REITs on the Anvil

Real estate investment trusts (REITs) are similar to mutual funds. However, unlike mutual funds that usually hold securities, the underlying assets held by REITs are constituted by real estate properties. Investors in REITs can participate in returns from these real estate investments.

The last couple of years have seen a boom in the real estate sector, and several Indian real estate companies have successfully accessed capital from the markets with multi-billion dollar issuances of shares. However, Indian laws and regulations did not provide investors with the ability to invest in a vehicle such as the REITs, which enables investors to hold a diversified portfolio of real estate investments (that are not confined to one real estate company or group only). There was also the risk of exportation of the capital markets for REITs with companies either having listed, or planning to list, their properties through issuances of REIT securities in overseas markets such as Singapore and other Asian stock exchanges. SEBI has seized the opportunity to introduce an Indian REITs regime so that Indian companies can raise funds domestically by issue of REITs securities without resorting to international capital markets.

In an announcement made on December 28, 2007, SEBI has issued a draft of the SEBI (Real Estate Investment Trusts) Regulations, 2008 that allows for establishment (and registration with SEBI) of real estate investment trusts and real estate investment management companies. Comments have been invited on the draft from the public by January 10, 2008.

The key features of the draft Regulations are reported in The most important aspect of the draft relates to valuation of properties. Traditionally, valuation of real estate has been a contentious matter, especially in relation to issuance of securities by real estate companies. Consequently, SEBI has devoted considerable attention (and an entire Chapter VI of the draft Regulations) to ensure proper and independent valuation of properties to be held by a REITs scheme so that investors are provided with a reasonably accurate picture regarding the value of the properties held by the scheme. The report of such valuer is required to contain details regarding the manner in which the properties were valued, all of which would make the valuation methodology transparent and readily available to investors. While the draft Regulations lay down the statutory framework regarding property valuation, more effort would be required at a peer level among valuers to set out working rules and norms for valuation of properties so that the regulations are given effect not only in letter, but also in spirit.

There are other issues (that fall outside the direct ambit of the draft Regulations) that need to be ironed out before REITs can be implemented in practice. First, there are several industry-specific problems underlying the real estate sector. One important legal issue is the absence of clear title and the existence of incomplete contracts that plagues several real estate transactions in India. This enhances risks borne by investors in REITs. Therefore, it is imperative that there be stringent disclosure norms for issuance of securities by REITs that make it mandatory for issuers to qualitatively disclose these risks to investors. In other words, the offer document requirements to be prescribed by SEBI for REITs should encompass all industry-specific issues and matters that are associated with the real estate sector.

There is also a need for clarity on the position regarding taxation of REITs themselves as well as their investors, as also any stamp duty implications on the issue and transfer of the REITs securities. This is required to ensure smooth implementation of the regulations.

While SEBI’s announcement of REITs cannot be more timely, there is evidently a need for a comprehensive review of all aspects that have a bearing on REITs transactions before the mechanism can be put in place, so as to make its implementation successful.

Related stores: Business Standard, Financial Times, Hindu Business Line (SEBI announces guidelines for REITs and Making the REIT move)

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

1 comment

  • The underlying philosophy behind floating this new breed of fund was primarliy to enable retail investors take small positions in a professionally managed portfolio of assets and share the returns – something they could not do directly. However, with so many grey areas and unresolved issues are the investors interest really taken care and protected.
    The Draft REIT regulations are up for comment, by SEBI but there are still certain issues which need clarity.Most prominent among them is that might make valuation of schemes floated by REITs difficult would be availability of independent property valuers.In presenti, the market does not any paraphenalia or bench mark for rating the schemes. It is apparent that such factors such as geographical placement of project, its developers and promoters etc would be deciding factor, but in absence of any regulatory authority, will the anti trust laws and competition issues be impinged.
    Another issue which requires deliberation is taxation issue, world over REITs are required to distribute 90 per cent of their income, which may be taxable in the hands of the investors. Even the SEBI draft guidelines compulsorily require REITs to distribute 90 per cent of its income after tax. However there is no guidance in the draft REIT regulations on the basis of taxation of REITs or its investors.
    Going by the practice and procedures followed by the market, it is most likely that REITS would be taxed at 30 per cent plus surcharge and cess.
    This stands diffferently from taxation of mutual funds, which are specifically exempt under the Income-Tax Act, and taxation where applicable is only at the investor level.
    It is therefore, pertinent that the uncertainty regarding basis of taxation norm for REIT’S be clearly defined.
    Further on, stamp duty is another grey area.The stamp duty implications on tranfer of REITs mightpose a challenge to their growth.


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