REITS IN INDIA Indian financial institutions seem to have escaped the current financial crisis due to the lack

of a complex structure and products in place, unlike in the developed world. Lack of a range of financial products has worked to our advantage now, but will it always be so? There are some products that, if adopted, would bring about a change in the way of investing. One such product group is REITs, which would bring about greater transparency, among other things, in the real estate sector. A real estate investment trust (REIT) is a fund that holds real estate or mortgage using capital pooled from investors. REITs could be listed on stock markets or could be unlisted but still be under the eyes of a regulatory board. REITs can be classified as -equity REIT (investing in properties), mortgage REITs (investing in mortgages) and hybrid REITs as the combination of two. REITs are a popular form of investment vehicle in the developed markets, especially in US, UK, Australia, Japan and Singapore. The concept of REITs is still taking form in most of the Asian markets. Equity REITs are most commonly seen around the world, especially in the US which is the worlds single largest REIT market. These equity REITs can have a sector specific mandate, investing in office buildings, apartments, regional malls, shopping centers, warehouses, community centers, and entertainment centers including bowling alleys, gyms and marinas among others. A specific mandate helps investors in choosing the asset base based on their risk appetite. For example, a REIT which invests in grocery anchored shopping centers would have a steady flow of income due to the non discretionary nature of the asset base. How does a REIT work? An equity REIT typically pools money from various investors (unit-holders) to acquire commercial real estate and manages it. The rent collected from this real estate is the income generated by the REIT. This income, after accounting for operating and non operating expenses along with one offs is then distributed to the unit holders as a distribution (similar to dividend in the case of share holders). In the US, a REIT should annually distribute 90% of its taxable income to shareholders in the form of dividends to qualify as a REIT apart from other investment requirements. In other words, earning distributions from REITs is similar to earning rent on an owned property.

To an investor, REITs offer the ability to diversify across various real estate sectors with smaller capital base unlike the case of fully owning a commercial real estate, which requires a large capital base. In a sector specific REIT, diversification could be seen in asset quality, geographical location and tenant base. For example, a REIT investing in office buildings would have tenants ranging from banks to software companies. This will help the REIT tackle the issues of vacancy in the current scenario where banks are closing their offices. An exposure to only banks within the office portfolio could mean unforeseen vacancy levels, thereby affecting the rental collections. Similarly, exposure of shopping center portfolio to bankrupt retailers like Boscovs, Linen n Things (in the US) could mean higher vacancy that could add a ripple effect, further reducing occupancy and rental growth as small tenants in large shopping centers try to take advantage of the traffic levels arising from the major tenant in the center. REITs in India In India, there is no legislation yet for the establishment of REITs. SEBI has outlined draft regulations for these trusts in December 2007. With the current market conditions tending to be more bearish than expected, this legislation seems to have taken a back seat. Establishing a REIT is a capital intensive process with SEBI draft guidelines laying out Rs 5 crores as minimum capital base for REITs. While there is a current lack of investor confidence in real estate pricing, another challenge is the raising of debt in the credit crisis scenario. Most REITs use debt at the trust level or property level to increase the total returns. Also, RBI has been very cautious of loan exposure of banks to real estate sector and has maximum cap on real estate loan exposure for the banks. If loaning out to REITs constitutes real estate exposure, then RBI needs to come out with guidelines which will expand the availability of credit to this sector irrespective of market conditions. SEBI guidelines state that the trustees holding the REITs could be banks, trust company of scheduled banks, public financial institutions, insurance companies or body corporates. While the real estate investments would be more organized with the above trustees, what needs to be seen is the readiness of individual commercial real estate owners to sell their properties to these trusts. While big cities with real estate prices hitting the roof will be ready to sell into the trusts, will the same hold for smaller cities and towns? In a country where holding real
estate is seen as a status symbol, will these corporates be successful in convincing the owners?