S Murlidharan

Build on a decent foundation

S. MURLIDHARAN | Updated on March 12, 2018

A Rs 1,000-crore entry barrier for IPOs is steep. — K.K. Mustafah

SEBI’s REIT Regulations are on the right lines but the rules need tweaking.

The Securities and Exchange Board of India (SEBI) has put up SEBI (Real Estate Investment Trust) Regulations, 2013 for public comments.

While there is definitely a case for REIT, given the immense potential it offers investors to earn safe income from the burgeoning market for commercial properties in India, some features of the draft regulations are bound to raise eyebrows.

Only REITs with a minimum asset size of Rs 1,000 crore are entitled to make an initial public offer. This makes the job of the sponsor onerous or attractive, depending upon who he is.

If he is a genuine real estate developer, he may find it difficult to find cash of such staggering magnitude, unless he joins hands with other developers to form a consortium of sponsors.

But if he harbours considerable black money seeking an investment outlet, the requirement would be a godsend, like the discredited Participatory Note mechanism under the SEBI’s FII dispensation.

One hopes this is not a scheme designed to be winked at by the powers-that-be. Public offers should be allowed to be made at a lesser asset size threshold. However, sponsor investment at all times should be at least 25 per cent of the capital to bring about seriousness on their part. This will provide an assurance to the public that they are not fly-by-night operators.

IPO specifications

It must also be ensured that investors who are called upon to fork out a minimum Rs 2 lakh comprising two units each bearing a face value of Rs 1 lakh at the time of initial public offer are not made to pay a premium.

All that the draft says is the minimum issue size should be Rs 250 crore. It must be made clear that no premium can be charged from investors in an IPO in keeping with the parallel provisions in mutual fund investments.

A new fund offer (NFO) by a mutual fund scheme has to be at a standard rate of Rs 10 per unit, that is its face value.

Likewise, a unit of REIT should also be offered only at par on IPO lest sponsors extort money from public investors a la the promoters of companies making IPOs — they subscribe at par but call upon the public to pay mind-boggling premiums, even though the company has not gone on stream, leave alone made a rupee of profit!

That a REIT must invest 90 per cent of its corpus only in completed projects might make its investments a tad expensive, though the intention admittedly is in public interest — investments in work-in-progress are fraught with risks, including feet-dragging by municipal authorities in granting completion and fitness certificates.

A little more latitude must be given so that REITs can nurse an investment in property from its infancy. That would morph them into the role of active builders with attendant cost benefits, as opposed to the role of passive purchasers that the regulations seem to condemn them to.

Freedom to invest up to 25 per cent in work in progress as well as new projects would have struck a golden mean and steered clear of the extreme caution or extreme risk taking.

Quarterly valuations

This cautious stance of the draft regulations flies in the face of another provision that allows a REIT to put all its eggs in one basket — in a single completed project if its size is not less than Rs 1,000 crore in terms of value.

A REIT is nothing but an extension of mutual fund, though it is supposed to cater to high net worth individuals and institutions such as provident and pension funds alone, what with an entry barrier of a stiff Rs 1 lakh investment per unit.

One of the abiding principles of mutual fund investment is diversification and the permission to put all eggs in one basket is antithetical to this principle.

The compulsion to list the units in bourses is welcome, but the market could be clueless as to the true worth of the investment portfolio of a REIT in the absence of publication of NAV at frequent intervals.

The regulations mandate publication once in six months.

To be sure, unlike a mutual fund investing in shares that can easily publish NAV every day as is mandated for an open-ended scheme, it would be impossible for a REIT to do so on a continuous basis.

But six months is too long an interval that could only encourage speculation in the bourses. Quarterly valuations would be a golden mean.

One also wonders at the wisdom of the leeway given to REITs to borrow up to 50 per cent of their assets, though the moment the borrowings cross 25 per cent, credit rating has been mandated.

Ideally, a collective investment scheme should not have the freedom to borrow. It should be debtless or debt-free.

Freedom to borrow could goad a REIT to indulge in a bit of brinkmanship inimical to the spirit of collective investment.

If the above shortcomings are removed, REIT would be an excellent investment tool for those looking for attractive but safe returns, oxymoronic as that might sound. If the REIT enters into a water-tight contract with its tenants, the threat of bad debts would be minimal.

Given the burgeoning commercial property market in India which is bound to witness a staggering growth on the back of the Food Security legislation calling for massive investments in warehouses, rental income is what the doctor has ordered.

There is no reason why the provident fund managers should not be allowed to park a sizeable portion of their funds with REITs.

Their reluctance to invest in share market is understandable, but they would lap up the REIT opportunity with two eager hands.

(The author is a New Delhi-based chartered accountant)

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Published on October 18, 2013
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