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Will REITs provide lifeline to real estate industry?

Though in India the first REIT (Real Estate Investment Trust) issue hit the market only in April 2019 (Embassy Office Parks REIT IPO), the concept has been in vogue in the financial world since last 60 years. REIT markets around the globe have seen immense growth in recent years. The cumulative market capitalization of REITs globally is estimated at approximately USD 2 trillion now! Though REITs were initially USA centric, now they are spread out globally. India’s late entry into this arena may be partly attributed to factors such as opacity in transactions, lack of clarity with respect to regulations, tax and investment requirements.

What’s a REIT?

REITs are entities that own or finance income producing real estate assets in a range of real estate properties. They provide investors an opportunity to own valuable real estate and get access to dividend and capital appreciation. They are among the few options for small investors to have a source of income from real estate based derivatives.

How REIT operates?

Real Estate Investment Trusts (REITs) operate almost like a mutual fund by pooling funds from investors and investing them in real estate assets. REITs are investment trusts that work similar to mutual funds with the only big difference being that instead of using the money collected from investors to buy stocks and bonds, in case of REITs capital is deployed to own real estate assets. The Trust will earn either from capital appreciation or through rentals on commercial properties like office, shops, malls and hotels. While rentals provide quick and regular returns, capital gains are usually long term in nature. It should be noted that REIT is essentially a framework for completed and revenue generating assets.

REITs around the world

Importance of REIT as an avenue to raise fund for real estate sector can be gauged from the fact that in the last 6 years, around USD 200 billion has been raised through REITs globally. Further, of the funds raised, more than 70% has been in USA alone. Apart from USA, UK, Singapore, Canada and Australia are the other key markets for REITs. Nearly six decades after their creation, the US REIT industry has grown to a USD 1.3 trillion equity market capitalization representing over 70% of the worldwide share. It’s not wrong to say that REIT has contribution in the growth of real estate market in USA, especially in the 21st century.

On the other hand, REIT is relatively of recent origin in Singapore having made its beginning in 1999. Today, S-REITs and property trusts, have a market capitalisation of around SD 100 billion accounting for 12% of Singapore Exchange’s market capitalisation and making it an important global REIT hub. Importantly, over 80% of S-REITs and property trusts (by market capitalisation) own properties outside Singapore and the trend of acquiring assets outside Singapore has intensified in recent years.

Commercial real estate in India

India’s commercial real estate is the only saving grace of our real estate industry which has been going through a lean patch for the last 5-7 years. Things were going on smoothly for the commercial real estate sector till the outbreak of COVID-19 and subsequent nationwide lockdown. In fact, Indian Commercial Real Estate (CRE) office market saw record leasing in CY19 with 42msf of annual net absorption.  The office market has been in a upcycle over CY14-19 with rising rentals, falling vacancies, consolidation among developers and emergence of REITs. Even in 2020, initially, followed the previous year trend before the COVID-19 putting spanner in the works.

COVID disrupts commercial real estate market

Prolonged COVID-19 crisis in the country may lead to corporates having a relook at their space requirements in 2020 and possibly next calendar year too. Given the fact that 30-40% of Indian office space demand originates from the USA, a prolonged economic slowdown in the USA may further dampen the mood in the market.  Further, the COVID impact has led to companies having to shift to the Work from Home (WFH) model. Commentary from corporates increasingly indicates that they would try to replicate the WFH model over the long term, especially in the case of IT/ITeS companies that account for 40-50% of overall Indian office demand.

Rental rates may be impacted

Apart from the reduced demand for office space, even the rental rates too may go down with the prevailing uncertainty in the market. Tenants may not insist on the renegotiation of the existing lease rentals but may go for bargain at the time of renewals. Even in case of pre-leasing, corporate occupiers may insist on to renegotiate rentals downwards. Some experts believe that rentals, on a conservative basis may go down by 5-10% during the current year. However, the silver lining is that rentals in India remain affordable at just under 1 USD/psf/month in suburban/peripheral markets of India which is one of the most attractive among the emerging markets.

Rollback of DDT a positive

This year’s Union Budget had proposed to impose a Dividend Distribution tax (DDT) on REIT investors which had dampened sentiment for REIT investors. Numerous representations by industry stakeholders has prompted the government to rollback the proposed DDT on REITs in March 2020. However, this waiver is on the condition that REIT SPVs will not move to the new tax regime (of lower tax rate). The government’s decision is a strong positive for those who are planning to come out with REIT issue in the coming days.

COVID like situation may be a dampener

COVID-19 has brought out one of the risk factors involved in this type of transactions. Meanwhile, it should also be remembered that COVID like risks don’t appear every now and then and they are a rarity. Even if they happen, our technology is far advanced to ensure that suitable remedies will be developed much faster than that would have been in the past.

Real estate markets elsewhere have grown immensely after the introduction REIT in their markets and India cannot be an exception to this general trend. New asset classes like warehouses and data centers offer excellent growth opportunities for both realtors and the investors. Large office developers with ability to weather the storm and liquidity issues will solidify their positions further and will take advantage of falling benchmark rates. Access to cheaper capital is expected to play a pivotal role in further consolidation of the real estate office market. A well-regulated REIT market in the country providing easy entry and exit options to non-traditional investors with respect to real estate derivates could well be the next chapter of real estate success story in the new decade.

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