Small realty firms to benefit from REITs

As real estate investment trusts (REITs) are set to become a reality in the country, small and medium property developers, who constitute 80 per cent of the total realty industry, can now breathe easy.

These developers, who were hit by the credit squeeze following strict measures of the Reserve Bank of India, can now sell some part of their properties to REITs and liquidate.

"A lot of medium and small developers, who are holding income generating assets, can unlock their value by transferring some of the assets to professionally managed REITs. A large avenue is being opened for these players who cannot go to foreign exchanges to list their projects," said Jai Mavani, executive director, KPMG India.

The second-rung developers were badly hit on funding due to anti-inflationary measures such as a ban on external commercial borrowings in townships, restrictions on lending to buy land, increase in interest rates and Sebi's clampdown on realty IPOs.

"REITs will create a healthy secondary market for these firms, which are hit by credit squeeze and restriction on foreign capital infusion," said Mavani.

Ganesh Raj, partner, Ernst & Young, adds, "Earlier when the smaller developers were building properties in tier-II or -III towns, they could not sell for high returns since there were not many takers, but now they can sell their properties to REITs, if they are strategically placed."

Meanwhile, big real estate companies may go ahead with their listing of REIT-type structures on the international exchanges since they have opted for listing their own trusts, while the proposed Indian REIT norms do not allow them to fully invest their funds in their own assets.

Companies such as DLF, Unitech and the Embassy Group have already announced their plans to raise nearly $5 billion from the Singapore Stock Exchange through REITs next year.

"Sebi's guidelines stipulate that a trust cannot have exposure to more than 25 per cent of realty projects by a group of companies. This limits a big property company from listing its own trust in the country. Hence, exchanges such as the Singapore Stock Exchange are always preferred, despite less rate of returns of 4 to 6 per cent compared with 10 to 12 per cent in India," said an executive of DLF, which is listing a $1.2 billion REIT on the Singapore Stock Exchange in January 2008.

"Even a big developer without a business plan of listing the REIT abroad can sell a portion of his developed properties to a trust," the executive said.

Analysts also believe that the component of black money in smaller companies could come down significantly since institutional money is expected to flow into REITs and these structures demand a high level of disclosure and transparency.

 "Normally, buyers invest in properties in unaccounted money due to arbitrary demands of developers and their own needs. Since institutional money is expected to flow in REITs, it will curtail the black money element. However, REIT structures always stipulate a high level of disclosure and transparency," said a property consultant.

Though the real estate industry welcomed Sebi's move, many are wary of tax treatment to REITs in the country.

"If the structure was that of a mutual fund, there would not have been a need for a separate tax treatment. But because they are trust structures, they have to pay stamp duty and registration charges when they invest in properties, resulting in their costs going up. Stamp duty being a state subject, there should be uniformity in the matter," said a tax expert.

The Securities and Exchange Board of India on Friday proposed the setting up of REITs, paving the way for a wider participation by retail investors in the booming real estate sector.

Under the draft guidelines issued by Sebi, scheduled banks, public financial institutions, insurance companies and corporates will be eligible to set up an REIT, with an initial net worth of Rs 5 crore (Rs 50 million).

REITs are listed entities, similar to mutual funds, that use collective funds for owning and managing investments in real estate projects.