New Draft Norms For REITs On Anvil

Market regulator - Securities and Exchange Board of India (SEBI) - has issued a draft paper containing fresh norms for the public issue of Real Estate Investment Trusts (REITs). In its draft paper, SEBI has proposed that the allocation in the public issue should be maximum 75 per cent to qualified institutional buyers (QIBs). But for other investors, there should be at least 25 per cent allocation. The paper suggests that the investment manager can allocate up to 60 per cent of the portion available for allocation to QIBs to anchor investors, subject to certain conditions.

SEBI will issue the final norms after taking into account public comments which have been invited till January 15, 2016.

The REIT works as a mutual fund by pooling funds from several investors and investing in real estate on their behalf. Income earned by it could be through rentals or capital gains or both and gets distributed to unit holders.

The draft norms suggest all the disclosures made in the offer document should be kept in the public domain for a minimum of 21 days. Other suggestions pertains to new avenues for raising funds, appointment of merchant bankers, and disclosures in the offer documents and filing of draft papers among others. Also, no REIT can come out with a public issue if any of the sponsors, trustee or investment managers have been debarred from accessing the capital market by SEBI. The restriction will also apply for promoter, director or person in control of any other company or a sponsor, investment manager or trustee of any other REIT or REIT that is debarred from market by SEBI, as also in the case of wilful defaulters identified by the Reserve Bank.

Also, public issue can't be launched if REIT is in default of payment of distributions to the unit holders in accordance with the SEBI norms for a period of more than six months.

According to the suggestions made in the draft, an anchor Investor should make an application for at least Rs 10 crore in the public issue and allocation to such investors should be on a discretionary basis and subject to the minimum of two investors for allocation up to Rs 250 crore and five such investors for over Rs 250 crore. SEBI said that REITs will need to deposit, before the opening of subscription, and keep deposited with the stock exchange, an amount calculated at the rate of 0.5 per cent of the amount of units offered for subscription to the public.

The issue would need to be opened after at least three working days from the date of filing the offer document with the market regulator. Besides, the issue would need to be kept open for at least three working days but not more than 30 days. The investment manager may issue advertisements for issue opening and closing advertisements, it said.

The regulator also said that any public communication including advertisement, publicity material and research reports concerned with the issue should not contain any matter extraneous to the contents of the offer document. In September, 2014 SEBI had notified norms for listing of business trust structures, REITs and InvITs that would help attract more funds in a transparent manner into realty and infrastructure sectors.

A non-starter
In the story titled "The REIT Way To Invest" (published in BW | Businessworld Issue Dated 14-12-2015) Saurabh Chawla, senior executive director, Finance, DLF, had pointed out that 40-50 per cent of cash flows generated by the developers is currently taxed so why should anyone launch REITs in its current form.

In this background, perhaps SEBI has launched the current draft norms on raising capital through public issue or otherwise.

Although market watchdog SEBI came out with guidelines for REITs in September 2014, not a single REIT offering has so far come from any player. According to Hemant Tikoo, Chairman, Experion Developers, three or four things if implemented can push REITs. “REITs should be made a pass through structure. While rental income is a pass through, capital gains on sale of assets/SPV is not a pass through. Stamp duty on transfer of shares of SPV or commercial assets from developer to REIT should be exempted,” says Tikoo whose Experion is a FDI-funded developer. He says the Dividend Distribution Tax by SPVs to REITs should also be exempted and transfer of assets in lieu of units of REITs should have tax deferral provisions.

The SEBI (Real Estate Investment Trusts) Regulations, 2014 instruct that REITs shall invest only in commercial real estate assets, either directly or through SPVs. If the investment is through a SPV, the controlling interest in it should still be with the REIT. It appears that REITs will be kept away from many retail investors as the minimum investment has been fixed at Rs 2 lakh. However, they will be listed and trading is allowed in lots of Rs 1 lakh. This brings in liquidity to real estate investments that otherwise are highly illiquid in physical form.

According to SEBI, at least 80 per cent of the value of the REIT assets shall be in completed and revenue generating properties and the balance 20 per cent may be in developmental properties, mortgage-backed securities, corporate debt of the real estate sector, equity shares of companies deriving not less than 75 per cent of their operating income from real estate activity, government securities and money market instruments or cash equivalents. It also rules that REITs shall distribute not less than 90 per cent of the net distributable cash flows to their investors at least on a half yearly basis.

Concerns galore
The Dividend Distribution Tax (DDT) is the biggest concern for REITs in India. Rajesh Narain Gupta, Managing Partner, SNG & Partners recently told BW Businessworld that if DDT is applied and thereafter the withholding tax is also applied as per the current norms there will not be any interest in REITs.

In the current form, the SPV will pay tax on its profit which is corporate tax. Out of the balance profit, if a dividend of another 22 per cent is to be paid, what remains is almost half of the original cash flows. Alternatively, if the asset is first moved into a trust, then stamp duty has to be paid on asset sale which is around 7-10 percent. On the balance, DDT gets paid.

According to another expert, the road map for foreign investment in REITs also requires more clarity. “Under the extant norms, FDI is not permitted in entities carrying on real estate business. Although the Union cabinet gave its approval for foreign investments in REITs on 6 May 2015, no formal notification under the FDI policy has been issued so far”, he had said.