How REITs will be a game-changer for Indian real estate

Written By Unknown on Kamis, 04 September 2014 | 21.03

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The Securities and Exchange Board of India (Sebi) recently announced guidelines for the creation of real estate investment trusts (REITs) in India.

Just as mutual funds do with equity and debt, REITs will pool money from investors and invest them in income-generating (rental assets) offering them a way to diversify their portfolios by investing in property.

After collecting money, REITs will issue units to investors, which will then be listed on exchange for buying and selling.

This will help establish a new asset class, and being a quasi debt-equity instrument, be attractive for risk-averse investors get the twin benefits of yield as well as capital appreciation, an ICICI Securities report says.

For developers, it would "improve property market transparency, smoothen volatile property cycles, and potentially lower the cost of capital."

i-Sec expects     REITs to get launched about six-nine months after Budget 2015.

Here are excerpts from the report, which terms the introduction of REITs as a "potential game-changer for real estate in India".

Key benefits

Portfolio diversification : For small investors and institutions, REITs provide an opportunity to invest in largescale commercial real estate, which would have otherwise been only possible for HNIs and wealthy individuals.

A compulsory dividend payout (typically >80% globally and >90% in India) makes the underlying asset similar to a bond, with a growth component built-in through price appreciation.

Liquidity and cost of capital benefits: REITs are mandated to provide recurring dividends, and most REIT legislations globally also put a cap on gearing (debt-to-asset) ratios, which reduces the risk perception associated with the asset class.

Further, tax concessions ensure that dividend payouts are healthy and less impacted by changes in central tax laws.

Improved transparency and less volatile markets: REITs improve transparency in the real estate markets as information is periodically disclosed on average rents, occupancy levels, tenant profile, renewal profile, etc. Availability of such information reduces information asymmetry, which is typically seen in real estate markets and is a key reason for volatility.

Nature of instrument

Due to the underlying cashflow stability (recurring annual rental income) of the asset, and predictability of dividends (compulsory distribution), REITs are commonly viewed as an yield instrument. They typically tend to have a high correlation to bond yields. Thus, in a softening interest rate environment, cap rates will fall (assuming spreads remain same).

In most cases, REITs trade at a positive spread over bond yields to account for market risks and individual property risks such as local market demand-supply, vacancies, tenancy risk, gearing risk, etc.

A commonly used valuation metric in the commercial asset class is cap rate or capitalisation rate. It is defined as net operating income (rent minus expenses) produced by an asset divided by the market value of the asset.

Cap rates used in valuing properties are impacted by bond yields (cost of capital), and the expectation of rent reversion defined as growth or de-growth in rent due to changes in the physical property market.

How i-REITs compare

The key basic Indian REIT structure is broadly in line with REIT legislations in Asia, especially on limits on gearing (currently set at 50 percent), payouts (90 percent), and investment in real estate (80 percent).

Only developed REIT markets (US, Australia, etc.) have significantly higher freedom in gearing requirements (no gearing limits). While investments in foreign assets are not allowed, we believe it is largely irrelevant as long as there is a ready availability of REIT'able domestic assets.

The key aspect that remains to be resolved is tax transparency, which is out of SEBI's ambit and needs to be addressed by the Union Finance Ministry.

Macros, micros aligning for i-REITs

Consensus expectation is that bond yields in India are expected to decline in the next 12 months, and unlikely to spike unless driven by global market conditions

The office sector appears to be a silver lining for real estate developers given its declining vacancy levels and improving rents. Softening yields and increasing exit options (such as CMBS, potential REITs) are likely to positively impact cap rates and improve asset valuations.

Large developers in India such as DLF continue to be burdened with debt in their balance sheet and a weak cashflow generation profile, which is likely to make them closely pursue equity options (including REIT).

As residential markets remain sluggish due to inventory overhang, and weak sales, REIT listings can offer a potentially attractive exit option to such developers to improve their balance sheets.


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