Final Regulations Indian REIT

SEBI announced India Real Estate Investment Trust Regulations, 2014. It has made key changes in terms of investment required in completed assets, minimum size of REIT, limit on number of sponsors, and minimum number of assets requirement, in-line with the announcement in Aug’14

Key changes announced in final regulations vs. draft regulations are on minimum asset value of REIT (Rs 5bn vis a vis Rs 10bn in draft), minimum project requirement (atleast 2 projects vs. 1 in draft), limit on number of sponsors (3 sponsors vs. no cap in draft) and value required in completed projects (80% vs. 90% in draft). In addition REITs will be required to make 90% of net distributable profits on a half yearly basis.

Special purpose vehicle is defined as corporate or LLP: a) in which the REIT holds or proposes to hold controlling interest and not less than 50% of the equity share capital or interest; b) which holds not less than 80% of its assets directly in properties and does not invest in other SPVs; and c) which is not engaged in any activity other than holding and developing property. In the SPV no other shareholder/partner shall have any rights that prevent the compliance from REIT regulations. In addition SPV is required to distribute not less than 90% of distributable cash flows. There is no borrowing limit at SPV level.

While REITs have been given a pass-through status, taxes (corporate and dividend distribution) will be applicable at the SPVs controlled by REITs. In a scenario of all equity REIT investment in SPV, limited benefit of tax pass through will be available to investors as all taxes will be applicable at the SPV level. A structured investment in SPVs (Debt/Equity mix) will improve return profile by 80bps. However the yield profile is likely to be below 10 year Gsec for both domestic and foreign investors.

Key monitorable remains the expectations gap between sponsors and investors. While sponsors look to factor in the benefits of capital appreciation in the valuation of assets, investors are still skeptical on building in significant capital appreciation and would keep appreciation as option value for their investments. Lower interest rate scenario is necessary to bridge the gap.

While SEBI has largely addressed regulatory issues, certain tax related issues still need to be clarified by Ministry of Finance inorder to improve viability of REITs in India. MAT arising on revaluation during swap of units and SPV shareholding will lead to cash flow mismatch for sponsors (while actual capital gains matches realisation). In addition capital gains tax imposed on sale of assets by REITs (vs internationally exempted if gains distributed) will lead to a listing discount on NAV. Any clarity on these aspects will improve attractiveness of I-REITs for both sponsors and investors.