Reality check

Real Estate Investment Trusts were expected to be the answer to all the problems facing the beleaguered realty sector when they were launched in 2014. But with no action on the ground even three years after implementation of the regulations, the Securities and Exchange Board of India has reason to feel concerned. Despite multiple amendments to the regulations governing these instruments — relating to taxation, holding structure, related party transactions and methods of valuations of assets — developers have still not launched any REITs in India. The changes to the REITs and InVITs regulations announced by SEBI this week shows that the regulator is spending considerable time deliberating with stakeholders to understand the issues impeding the launch of REITs in India and to remove them. But in its haste to make developers launch REITs, SEBI could be inviting a fresh set of problems.

The real estate sector in India has been grappling with multiple issues. Property prices haven’t fallen despite large inventories and falling demand. Debts of most companies have been mounting as they have struggled to monetise projects. REITs can help real estate developers raise funds by selling some of their rent-bearing assets to these trusts, which could be used to complete other projects. But developers have not been enthused by this idea so far. The regulator is now trying to entice real estate developers towards these instruments by allowing REITs to raise funds by issuing debt securities. Besides this, REITs have also been allowed to lend to their Holdcos or Special Purpose Vehicles. While the money raised could be used to meet the short-term funding requirements of the underlying projects, investors are likely to demand high rates of interest from such debt securities since they carry high risk. The margin that the REIT is likely to earn by lending these funds is not likely to be very high. Servicing the debt could become a problem if the underlying projects get stalled. In view of the state of the sector, the regulator will need to keep a tight watch on the utilisation of funds raised through these debt securities to prevent the diversion of funds.

Allowing REITs to hold a single asset akin to infrastructure investment trusts is not good for investors. The diverse portfolio of rent-yielding assets, originally proposed to be held by REITs, scores over direct investment in real estate. This model could, however, find favour with real estate developers who have greater control and ownership over the asset. Also, smaller developers with single projects could now consider launching REITs. While the regulator cannot be faulted for trying to start trading of REITs, it needs to understand that these instruments are unlikely to meet the same success they did overseas due to low rental yields in India. Further, given the moribund state of the real estate market in India, capital gains will be hard to come by.

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