India is laying the groundwork to make real estate investment trusts tax-exempt and allow them to trade on public exchanges, a move that may help unlock as much as $20 billion of listings.
Regulations on taxation will be amended, Finance Minister Arun Jaitley said on July 10, and the stock-market regulator is preparing to allow REITs to be traded on exchanges, according to Edelweiss Securities Ltd.
The introduction of REITs will provide a new source of cash to Indian developers that have struggled to reduce debt with interest rates among the highest in Asia, while giving investors the ability to buy into the country’s property market. Assets that may qualify to be included in REITs may reach $20 billion by 2020, according to an estimate by property broker Cushman & Wakefield. In the first three to five years, as much as $12 billion could be raised.
“REITs could be the game changer for India’s property sector,” said Priyaranjan Kumar, regional director of capital markets at Cushman & Wakefield in Singapore. “It will force much needed transparency at least in the commercial sector, and lower the reliance on financing from banks and incentivize developers to own and manage assets with a long-term view.”
Prime Minister Narendra Modi, who won with the most decisive mandate for any single party since 1984, has promised changes in India’s property market, which was valued at $66.8 billion in the year ended March 2011, according to the most recent data from India Brand Equity Foundation, a government division that promotes commerce.
REITs, which were pioneered in the U.S. in the 1960s and are publicly traded, pool investor money to buy real estate such as shopping malls, office buildings and rental housing. India’s REIT market has the potential to grow to rank among the top five markets in Asia by market capitalization, according to Cushman & Wakefield.
While the Securities & Exchange Board of India released the first draft of guidelines for REITs in 2008, it never got final approval because of a lack of clarity on taxes and because the global financial crisis hurt the investment climate, according to a report by Knight Frank LLP in June. Since then, the regulator released a new set of guidelines in October, outlining the eligibility criteria for setting up REITs.
REITs will have to pay out at least 90 percent of their net distributable income to investors as part of the requirements for tax-exempt status.
The minimum initial offer size should be 2.5 billion rupees ($42 million) and the public float should be at least 25 percent, according to the stock regulator.
Under the proposed framework, only domestic and foreign institutional and high-net-worth individuals will be allowed to invest initially, while retail investors will be able to participate later as the market develops. The minimum investment would be set at 200,000 rupees.
To help develop the trusts, the Bombay Stock Exchange has set up an 11-member advisory group of experts, bankers, legal professionals and consultants in the real estate industry, according to a statement on July 10. No date has been announced yet for the introduction of REITs.
India has plenty of assets ready to be packaged into trusts. Asia’s third-largest economy has been in the top five global office markets for at least seven years, with average annual net demand of more than 30 million square feet (2.8 million square meters), Cushman & Wakefield said.
The South Asian country has top quality office space of about 350 million square feet across its six biggest cit0ies, according to Jones Lang LaSalle Inc. Of this, about 100 million square feet are potentially available for REIT listings, which could be valued at as much as $9 billion, the broker estimates.
The combined debt of India’s six largest developers climbed to a record 394 billion rupees in the 12 months through March 31, more than double the 158.8 billion rupees in 2007, according to data compiled by broker IIFL Ltd.
Among developers that have income-producing properties and may introduce REITs are DLF Ltd., India’s largest developer by value, with about 28 million square feet of operational rental assets, according to HDFC Securities Ltd. Others include Prestige Estates Projects Ltd, a Bengaluru-based developer with 8 million square feet, and Phoenix Mills Ltd., a mall operator owning 6 million square feet, HDFC said.
An introduction of REITs in the Indian market will reduce the cost of business for both local and foreign investors, Rajeev Talwar, group executive director at DLF, said in an e-mailed response to queries. DLF shares gained 2.1 percent to 202.5 rupees at 12:23 p.m. in Mumbai trading as the benchmark S&P BSE Sensex lost 0.3 percent. DLF shares have gained 21 percent this year, compared with a 22 percent gain in the Sensex.
“It will help ease liquidity for developers and provide access to retail investors to benefit from regular income and appreciation from real estate,” said Neeraj Bansal, partner and head of real estate and construction at KPMG LLP.
Foreign institutional investors such as Blackstone Group LP and Brookfield Asset Management Inc., have been accumulating rental assets to potentially create REITs in the country, according to a July 10 report from HDFC Securities. Blackstone is the largest private-equity landlord of office assets in India, with about 22 million square feet, while Brookfield has about 15 million square feet across the country.
Not all agree that REITs will be the investors’ choice. The tax break may not be enough, said Adhidev Chattopadhyay, a Mumbai-based property analyst at HDFC Securities.
Rents for assets included in the REIT will need to appreciate by 4 percent to 5 percent annually, followed by an increase in capital values, to become attractive, Chattopadhyay said. Indian REITs would have post-tax yields of 7 percent to 8 percent, lower than the Indian government bonds with yields of between 8 percent and 9 percent, he said.
The government must address the differing stamp duties for purchase and sale of assets in India, which currently range from 5 percent to as high as 14 percent across the country, depending on the city, he said.
“Interest rates in the economy would need to decline meaningfully from here on for a REIT to become a viable financial vehicle,” Bhaskar Chakraborty, an analyst at IIFL, said.
The Reserve Bank of India’s benchmark repurchase rate is at 8 percent, the highest after Pakistan among 11 Asian economies tracked by Bloomberg.
The introduction of REITs will help India’s market become more institutionalized, said Shobhit Agarwal, joint managing director of capital markets at Jones Lang LaSalle India.
“The legislation has come at the right time,” Agarwal said. “Markets, business and investors all will benefit.”
The REIT market in the Asia-Pacific region is worth more than $250 billion, according to data compiled by Bloomberg. Australia, Japan and Singapore are the region’s three largest REIT markets, the data showed. REITs and business trusts were the biggest fundraisers in Singapore’s IPO market in the past year, according to data compiled by Bloomberg.
“Many countries have implemented the REIT framework but only a handful have continued to retain investor confidence and grow consistently over time,” said Kumar of Cushman & Wakefield. “India has the right underlying dynamics to fuel the growth of the industry. Only time will tell if the potential is fully realized.”