Reviving trust

Ever since the Securities and Exchange Board of India flagged off its new Real Estate Investment Trust regulations in 2014, property developers and lenders to the sector have rejoiced, while investors have remained unenthused. While developers see REITs as a convenient way for them to offload commercial assets and reduce debt, investors seem to be put off by the governance risks in the asset class and its low liquidity compared to equities or bonds. As returns on REITs depend on the demand and rents for office space, they have also compared poorly to other debt instruments during the economic slump. Recent tweaks proposed in SEBI’s board meet are the latest attempt to revive REITs.

SEBI has indicated that it is considering three key relaxations in its current regulations. For one, it proposes to allow REITs to invest in property via multi-layered special purpose vehicles (SPVs) rather than single-level SPVs allowed earlier. It also plans to ‘rationalise’ the onerous rules governing related party transactions. Two, it plans to allow as many as five sponsors to kick off a REIT, as against three currently. Finally, an investment of up to 20 per cent (against 10 per cent) will be allowed in under-construction properties. Now, while these relaxations may make life easier for the sponsors and managers of REITs, they may turn out to be quite undesirable for investors. A multi-layered SPV structure will make it harder for investors to discern the ultimate assets held in their REIT portfolio. Allowing more sponsors into REIT may reduce skin in the game for sponsors. Already, the fact that REITs can kick off operations based on property assets transferred by their sponsors, creates a direct conflict of interest between the sponsors of REITs and their ultimate investors. This risk is addressed both by elaborate related party rules and skin in the game requirements in SEBI’s current regulations. These require sponsors to collectively invest at least 25 per cent of the outstanding corpus of a REIT for the first three years with a collective net worth of at least ₹100 crore. Expanding the number of sponsors from three to five may water down these stipulations. There is an attempt to safeguard investor interests against related party transactions by stipulating unit-holder approvals and independent valuation reports for such transactions. But the experience with related party deals in listed companies, where disinterested investors often rubber stamp such proposals, shows that such safeguards are often ineffective.

Rather than dilute the governance norms to make REITs more attractive to their sponsors, SEBI must focus on new ideas for more transparency and a better exit mechanism for investors. A more frequent mark-to-market valuation for this vehicle may help. Today, though compulsory listing has been envisaged to facilitate anytime liquidity, it is not clear how investors in the secondary market can really trade when valuation of REIT portfolios will only be done once in six months. As for the rest, policymakers should leave it to the ongoing revival in the commercial real estate to kindle investor interest in REITs.

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