Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs), which enable investors to own a part of a commercial real estate or infrastructure project and receive a steady stream of income, have an important role in addressing the funding needs of these sectors. But despite more than a decade having passed since the launch of the first REIT, investor interest in these securities is rather tepid. A recent consultation paper released by the Securities and Exchange Board of India (SEBI) seeks to increase the demand for these instruments by enhancing the limits for mutual fund (MF) investments in REITs and InvITs. But given the higher risk and low liquidity, it may not be a good idea to increase MF exposure to these instruments.

SEBI’s consultation paper has three proposals. One, classify these instruments as equity and include them in equity indices so that passive funds automatically buy these securities. The idea of classifying REITs and InvITs as equity had been rejected by the SEBI Board in 2017 and more recently by the regulator’s mutual fund advisory committee. Both noted that these instruments should be classified as hybrid securities since they possess features of equity as well as debt securities. Though unit holders own the equity of the trusts, 90 per cent of the net cash flow must be distributed among the unit holders, giving them the properties of a fixed income security. Voting rights of unit holders are also limited to some operational decisions, unlike other equity securities.

Adding REITs and InvITs to equity indices is also a bad idea because: first, price movement is unlike other equity shares since the value is derived partly from capital appreciation and partly from the distributed income, and the returns of the index could be negatively impacted; second, their market capitalisation is very small; and third, liquidity is very thin, which makes them vulnerable to price manipulation. The second proposal in the consultation paper about having a dedicated MF category for these securities is also difficult to implement given their extremely low volumes. Transactions of MFs will result in distorting the prices of these securities. Such a proposal can be considered perhaps after a few years if the trading volume in these instruments increases significantly.

The third proposal in the consultation paper concerns increasing the investment limit for MFs in these schemes. As per current rules, a MF scheme is not allowed to invest more than 10 per cent of its net asset value in REITs and InvITs, and not more than 5 per cent can be invested in the securities from a single issuer. These limits are appropriate, given the higher risk in the income flow from these securities, especially in infrastructure investment trusts. SEBI’s proposal to double these limits will expose small investors in MFs to higher risk.

Published on April 24, 2025