REIT – catching up momentum in India

Evolution of REIT in India

India saw its first Real Estate Investment Trust (REIT) listing in April 2019 and second during the Pandemic lockdown in Aug 2020. It was lapped up by the investors both retail and institutional; domestic and international alike despite challenges being faced by Indian real estate sector over the last few years. It is an indicator of the potential of REIT in India. It is a testimony of investor appetite for such stable and diversified asset based investment preference in India backed by strong inflow of global capital being put up in core and development of commercial assets in India.

However, India has taken quite some time since December 2008 when SEBI first proposed it followed by SEBI (Real Estate Investment Trusts) Regulations, 2014 and time to time amendments made by SEBI between July 2016 and March 2019. The introduction of changes in taxation in recent years with introduction of Business Trust, easing of tax reforms for REIT, partial pass through status to REIT income, recognising Registered Valuer in Companies Act 2013, allowed FDI through ‘investment vehicles’, RBI allowed ECBs by including in ‘eligible borrowers’, SEBI allowed to issue listed debt securities etc., have provided impetus to it and has timely supported the reality of REIT in India. Although India has joined the global REIT operated countries like US, UK, Australia, Japan, Singapore, Hong Kong, etc., it has a long way to go before it catches up with the depth and spread of REIT in these countries.

REIT structure and relevant norms in India

[1] As per SEBI (Real Estate Investment Trusts) Regulations, 2014 [last amended on 22 April 2019]

Eligibility and governance norms

Party	Sponsor	Trustee	Manager
Value of REIT assets	INR 500 crs	NA	NA
Experience	At least 5 years in development or fund management in RE industry	Registered with SEBI, not an associate of sponsor or manager and has infrastructure, personnel etc. to the satisfaction of SEBI	At least 5 years in fund management, advisory services or property management in Real Estate industry Minimum two employees with above experience At least 50% of directors or governing Board members be independent
Networth	INR 20 crs each with INR 100 crs on collective basis	Not prescribed	INR 10 crs
Investment & lock in period	After initial offer, hold at least 25% of total units for three years (one year for exceeding 25%) and at all times, hold not less than 5% by each with not less than 15% on collective basis	Not allowed to invest in units of REIT in which it is a Trustee	NA
Rights & responsibilities	Set up the REIT, appoint Trustee, transfer entire shareholding or interest in SPV to REIT, arrange another person to act as re-designated sponsor	Hold asset in the name of REIT, appoint manager & obtain quarterly compliance certificate, review transactions & ensure it at arm’s length basis, make distributions, review of unitholders complaints and its redressal	Make the investment decisions, appoint valuer, auditor, RTA, management of RE assets, responsible for offer document, listing of units, make disclosures to the unitholders, SEBI, trustees, stock exchanges, declaration of NAV

Investment norms

At least 80% of the value of assets in completed and rent &/or income generating properties
Not more than 20% of the value of the REIT assets in Under-construction properties, Listed or unlisted debt of companies in RE sector, mortgage backed securities, Equity shares of listed companies deriving at least than 75% of their operating income from RE activity, unlisted equity shares of RE companies, unutilized FSI / TDR of a project where it has already made investment, G-Secs, money market instruments or cash equivalents
Not in vacant land or agricultural land or mortgages other than mortgage backed securities
Not to invest in units of other REITs

Initial offering norms

Initial offer by way of public issue only
No initial offer unless
- REIT is registered with the Board
- Value of REIT holding in the underlying assets is not less than INR 500 crs
- Offer size is not less than INR 250 crs
- The units proposed to be offered to the public through initial offer be:
  - Post issue REIT capital < 1,600 crs – at least 25% of the total units
  - Post issue REIT capital from 1,600 crs to 4,000 crs – at least 400 crs
  - Post issue REIT capital > 4,000 crs – at least 10% of the total units
Subscription of minimum INR 50,000 from every applicant
Determination of price of REIT units through the book building process
If the REIT fails to make its initial offer within 3 years from the date of registration with SEBI, it shall surrender its certificate of registration to the SEBI and cease to operate as a REIT
Trading lot shall consist of 100 units
REIT shall redeem units only by buy-back or delisting of units

Other norms

Aggregate consolidated borrowings and deferred payments of the REIT, holdco &/or SPVs net of cash & cash equivalents not to exceed 49% of the value of the REIT assets
Borrowings not to include any refundable security deposits from tenants
If on aggregate consolidated amount of borrowings and deferred payments exceeds 25% of the REIT assets, for any further borrowing
- credit rating be obtained from a credit rating agency
- approval of unitholders be obtained
Distributions by the REIT and the holdco &/or SPV
- Not less than 90% of net distributable cash flows subject to applicable provisions of Companies Act or LLP Act
- In case of by holdco – 100% of the cashflows received from SPVs and 90% of the net distributable cash flows generated on its own
- Not less than once in every six months in every financial year
- If any property is sold by the REIT or holdco or SPV or if the equity shares or interest in the holdco /SPV is sold by the REIT
  - Not required to distribute the sale proceeds to the unit holders if REIT proposes to reinvest into another property
    Distribute not less than 90% of the sale proceeds within a period of one year if REIT proposes not to invest into another property

Valuation norms

Valuer not be an associate of the sponsor(s), manager or trustee & have at least 5 years of experience in valuation of real estate
Full valuation be conducted at least once in every FY & within 3 months from 31 March
Half yearly valuation incorporating key changes within 45 days from 30 September
Full valuation be undertaken prior to any issue of units to the public & include a summary of the report in the offer document. It shall not be > 6 months old at the time of such offer

Taxation norms

Transaction	Party(s)	Taxation norms
Transfer of RE asset / Shares of HoldCo / Interest in LLP by Sponsor to REIT against Units of REIT / Cash	Sponsor	Taxable on such transfer at 20% or applicable rate for long term (> 36 months) or short term respectively MAT applies
Transfer of Shares of SPV by Sponsor to REIT against Units of REIT	Sponsor	Capital Gain is deferred and payable at the time of sale of Units of REIT MAT deferred
Rental income from Lessee(s)	REIT	Exempt
Rental income from Lessee(s)	SPV(s)	Taxable
Dividend from HoldCo / SPV	REIT	Exempt
	SPV(s)	TDS @ 10%
	Unitholder	Taxable Not taxable if SPV does not opt for Sec 115BAA
Interest income from HoldCo / SPV	REIT (SPV is Co.)	Exempt
	REIT (SPV is LLP)	Taxable
	Unitholder (SPV is Co.)	Taxable
	Unitholder (SPV is LLP)	Exempt
Dividend from domestic cos (other than from SPV)	REIT	Taxable Not taxable when such dividend income is received post 1 April 2020 and on which the company has paid DDT
Sale of listed equity shares or MF units	REIT	When STT is paid, taxable at 10% or 15% for long term or short term respectively When STT is not paid, for long term - taxable at lower of 20% with indexation and 10% without indexation When STT is not paid, for short term – taxable at MMR
Buy back unlisted domestic co (including SPV) shares	REIT	Exempt
Any other income	REIT	Taxable
Distribution by REIT to Unitholder	REIT	No DDT TDS @ 10% on distribution of income which are in the nature of dividend / Rental / Interest Section 194LBA(2A) - No TDS if SPV has not exercised the option u/s 115BAA
Distribution by REIT to Unitholder	Unitholder	Exempt to the extent that the distribution takes the character of profits and gains of business or profession / any other income Taxable at applicable rate to the extent that the distribution is of the same nature of Interest, Rental or dividend income of the REIT Dividend not taxable if SPV does not opt for Sec 115BAA
Sale of Units of REIT (assuming held as capital asset by Sponsor / Unitholder)	Sponsor	When STT is paid, taxable at 10% or 15% for long term (> 36 months) or short term respectively When STT is not paid - for long term - taxable at lower of 20% with indexation and 10% without indexation – for short term – taxable at applicable rate CoA of Units be CoA of Shares of SPV Holding period of Shares of SPV be added in computing period of holding of Units MAT applies which was deferred at the transfer of Shares of SPV against Units of REIT
	Unitholder	When STT is paid, taxable at 10% or 15% for long term (> 36 months) or short term respectively When STT is not paid - for long term - taxable at lower of 20% with indexation and 10% without indexation - for short term – taxable at applicable rate MAT applies for Companies

Note: 1. Contents mentioned in italics and red font is as per the Finance Act, 2020
2. The table depicts the tax provisions for salient transactions specific to REIT structure

Finance Act 2020 while passing the Finance Bill by Parliament, has played balancing act in taxability of dividend i.e. either tax free dividend to unitholders or concessional corporate tax structure to the SPV. The provision of WHT by SPV while paying dividend to REIT leads to additional cash flow leakage as it’s an exempt income to REIT. Thus, partial taxation of dividend to unitholders and WHT by SPV on dividend to REIT may take away the competitiveness of REIT and may adversely impact the yield of its investors. Further, it may require revisit to the structuring strategies as it requires careful consideration of residency status of its various classes of unitholders and equity component in the SPV by REIT.

Suggested way forward

Regulators and policy makers may consider below mentioned points for making REITs more robust in India:

Guidelines and regulations in respect of follow-on offerings of Units by REITs
Exemption for capital gains on direct transfer of RE asset / Shares of HoldCo / Interest in LLP to REIT by Sponsors
Waiver of stamp duty & registration fees on such transfer
Grant full pass through status to rental income of SPV
Reduce holding period for qualifying for long term capital asset for REIT units to 12 months like that of other securities like shares, MF units etc.
Bring parity in the extensive corporate governance norms and disclosures available to the Unitholders with those available to the equity shareholders of listed companies in respect of
Changes in directors & KMPs, amendments to the constitutional documents
the outcome of meetings of their board of directors
Clarity needed regarding the applicability of other regulations of SEBI such as the SEBI (Prohibition of Insider Trading) Regulations, 2015, the Securities and Exchange Board of India (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Markets) Regulations, 2003, the Securities and Exchange Board of India (Intermediaries) Regulations, 2008 and the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011

Taking realty to next level

Indian real estate sector is currently facing crisis of confidence more than any other challenges. This scenario is prevailing despite positive milestones like RERA, demonetisation, GST implementation etc. Riding on the tech enabled disruptions, the Indian real estate sector is witnessing a significant rise in investments flowing to tech-based real estate start-ups in construction technologies (ConTech); property technologies (PropTech); digital business platforms, and ‘shared economies’ based real estate models. New age technologies such as Internet of Things (IoT), automation, cloud, artificial intelligence (AI), big data, augmented and virtual reality (AR/VR), blockchain and drones are increasingly finding applications across real estate business platforms.

Realty developers have tweaked their business models to adapt to newer trends like co-working places, co-living residences, student housing / accommodation and senior citizen living in the Indian real estate sector. These trends have emerged out of the very challenges experienced by them – the significant one being alternate avenues for public investment and capital / finance at reasonable cost of funds coupled with their aspiration to turn realty into service sector. Recent transactions flow depicting chase of global tie ups & capital infusion into these trends are proving potential lying in it.

Globally REIT prevails in various sectors like diversified, Residential, Retail, Office, Industrial, Healthcare, Self-storage, Lodging / Resorts etc. and the fact that no penetration as of now in India as it has its two Office REITs launched in April 2019 and Aug 2020. It is witnessed that all these trends are stable revenue generating propositions and its inherent need for sustainable capital. REIT offers the perfect fit for this as it requires such assets in its main play and provide capital with institutional and public participation. Eventual offloading the developed and income generating asset into REIT at valuation can provide timely capital replenishment and lean balance sheet structure to the developers. To operate in such unconventional way may hopefully help developers designate them as pure service providers and continue their march towards evolving more such trends and take realty to the next level.

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