By Invitation. Strengthening the REITs framework

While REIT (real estate investment trust) and InvIT (infrastructure investment trust) regulations were notified in 2014, they hardly found any takers due to tax uncertainties, regulatory impediments, market sentiments and doubts over practical feasibility of REITs and InvITs in India.

The Securities and Exchange Board of India (SEBI), recently approved certain amendments to REIT and InvIT regulations based on the recommendations of market players. The latest round of relaxations comes after the much needed impetus provided by the Ministry of Finance (MoF) in the last Budget exempting dividend distribution tax (DDT) for distributions made by special purpose vehicles (SPVs) to business trusts. The tax benefits by MoF, coupled with the proposed amendments by SEBI, will hopefully give market players greater flexibility to tap the potential offered by REITs and InvITs.

A key amendment introduced by SEBI was a two-level SPV structure, a huge relief for the industry as this would eliminate the structural constraints prior to the amendment whereby REITs and InvITs were allowed to invest through only one SPV structure.

Since many real estate and infrastructure projects are held under project-specific SPVs, this flexibility will help not only the industry participants at the time of structuring the REIT/ InvIT, but also the managers and investors at the time of exit.

Another vital amendment was the introduction of the concept of sponsor group for REITs and removal of the limit on the number of sponsors. The ‘sponsor group’ is likely to include the sponsor and its group companies/associates and may provide a REIT the option to either be solely held by one sponsor group or be held by one or more sponsors as may be specified in the amendment.

Investment vehicles were only allowed to have a maximum of three sponsors. By removing the restriction, SEBI has paved the way for stakeholders of project SPVs (joint venture partners, developers, private equity funds or group companies/associates of sponsors), to become sponsors and take part in the REIT or InvIT.

Another major amendment introduced is allowing REITs to invest up to 20 per cent of their assets in under-construction assets. Currently, REITs are allowed to invest only up to 10 per cent of their assets in under-construction assets, similar to other Asian jurisdictions like Singapore, which means less access to capital by under-construction properties.

With this relaxation, REITs in India will not only have a competitive edge and be attractive to investors compared to other jurisdictions but will also provide the necessary stimulus to under-construction assets. In India, where interest rates are high unlike in Singapore, the pressure on REIT managers to deliver better returns is tremendous. With this proposed amendment, there will be some respite for managers to achieve competing returns for their investors. REIT managers will be able to diversify and widen the portfolio to tap the higher earning potential of under-construction assets.

The other significant proposal put forth in the consultation paper for amendments to the REIT regulations is to do away with the current requirement of having minimum 200 public unit-holders, at all times, during the life of a REIT. This poses a serious challenge to industry players as they will not be able to control the inter-se transfer of units among public members post initial offer, due to which maintaining a minimum of 200 public unit-holders at all times is highly improbable. In the US, which still remains the largest listed real estate market in the world, the required minimum number of members stands at a mere 100. Hence, it is surprising and unexpected that the recent press release of SEBI has not considered the above.

Similarly, when REITs were introduced in Singapore in 2005, stamp duty remissions were given for up to five years on properties sold to REITs to encourage industry players and enhance the competitiveness of REITs in their acquisition drives. In the Indian context, the MoF has already exempted distributions, made by special purpose vehicles to business trusts, from DDT. If this tax exemption is bundled with stamp duty remissions it would create a conducive environment for a robust growth of the REIT market in India.

In all, the proposed amendments are definitely a step forward by SEBI in promoting REIT instruments for capital raising and facilitating growth in the real estate sector.

The writers Divaspati Singh - Principal Associate, Vivek Mimani - Principal Associate and Alvin Selvam - Associate are associated with Khaitan & Co

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