The capital markets regulator has notified the draft regulations for Real Estate Investment Trusts (REITs),a long-standing demand of the realty sector. This marks a key step in bringing greater transparency and professionalism in the industry.

A key funding mechanism for the real estate industry is set to become operational with the capital markets regulator Sebi notifying the draft regulations for Real Estate Investment Trusts or REITs on Thursday.

Funding has always been a major issue for the real estate sector. There are limitations to the availability of bank credit for a project,and this route is inaccessible for purchase of land,a key component of any real estate project. With formal sources of financing limited,developers have to resort to informal means such as money lenders,high net worth individuals with a huge investible surplus,private equity funds and even home buyers,who finance construction through timely payments linked to the stage of construction.

Until recently,developers also resorted to innovative practices such as the 20:80 payment schemes where home loans were clubbed with project loans that have been effectively terminated by the Reserve Bank of India.

A report by property consultant Cushman & Wakefield estimates that housing demand will touch 12 million units across India during the next five years,keeping pace with the population growth and the rate of urbanisation. Of this,the top eight cities Ahmedabad,Bangalore,Chennai,Hyderabad,Kolkata,Mumbai,Pune and the National Capital Region would account for 23 per cent of the demand. That translates to nearly 2.5 million units. The study projects that the total supply,at the current rate of absorption would still leave a gap of 45 per cent across these eight markets.

Addressing that shortfall would call for a massive increase in housing supply,but delivery would depend a lot on the financing mechanisms in place. This is where REITs become important players.

Enter REITs

A REIT is a company that raises money from investors through an initial public offering (IPO) like any listed entity. The investors hold shares in the REIT,which uses the funds raised to buy property.

Unlike a share owned in a listed developer,a REIT owns income-generating real estate assets,which enables individual investors to earn a share of the income produced through these assets.

Individual investors will not have to invest substantial sums to buy a property. They can get the benefit of the property market by investing small sums to buy shares of a REIT in the same way as a mutual fund.

Currently,investors who make investments in property look to holding it for the maximum possible period their financial resources permit. Usually,such investors buy into an under-construction property and sell it (even when not complete) at the first hint of an appreciation in value. This speculative nature of investment is responsible for high prices and also contributes to delays,say industry sources,for there is a temporary suspension of funds towards the construction process.

The draft Sebi regulations allow only high net worth individuals and institutions to invest in REITs and has kept the investment threshold at Rs 2 lakh.

As with the mutual fund industry,the market regulator has mandated that only serious players enter this space too. Then draft states that only sponsors having a net worth of at least Rs 20 crore and minimum five years of experience would qualify and the manager should have a net worth of Rs 5 crore and at least 5 years of experience in fund management in the real estate industry.

Sebi has also proposed that 90 per cent of the value of the REIT assets shall be in completed revenue generating properties and 10 per cent can be in other assets and put a condition that at least 90 per cent of the net distributable post tax income shall be distributed to the investors.

To begin with,all REIT schemes will have to be close-ended real estate investment schemes that will invest in real estate with an aim to provide returns to unit holders. Returns will be derived mainly from rental income or capital gains from real estate. The minimum size of an initial public issue will not be less than Rs 250 crore,of which at least 25 per cent has to be publicly floated.

“Lot of emphasis has been given to transparency and disclosures. Indian investors will get an additional investment opportunity to invest in real estate. It will also benefit real estate developers who will be able to transfer their developed assets into a REIT,” said Bhairav Dalal,associate director,PwC India.

The impact

Real estate experts have welcomed the move. “Once in place it will provide an additional exit route for investors and enable retail money to be channelised into India’s realty sector through a regulated network. The introduction of REITs in the long term would propel the sector,spurring capital inflows and bringing institutional credibility,” said Anshuman Magazine,Chairman & MD,CBRE South Asia.

“Allowing REITs in India has been a long pending demand of the real estate sector. After five years of waiting,Sebi’s move to issue this consultation paper will revive substantial investor interest from domestic and global investors in India’s currently subdued real estate markets as it moves towards more organised and globally well accepted practices of funding real estate development,” says Sanjay Dutt,executive managing director,South Asia,Cushman & Wakefield.

The move comes at a time when the real estate sector is facing a slowdown in demand,and Dutt says that both the regulator and the government should move in quickly and facilitate the functioning of REITs as it would be a significant boost to the industry.

“If implemented,timing would be great as many developers are faced with liquidity issues as they have large amounts of capital locked in commercial assets and are finding it difficult to sell due to the large ticket sizes. Investments by REITs in these and other assets would indirectly reduce the exposure of banks to risky assets as they had provided construction finances to many projects,” says Dutt

“We have nearly 57 million sq ft of office space vacant,with approximately 132 million sq ft of additional office demand by 2017 and over 200 million sq ft of investible Grade A leased office assets not sold,which would be quickly monetised through REITs at a cap rate of 9-10.5 per cent,” adds Dutt.

Along with the draft guidelines,the process to establish a real estate regulator is also underway with the government introducing the bill in the Rajya Sabha.

“One concern is with regards to the strengthening of our legal framework surrounding real estate in India,which is a pre-requisite for REITs to thrive here. The Real Estate Regulatory Bill is a move in the right direction,” says says Anuj Puri,chairman and country head,Jones Lang LaSalle India.