIFs as it seems to be better equiped for attracting FDI and as of now look very similar to REITs, without the hiccups. The trouble is that AIFs require a minimum investment of ten million rupees (apx US$ 145,000) which pushes away the retail investor.  From a retail investor's point of view, SEBI wrote out the regulation for an investor that could participate with as low as two hundred thousand rupeees (about US$ 2750). It was not so much about participation, but protection that SEBI has aimed for with the way REITs have to be set up and run. Over regulated. It is certainly laudable and responsible of SEBI to do what it has done, as it is what the regulator has been mandated for, protect the weak and ill informed investor.

However, I am not sure if the lowest common denominator, in the form of the Rs 200,000 retail investor, would actually subscribe to REITs as an investment? That investor is, believe it or not, yet struggling to understand the benefits of investing in the stock market through mutual funds. No wonder the right market according to SEBI is not really the REIT market and no is excited.