[A.S Vamsi Krishna and Swagat Ahuja are 4th year B.A.LL.B. (Hons.) students at Rajiv Gandhi National University of Law, Punjab]
Real estate investment trusts (‘REITs’) are publicly owned entities that enable a broad spectrum of investors to acquire fractional ownership in real estate assets. In recent years, farmland investments via REITs has gained traction due to their ability to provide stable and substantial returns and act as an effective hedge against rising global inflation. However, in India, regulation 18(2) of the Securities and Exchange Board of India (Real Estate Investment Trusts) Regulations 2014 (‘REIT Regulations’) expressly prohibits REITs from investing in agricultural and vacant land. This regulatory restriction hampers the efficiency of the Indian real estate market by creating an artificial barrier preventing investor participation in agricultural land since investment cannot be accessed through a REIT. In this post, the authors argue in favour of permitting REIT engagement in agricultural land, in light of the positive economic impact it would have on the Indian economy. Further, the post addresses potential regulatory issues that may arise, offering solutions to mitigate these issues.
The Attractiveness for Farmland Investment through REITs.
Historically, investing in agricultural land has been particularly attractive due to the quantum and consistency of the returns offered. Globally, returns from farmland have outpaced global stocks delivering 10% annualised returns over the past 20 years compared to 8% from global stocks, with much lower volatility. Farmland also provides a way for investors to diversify their portfolios, as its prices have been largely uncorrelated with bond and equity markets.
However, traditional real estate investment methods are capital-intensive, which restricts participation to a smaller, wealthier group of investors. REITs resolve this hurdle by significantly lowering the initial capital requirement, while also offering the possibility of diversification. According to the notification issued by the Securities and Exchange Board of India (‘SEBI’), the minimum ticket size for REIT investment is between 10,000-15,000 INR, which was reduced from the earlier 50,000 INR limit so as to cater to a wider range of investors. The thesis is that this higher participation would enhance overall investment, which has a positive correlation with market capitalization of the underlying asset, similar to how a stock valuation benefits after a split since now it is affordable to more investors.
There is no shortage of thriving farmland REITs in countries like the United States where a single publicly owned REIT such as Farmland Partners manages over 170,000 acres of farmland. Smaller REITs like Rural Funds Group, operating in Australia have also gained popularity since inception. The need for introduction of REITs to provide diversified ownership of farmland is elevated in countries like India which suffers from the issue of smaller average agricultural land size. A neighbouring jurisdiction like Pakistan, which faces a similar issue of lower yields owing to land fragmentation, has seen a strong case being made for launching farmland REITs.
India has long battled the problem of fragmentation of land resulting in smaller average farm sizes, which has been linked to inefficiency due to higher operational cost. A significant advantage of establishing farmland REITs lies in the potential for managing larger farms, which individual investors might find to be beyond their reach. REITs can consolidate smaller tracts of land into larger agricultural operations. This consolidation enables REITs to leverage economies of scale, allowing for the utilisation of advanced heavy-duty equipment, such as tractors, high-quality seeds, and irrigation systems, which are typically only viable in larger-scale operations. Consequently, this consolidation transforms previously unviable smaller operations into viable enterprises with enhanced overall yields. Additionally, encouraging investment from retail investors in a producing asset such as farmland as opposed to non-producing assets would invariably allocate more capital towards the agricultural operations of the country.
Economic Implications of Limiting REIT Investments to Specific Real Estate Sectors
Currently, to the average Indian, investing in other commercial real estate is more convenient than investing in farmland since there exist REITs facilitating such investment commercial real estate. Both the larger ticket size and the inability to obtain a diversified exposure discourages investors who would have otherwise invested in farmland.
The express bar by SEBI on farmland REITs will create an artificial economic preference which results in disproportionate investment favouring the real estate which can be invested in through REITs. This could reflect a disparity in terms of the valuations of these types of real estate assets with agricultural land seeing relatively muted capital inflows. Additionally, this reduces the opportunities available to smaller investors. Regardless of the returns, investors should be able to have vehicles to gain exposure to their preferred assets unless there is a very good justification suggesting otherwise.
Implementing Farmland REITs in India
Considering the numerous benefits outlined for farmland REITs, a strong case exists for amending the REIT Regulations to allow REITs to invest in agricultural land. The amended regulations need not create an entirely new set of rules to regulate farmland REITs. Instead, it can rely upon the existing structure developed for investment in commercial real estate. The amended regulations should mirror the investment cap developed for commercial land under section 2(zs), stipulating that a minimum of 80% of the land developed must generate rent. In the case of agricultural land, the criterion of “rent” should be substituted with the revenue generated from agricultural activities. The calculation of agricultural revenue may be based on the existing procedure for calculation of agricultural income as defined under section 2(1A) of the Income Tax Act, 1961 (‘IT Act’). Such an investment cap ensures that REIT investment strategies are focused on overall revenue generation rather than speculative endeavours. However, to ensure the successful implementation and acceptance of farmland REITs in India, additional challenges which manifest in the form of regulatory hurdles and cultural barriers need to be addressed.
Foreign Investment in REITs
In India, foreign investment in agricultural property is expressly prohibited under the regulation 3(1) of the Foreign Exchange Management (Acquisition and Transfer of Immovable Property in India) Regulations, 2018 (‘FEMA Regulations’). However, REITs are allowed to allot shared to foreigners in terms of regulation 14(12) of the REIT Regulations. Consequently, allowing REITs which undertake foreign investments to engage in agricultural properties would contravene FEMA Regulations. Thus, to ensure compliance, REITs could be categorised based on their investment preference, allowing only those operating with domestic financial investments to invest in agricultural lands. This segregation of REITs would ensure that agricultural land in India does not receive investments from foreign investors, in accordance with FEMA Regulations.
Taxation of Sale of Agricultural Land
The extension of the REIT Regulations to include farmlands as well would also be a source of concern with respect to taxation. Particularly under section 2(14) the IT Act, the sale of rural agricultural land is exempt from taxation to safeguard the interests of the marginalised segment of farmers in rural areas. However, farmland REITs do not fit the intent of the exemption and they could easily misuse this provision. To address this issue, an amendment to section 2(14) of the IT Act is proposed whereby the sale of agricultural land by a REIT would not be exempt from tax. Instead, the applicable tax rate may either align with the existing tax rate for the sale of non-rural agricultural land (i.e., 20%), or it may be determined by the Government through alternative means.
Cultural Barriers
India has a culture of prioritising retention of land ownership by actual farmers over other non-farming entities owing to its history where farmers were exploited under the Zamindari system. Hence, land ownership by non-farming entities could be seen as culturally inappropriate in the Indian context. However, it must be recognised that REITs cannot be compared to other exploitative structures of land ownership since they involve public ownership. Further, it must be noted that farmland REITs will only acquire land from willing sellers which may in turn facilitate the gradual shift of the economy away from the current scenario where most of the population is engaged in agriculture. In any case, there is a stronger policy reason for facilitating this shift since the average farmer age is increasing rapidly in India, with the current average farmer being over 50 years old, and the growing disinterest among youth in this sector. This essentially means that REITs could provide a way out for people looking to exit agriculture while resulting in larger average farm size thereby boosting yields.
Conclusion
In conclusion, allowing REITS to invest in agricultural land in India would present significant economic benefits, fostering participation of a broader spectrum of investors and enhancing market capitalization. The advantages are apparent in countries across the world where farmland REITs have provided stable and substantial returns, outperforming global stock indices over the past two decades. The current restriction on farmland REITs under regulation 18(2) of the REIT Regulations is disadvantageous to Indian investors since it creates an artificial separation between agricultural and commercial properties leading to undue interference with the free market.
Lifting the restrictions on farmland REITs does require addressing regulatory challenges, such as compliance with FEMA Regulations and the IT Act, as well as defining the investment parameters based on revenue generation from the agricultural land. Further, cultural preferences are misplaced since REITs keep ownership with the public. These challenges can be effectively managed and should be seen as hurdles compared to the potential economic growth and increased agricultural productivity that farmland REITs could offer.
– A.S Vamsi Krishna & Swagat Ahuja