REIT taxation clarity provided

Union Budget 2015 finally provided some clarity on the taxation of REITs. As a brief recap, going into the Budget, there were two primary demands from the industry regarding taxation: 1. Exempt transfer of assets from sponsor to REIT from capital gains as it’s similar to a company doing an IPO; and 2. Exempt the project SPV from Dividend Distribution Tax when paying dividends to REIT. These norms would have incentivized sponsors to put assets into the REIT without undergoing significant tax outgo and also be able to upstream higher dividends from assets to final investors.

On the first demand, partial relief given. Transfer of assets from the sponsor to the REIT is exempted from capital gains tax. There will be a levy of MAT at transfer but this can be offset on other residential business that the sponsor may have. On DDT exemption, no relief has been given as against industry demands. Thus REITs will now need to take out dividends as interest income from the SPV. This, however, attracts withholding tax which is lower for FIIs.

 REITs can take out dividend in the form of interest income from the SPV. Under the regulations laid out, domestic investors pay higher tax on the REIT dividend as opposed to foreign investors that pay a withholding tax of 5% (additional paid depending on their tax jurisdiction). For both domestic investors and FIIs, REIT income is a pass through and is taxed at their hands (less withholding tax paid by the REIT). Thus for FIIs this is a good outcome. For domestic sponsors, technically, this will mean that entire rental income is taxed. Again for sponsors with large residential business can offset this. However, it might not be really attractive for pure commercial developers. We do note that the regulation is no worse than the existing tax structure. See pictorial representation below.

Exiciting Times for Mumbai Home Buyers

Developers are now offering freebies and discounts to sell projects, as the supply on offer is different from demand segments.

Similar to the trend in other markets, Mumbai also saw fewer (official) launches in 3QFY15 as developers pushed sales at existing projects (with more supply, investor deals still remain high, we believe). Pricing still remains high in certain markets, but is not increasing anymore. More deals and offers are now being followed up with absolute price-cuts at many projects, including those of larger developers and high-value markets.  

The residential market still remains slow and only strong brands are able to sell expensive products. Developers are open to giving discounts and cutting prices, but post definitive interest from buyers. Land buying has dropped and prices are not going up as only 4-5 developers have the capacity to buy land worth more than US$200 mn. Further, developers want to reduce absolute debt, but with changing approvals and increasing costs, we remain skeptical.  

Launches continue to slow down in Mumbai too, with the official launches during the festive season 50% lower than the average of the past 10 quarters. But our channel checks suggest developers are pre-launching projects to investors, offering deals for large projects that are yet to be reported as official sales.

Developers continue to push sales at existing projects, with many introducing discounts in the form of subvention schemes, schemes without interest rates linked to banks and apartment registrations, deferred payment plans and most even offering high discounts on offered rack rates. Our channel checks suggest discounts in certain high-value projects / large developers ranging from Rs 500/sq. ft to even Rs 5,000/sq. ft depending on locations and projects. Having done this, sales continue to hold ground in Mumbai on a consolidated basis.

Residential Demand Remains Weak

Residential absorption (area sold) in key cities of India fell -22%YoY/ -9%QoQ in 3QFY15 (Prop Equity data). While the decline in absolute terms is still substantial, the pace of demand decline has moderated over the past four quarters. Residential new launches fell 59%YoY/42% QoQ in 3QFY15


Residential prices have been increasing despite weak volumes over the past 3-4 years. However, now different data points are suggesting a sharp deceleration in price rises. Residential prices grew just ~2% YoY in 3QFY15 – a sharp deceleration from the 12%-16% YoY increase seen over 2QFY12 -4QFY13.

Commercial absorption in key cities grew 11%YoY/ -12% QoQ in 3QFY15. 3QFY15 was fourth consecutive quarter in which commercial absorption grew. Commercial absorption grew 15%/6%/51% YoY
in 4QFY14/1QFY15/2QFY15. High inventory (~50 months of available supply) has kept rentals in check. Rentals are flat YoY. Commercial new launches fell 95%YoY/ 98%QoQ in 3QFY15.

Commercial property demand is growing again while residential demand destruction is inching closer to bottom. Demand for premium residential property in Mumbai and Gurgaon has picked up in 3QFY15. However, full recovery is some time away

Transforming Mumbai - Infrastructure Thrust & FSI

A proposal has been mooted to increase Floor Space Index (FSI) across Mumbai between 3-8x. This is a follow-up of the announcement made at the recently concluded “Mumbai Metropolitan Region Transformational Enclave”, wherein the state government stated that it will look at increasing FSI in Greater Mumbai for the promotion of new industrial hubs and affordable housing. The state government is increasingly focused on urban infrastructure creation in Mumbai, something which the city desperately lacks. This is also in line with the Chief Minister’s resolve to make Mumbai a global financial hub. Even if half of these projects get implemented, it could have a cataclysmic effect on the city’s real estate / infra potential. Some of the key initiatives announced by the government are listed below

1. FSI increase in Greater Mumbai for promoting infrastructure creation and reducing population pressure on the city. Proposal has been mooted now to increase it to between 3.5-8x. However, the final notification of this plan is likely 1-2 years away.

2. Creation of an IT-based platform for project clearance thus cutting lead times. A “war room” at the CM’s office to coordinate projects across 17 different government agencies will also be put in place.

3. Implementation of the U$1.5B, 36KM coastal road project in two years.

4. Completion of the first phase of the Navi Mumbai International Airport by 2019.

5. Allowing the local municipal body (BMC) to raise bonds to fund new infra creation.

6. Release of a New Tourism Policy for the city.

7. Get work started on the Trans Harbor Link (22KM) that connects the city to the mainland and thus open up new development avenues.

8. Extension of Metro Rail in three new areas connecting the city to suburbs.

9. Creation of a new “BKC”-like district in Thane and improving connectivity of BKC to other suburbs via connector bridges and roads.

10. The state government has also asked the center for tax benefits for the promotion of financial activities in the city.

Mumbai, over the last 10 years, has lagged its competitor cities in new infrastructure creation. Delhi/NCR region has thus rapidly moved ahead of Mumbai driven by private/public infrastructure participation. However, the state government now seems to be intent on changing that. A master plan seems to have been laid for a “transformation” over the next five years.

SEZ Land - dual use of social, commercial infrastructure

In a recent gazette notification to amend the Special Economic Zones (SEZ) Rules, 2006, the Ministry of Commerce & Industry has allowed dual use (both by the SEZ and the domestic tariff area entities) of “social or commercial infrastructure and other facilities”, within non-processing areas. The core commercial activity of SEZ units is undertaken in the processing area, and the rest of the land in the SEZ is the non-processing area.

It is pertinent to note that non-processing areas will be divided into two zones: (1) where social or commercial infrastructure and other facilities are permitted to be used by both the SEZ and the domestic tariff area entities, and (2) one that will be exclusively used by SEZ units (this area will be bonded and physically segregated from the rest). While the first category will not enjoy tax incentives, the second will be eligible for tax concessions.

Notification lays out restrictions for duty-paid dual-use non-processing areas - The individual caps are: (1) housing (capped at 25%), (2) commercial (capped at 10%), (3) open area and circulation (not less than 45%) and (4) social and institutional infrastructure including schools, colleges, socio-cultural centers, training institutes, banks and post offices in the remaining area.

The notification is positive for SEZ developers with land monetization plans (will potentially lead to an uptick in land leased and pricing), given that it will lead to better economics for operators of social or commercial infrastructure facilities in the dual use non-processing area. The positive impact, though, for an SEZ developer, has been somewhat curtailed given that the dual-use non-processing area will get no tax concessions. The developer must refund prior central or state tax concessions availed for creation of the infrastructure

Affordability on Mumbai's Central Railway Corridor

Residential Apartment Affordability on Mumbai's Central Railway Corridor between 2008 vs 2014 is as shown below.

Rise in property prices has forced home buyers to move to suburbs which fits their income profile.

• A budget of Rs.132 laths could buy property in Sion(E) in 2008, but only in Bhandup(W) in 2014
• Family with pre-tax income of Rs 8 lakh can buy a house in suburbs like Ambarnath /Badlapur and Titwala
• Ambivali has seen the highest Rise while Kurla (W) has registered the Lowest.

Affordability On Mumbai's Western Railway Corridor

Residential Apartment Affordability in the Western Railway Corridor in Mumbai Metropolitan Area between 2008 Vs 2014 is as shown below.

Rise in property prices has forced home buyers to move to suburbs which fits their income profile, For Example, a budget of Rs.66 lakhs could buy property in Malad (W) in 2008, but only in Vasai (W) in 2014 • Family with pre-tax income of Rs 10 lakh can buy a house in suburbs like Vasai-Virar
• Bandra (W) has seen the highest price rise while Jogeshwari (W) has seen the lowest rise

Affordable housing norms eased significantly

The Government of India headed by the most able Prime Minister of Independent India, Shri Narendra Modi notified amendments to “Consolidated FDI Policy Circular 2014” inline with announcement made in Oct’14. Key revision from the Oct’14 announcement lies in the Affordable housing (AH) qualification criteria which has been eased significantly.

The amended norms provide for no restriction on capital and size if a project has 30% of cost in AH segment. Projects which have to qualify for AH have to use 1) at least 40% (reduced from 60% in Oct’14 announcement) of the FSI for dwelling units of Floor Area <140 sq mts (increased from 60 sq mts carpet area); and 2) 25% of the total number of dwelling units (reduced from 35%) constructed should be of floor area <60 sq mts (increased from 21-27 sq mts in Oct announcement).
The relaxation of qualification norms for AH significantly increases the ambit of FDI investment in the sector. Removal of FDI restriction, in addition to RBI incentives for AH segment (allowing banks to raise long term bonds); will reduce the cost of funding for developers undertaking affordable housing projects

However for AH concept to become a reality across country we need to see improvement in clearance process (reduce timeline of approvals), incentives to builders (extra FSI, higher low cost land availability), and incentives to customers (interest rate, stamp duty subsidy) inorder to improve the viability of the projects.

GoI has clarified that 100% FDI under automatic route is permitted in projects for operations and maintenance of townships, malls/shopping complexes and business centers. However we have limited clarity if this can be interpreted as FDI investment in completed assets or just for undertaking operations and maintenance activities in these projects

GoI has removed the condition of minimum 3 years lock-in (subject to completion of trunk infrastructure) while allowing the exit after completion of project. Inclusion of exit on completion clause helps shorter execution tenure projects (affordable housing projects).