The Resurgence of REITs

More than 5 years ago (in December 2007), SEBI had issued a
consultation paper and draft regulations with a view to paving the way for the
introduction of real estate investment trusts (REITs) in the Indian markets
(which we had the opportunity to discuss here).
However, the plan seemed to have gathered moss for a number of years.
Earlier this month, it was revived when SEBI issued another consultation
paper and a draft
of the proposed SEBI (Real Estate Investment Trusts)
Regulations, 2013, seeking public comments (which are due on October 31, 2013).
REITs are an attractive instrument for financing in the real
estate sector. It benefits promoters or sponsors of existing real estate
projects by providing an exit option from their investments. It also enables
investors who may be interested in investing in real estate as an asset class.
Despite the perceived advantages of REITs, and their prominence in developed
markets, the idea received limited attention in India. It is also not
surprising that a handful of Indian real estate companies sought to list their
securities in overseas markets. This is all set to change with the proposed
regulations.
According to the consultation paper, REITs would be
available primarily for completed, revenue generating real estate projects. In
other words, under-construction projects as well as trading in real estate or
undeveloped land would not fall within the purview of REITs, primarily due to
the uncertainties involved.
In terms of the investment structure, the REITs will have to
be set up as a trust, with a trustee, manager, sponsor as well as the valuer.
The REIT will have to be registered with the SEBI before it can operate.
REITs’ units shall be initially issued through an initial
public offering, following which the listing off the units shall be mandatory.
In order to ensure that this facility is available only to large, and well-recognised
projects, the minimum asset size is fixed at Rs. 1000 crores.  Similarly, there is also a minimum offer size
as well as a minimum public float. At the outset, the idea appears to be to
offer the units only to high net worth individuals and institutions. This is to
ensure that only sophisticated investors with the requisite capacity to bear
the risk are able to invest.
While there are customary responsibilities imposed on the
trustee, manager, etc., there is a great emphasis on matters of governance,
disclosure and transparency. For example, there is a detailed treatment of
related party transactions that the trust may undertake. Moreover, there is a
detailed focus on the valuation of the real estate assets held by the trust,
and also appropriate disclosures regarding the same. This is important given
the levels of fluctuation that real estate assets may experience from time to
time. Clearly, the proposed regime seems to contemplate the possible risks in
the real estate sector, and seeks to address them to the extent possible.
Overall, the proposed introduction of REITs in the Indian
markets is timely. While the proposed regulations are fairly balanced in that
they are on the one hand facilitative in nature, but on the other hand they are
also protective of investors and markets (implemented through the imposition of
several conditions on the establishment and operation of REITs).
At the same time, other issues need to be addressed as well.
We have discussed this in our earlier post, and they continue to be relevant at
the present moment as well:
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.

Added
to this list is the need for streamlining the foreign direct investment (FDI)
regime if this sector is to attract foreign capital, which may be necessary
given the potentially large sizes of offerings.

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.

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