The Hindu Business Line : REITs — poised to gain ground

Because of the rapid pace of construction, India will soon have a critical mass of assets that would allow a
real-estate investment trust market to form.
MR DOMINIC WHITING, AUTHOR OF ‘PLAYING THE REITS GAME’

D. Murali
C. Ramesh

With realty booming in India, it is just a matter of time before the concept of real-estate investment trust (REIT) gains ground among investors and policymakers. REITs, as investment vehicles that reduce the tax liability of corporates, are well established in Japan, Singapore and some western economies, and are bound to make an appearance in India in the next few years, according to Mr Dominic Whiting, author of Playing the REITs Game ( www.wiley .com), which focuses on the Asian opportunity in this sector.

In an e-mailed interview to Business Line on the concept and its relevance to India, he said that because of the rapid pace of construction, India will soon have a critical mass of assets that would allow a REIT market to form.

Half-way house

“At the moment, though, there is actually very little scope. Of an estimated $300-billion worth of commercial buildings in the country, only about $83-billion worth can be considered investment-grade. In comparison, Japan has $1.27-trillion of investment-grade buildings.”

A REIT, pronounced ‘reet’, essentially invests in real-estate using investor money and delivers returns by rental or other income from the property acquired. The profits are shared among the investors in the form of dividend.

Mr Whiting said that REITs give individual investors a “half-way house between stocks, which can be volatile, and the steady returns of bonds. You get a fairly predictable dividend, but if rents rise, there is potential for capital gain.”

He believes that REITs could be the perfect investment vehicle for personal pension plan or in the case of saving for children’s higher education.

On the average returns generated by REITs, he said that General Property Trust (GPT), probably Australia’s most successful property trust, has returned 14.7 per cent annually since 1971.

“For example, if a 30-year-old woman had bought $10,000 worth of units in GPT, a listed entity, in 1971, and reinvested all her dividends in the trust over the next 35 years, she could have retired at the age of 65 with over $1 million worth of shares and receive an annual dividend yield of $70,000 — enough to live on fairly comfortably.”

And in the US, REITs have given, on an average, annual returns of 13 per cent over the last two decades.

“Dividends in the US have almost always grown at a faster rate than consumer prices — so they have provided a hedge against inflation.”

The Singapore model

According to Mr Whiting, the Singapore model is frequently held up by REIT proponents as an excellent example of a REIT-friendly regulatory regime. “As in most countries with REITs, Singapore provides corporate tax exemption on trusts, but it has also completely waived dividend tax for all individual investors and cut the withholding tax for FIIs to 10 per cent from 20 per cent.”

He added that Singapore also has a relatively high limit of 60 per cent on debt gearing, which gives REITs more leeway to fund acquisitions and deliver higher returns to investors, than in regions such as Hong Kong, where the limit is 45 per cent.

“Regulators allow foreign assets to be packaged into REITs listed in Singapore, but that is important because the island-State has a relatively small domestic market. That would not be necessary in India.”

In his opinion, REITs would give Indian households a relatively low-risk alternative to stocks. “However, in a young market, REITs are usually lumped together with stocks and can suffer the same sort of volatility even if they don’t deserve to. But that changes with time.”

He added that the other risk with property in a country where buildings are coming up fast is that the market can change quickly. “A shopping centre can be thriving one year and suddenly go out of fashion in the next if a new and bigger mall is built nearby. It is important for REITs to be fairly big and diversified, geographically and in terms of asset types, in order to limit such risks.”

On the corporate opportunity in the REIT space for Indian companies, Mr Whiting said that the ‘asset light’ model could be of interest to Indian property companies.

In this model, the developer sets up a REIT or a series of REITs, but retains a stake — say, 30 per cent — in order to profit from any unit price gain. The developer also sets up a REIT management firm to manage the trust, thereby setting up a new fee income stream.

“The money raised by selling buildings into the REIT can be used for new development projects, which, in turn, can be sold into the REIT once completed and filled with tenants. So, instead of holding on to a shopping centre for 20 years and getting a return of 10-12 per cent each year, a developer can essentially flip buildings for returns of 20-30 per cent, or even higher.”

Selling in the capital market is also much more reliable, and fetches a much higher price, he added.

Property prices could soar

It is feared that the influx of foreign investment in REITs could contribute to asset price escalation in an emerging economy such as India.

Mr Whiting agreed that REITs can contribute to higher property prices because “they usually spark a rash of transactions for buildings, they tend to pay higher prices than private funds, due to the corporate tax waiver and also because stock investors are generally prepared to accept lower returns in exchange for the added advantage of liquidity.”

However, he added, REITs also make a huge contribution to improvements in property market information flows because they are obliged to disclose rental rates, occupancy rates, capital values, etc.

“In fact, the motivation for setting up REIT markets in Singapore and Japan was to give moribund property markets a kick-start, and it definitely worked. The fact that investors are setting a capital market value for a bunch of buildings also helps set a benchmark.”

According to him, the increased pricing information should make the property market function more efficiently and make it more difficult for landlords to charge over market rates.

“The REIT market in the US actually grew because of the bursting of a property bubble; after the savings and loans crisis in the early 1990s, trusts were formed out of distressed assets. The Japanese market also has its roots in corporate restructuring, formed to help companies offload buildings from their balance sheets. A REIT market in India could take off if the current boom turns into some kind of bust.”

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