[Rongeet Poddar is a 5th year student at the West Bengal National University of Juridical Sciences]
Real Estate Investment Trusts (REIT) can be defined as entities that own properties in the real estate sector and finance their development. Structurally, a REIT is identical to an ordinary trust. The real estate properties are owned by the REIT. Companies or limited liability partnerships (LLPs) may also be created by the REIT as special purpose vehicle for this purpose. The sponsor of the REIT sets it up on behalf of the unit holders and appoints a trustee. The trustee holds assets on behalf of the unit holders. A unit holder is a beneficiary who owns units of the REIT. The trustee may choose to appoint a manager for maintaining the property. This instils professionalism and efficiency in the administration of REITs. A proportion of the earnings which are generated from investment in the REIT then accrue to the unit holders as returns on investment.
The SEBI (REITs) Regulations, 2014 introduced a regulatory framework to recognize public trading of REITs. The Securities and Exchange Board of India (SEBI) also reserves the power to relax enforcement of the REITs Regulations under certain conditions enshrined in regulation 33A added by the 2016 amendment. This offers flexibility to the operation of REITS in India. Properties in the real estate sector would include ‘land and any permanently attached improvements’. Any asset classified by the Ministry of Finance as ‘infrastructure’ would, however, not qualify as real estate. Nevertheless, an exception has been carved out for hotels, hospitals and convention centres which form a part of composite real estate projects and generate rent or income. Common infrastructure for composite real estate projects, industrial parks and special economic zones would also be included.
REITs bear the potential of acting as an attractive investment vehicle. In a REIT, a single investor does not bear the entire financial burden of constructing property as it is not the sole owner. An investor can contribute in units collectively and obtain returns for the same as income. Investors also save time and resources by divesting their faith on professionals for managing their assets. The REITs Regulations seek to incentivize investment in the real estate sector by promising investors that the REITs would be policed in accordance to global best practices of trust governance.
On 17 January 2020, SEBI introduced a circular setting out guidelines for rights issue of units by a listed REIT through the exercise of regulation 33 of the REITs Regulations. Regulation 33 affords a special power to SEBI to remove ambiguities in the operation of REITs. The success story of India’s first listed REIT, the Embassy Office Parks, has already outlined the potential of the amendments to transform the real estate sector by offering an attractive investment vehicle for unit holders. The Embassy Office Parks REIT has seen a significant appreciation in the prices of its units after it had been listed in April 2019. The subscription of units in the Embassy Parks has been driven by institutional investors. The REIT has also had tremendous success in maintaining a high occupancy rate for its office spaces from e-commerce start-ups. A second REIT is also expected to be listed in the near future. However, there has been limited progress beyond these developments. The SEBI guidelines provide the missing piece of the jigsaw to re-assure investors of the viability of REITs.
The SEBI guidelines mandate a board resolution from the managing entity of the REIT for the issuance of units to unit holders. An in-principle approval of the concerned stock exchange must also be obtained for such a rights issue. However, SEBI is alive to the perils of over-penalization. Therefore, it provides an exception that the mere imposition of monetary fines by stock exchanges would not bar the REIT from issuing units. However, promoters, partners or directors of the REIT functionaries, i.e., the sponsors, manager or trustee must not be debarred from accessing the securities market by SEBI. An interesting addition to the REITs Regulations is the absolute bar imposed on issue of units in case a promoter, partner or director of the REIT functionaries has been classified as a fugitive economic offender under section 12 of the Fugitive Economic Offenders Act, 2018. This safeguard deters wrongdoers from raising further capital through the mode of REITs and thereby protects investors.
The SEBI guidelines for rights issue also provides for the appointment of merchant bankers in accordance to regulation 10(5) of the REITs Regulations for undertaking due diligence of the offer letter. The manager of the REIT has been empowered to file the draft letter of offer with the stock exchanges where the REIT units have been listed. Furthermore, the offer letter is also required to be made public on the website of the concerned stock exchange for seeking public comments within a span of seven days. Finally, the SEBI guidelines impose an obligation on the lead merchant banker to furnish a due diligence certificate to the stock exchange along with filing of the offer letter. It is expected that these standards will create greater transparency in the rights issue process and assuage investor concerns.
The pricing of REITs units is determined by the manager on the basis of consultation with the lead merchant banker. The final issue price is disclosed in the offer letter. The units allotted to the holders can only be allotted in a dematerialized form. Additionally, the guidelines preserve the right of an offeree to renounce the units offered in favour of any other person. In such a scenario, the draft offer letter and the notice sent to the unit holders must carry a statement recognizing this right. However, the REIT is barred from withdrawing its rights issue after date of announcement of the record date, i.e. date of offer.
The SEBI guidelines provide a three month timeline for issuing of units from the record date. The rights issue will then be open for acceptance for at least three working days but not more than fifteen working days. Likewise, a minimum subscription threshold also has been created by the guidelines according to which the rights issue can only be 90% of the issue size in the offer letter. In case this criterion is not fulfilled, the application monies will be refunded to the applicants to the offer within 15 days of the issue closing date. The guidelines allow additional subscription by sponsors who also don the hat of unit holders subject to adequate disclosure of such intent in the offer letter. SEBI imposes a blanket ban on the further issue of capital between the date of filing the draft letter of offer and the listing of units offered through the offer letter or the refund of application monies to streamline the process.
As highlighted, the SEBI guidelines make a sincere attempt to iron out the existing creases in the regulatory framework for REITs by not only clarifying the ambit of the REITs Regulations but also reinvigorating the existing governance standards. It clearly demonstrates a conscious attempt on the part of the securities regulator to strike the right balance for facilitating greater infusion of capital. It remains to be seen whether these guidelines create enough incentives for prospective investors and offer a new lease of life to India’s ailing real estate sector. The success of the REIT experiment can possibly resolve the liquidity crisis plaguing the sector in the long run.
– Rongeet Poddar