Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs) have been a hot topic of discussion in recent times, especially due to the uncertainties surrounding them which have caused their value to plummet. However, before we delve into the reasons behind the recent downfall of REITs, let us first understand what these investment vehicles are and how they work.
A REIT is a company that invests in premium real estate assets and mortgages. The assets owned by the REIT generate income in the form of rent and lease, which is then distributed to the shareholders as dividends. On the other hand, InvITs are similar investment vehicles but instead of investing in real estate assets, they pool money from investors to invest in infrastructure assets such as highways, power grids, and airports.
The sponsor plays a crucial role in setting up a REIT or an InvIT. In the case of a REIT, the sponsor is the person or group of people who set up the REIT and fulfill the eligibility criteria. Whereas, in the case of InvITs, the sponsor is a company, Limited Liability Partnership (LLP), or a body corporate that sets up the InvIT.
Reasons for the recent decline:
Despite the benefits of investing in REITs and InvITs, most of these investment vehicles have seen a significant decline in their value in recent months. One of the primary reasons behind this decline is the global pandemic, which has severely affected the real estate and infrastructure sectors. Due to the pandemic, the demand for office and commercial spaces has reduced, resulting in a decrease in the rental income generated by these assets.
Another factor that has contributed to the decline in the value of REITs and InvITs is the increase in interest rates. As interest rates rise, the yield on these investment vehicles becomes less attractive to investors, resulting in a decrease in demand for REITs and InvITs.
Proposed regulatory changes:
SEBI, the Securities and Exchange Board of India, has released a consultation paper on REITs/InvITs, which is aimed at improving the functioning of these investment vehicles. In the paper, SEBI has proposed that it is essential to have at least one sponsor throughout the life of the REIT/InvIT, given that this particular segment of the market is “in a nascent stage and continuously evolving.”
SEBI’s proposal is based on the idea that the presence of a sponsor throughout the life of the investment vehicle would ensure that there is an alignment of interest between the sponsor and the unitholder. The regulator has suggested that the sponsor must hold a certain percentage of units on a perpetual basis to ensure this alignment of interest.
Moreover, SEBI has taken into account the fact that the assets of REITs/InvITs are leveraged and that allowing a sponsor to completely dilute its unit holding immediately after the mandatory 3-year lock-in period would be “inappropriate” in view of the impending debt obligations that are of a long-term nature. This proposal is significant since sponsors play a crucial role in the functioning of REITs/InvITs, and ensuring their presence throughout the life of the investment vehicle would provide greater stability and sustainability to these instruments.
The consultation paper also discusses other important issues related to REITs/InvITs, such as the need for greater transparency in their functioning, the need to address the concerns of unitholders, and the importance of providing clarity on the tax treatment of these instruments. The regulator has also proposed measures to improve the liquidity of REITs/InvITs and has suggested ways to ensure that these investment vehicles are better regulated.
SEBI’s proposal comes at a time when the Indian real estate market is going through a challenging phase, with the COVID-19 pandemic having a significant impact on the sector. REITs/InvITs are seen as an important source of funding for the real estate industry, and their success is critical for the growth of the sector. In this context, SEBI’s proposal is a welcome step towards improving the functioning of these investment vehicles.
Another issue is the impending implementation of the Development of Economic and Social Hubs (DESH) Bill, which is expected to replace or modify the Special Economic Zone (SEZ) Act.
Under the SEZ Act, companies that set up offices in SEZs with net foreign exchange earnings were provided with initial tax incentives. SEZs were intended to facilitate both export-oriented and were seen as a means to boost economic growth. However, with the exemptions under the SEZ Act being withdrawn, vacancies in SEZs have been high, posing risks to the income expansion of listed REITs.
The delayed implementation of the DESH Bill (related to SEZs) and the proposed introduction of a tax for unitholders on the debt repayment/capital return portion of listed REITs have further dampened the mood and made it a recipe for the “perfect storm” for Indian office REITs. This has put pressure on the three listed REITs (Embassy, Mindspace, and Brookfield) that have exposure to SEZs, posing risks to their income expansion and overall financial health.
In light of these challenges and opaque regulatory changes, the REITs industry in India is calling for greater clarity and transparency from regulators, along with a more supportive policy environment.
SEBI’s proposal to have at least one sponsor throughout the life of the REIT/InvIT investment vehicle is a crucial measure towards enhancing the functioning of these instruments. The regulator’s focus on ensuring sponsor-unit holder alignment of interests, and addressing other important issues related to REITs/InvITs, is a positive development for the Indian real estate market. With the right regulatory framework in place, REITs/InvITs can potentially become a significant source of funding for the real estate industry and contribute to the sector’s growth.In conclusion, it is advisable for investors to carefully consider the current challenges and uncertainties facing the Indian real estate market before investing in REITs and InvITs. It is vital to conduct a thorough risk assessment and stay informed about regulatory changes and market trends. Our recommendation for new investors is to exercise patience and wait for regulatory clarity, while existing investors should continue to hold their investments for the medium to long term. We are optimistic about the sector’s long-term growth potential and believe that REITs/InvITs can offer attractive investment opportunities with the right risk management strategies in place.
This article should not be construed as investment advice, please consult your Investment Adviser before making any investment decision.
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