Would REITs make investing in real estate easy for you?

(Courtesy: Personalfn.com/knowledge-center; dated 14 Oct 2013)

Demand in the real estate sector has been sagging due to economic slowdown. Since many people are deferring their property purchases; inventory level in major property markets is rising. It is often found that due to higher ticket size, many find it difficult to buy properties. On the other hand, real estate developers have been knocked down by higher cost of borrowing due to which many projects have gotten stalled. To increase the investor-base and open up another financing avenue for real estate developers, Securities and Exchange Board of India (SEBI) has been considering allowing Real Estate Investment Trusts (REITs) in India. The initial draft was launched in 2008 but was subsequently withdrawn too due to non-transparent valuation norms, dissimilar stamp duty structure across different states and the lack of uniformity in land and property pricing. Recently SEBI has revived the plan by issuing draft regulations for launching REITs in the country.

What are REITs

REITs are trusts which are patterned like mutual funds. They pool capital from investors and deploy in real estate. REITs will be established under Indian Trust Act, 1882 and will have parties such as a sponsor, manager and valuer. Both, investors as well as property developers are expected to benefit from the launch of REITs.

 What are the positives?

For the real estate sector:

• It could help the real estate sector to raise stable funds
• Will encourage developers to think long-term
• Will infuse transparency to the real sector (and would be well-regulated now if the Real Estate Regulation Bill is passed in the monsoon session of the parliament)
• Instill professionalism in property management

For the investors:

• Can make investing in real estate accessible to those who may not have the resources or may not want to directly buy a property
• Offers an alternative investment avenue

For the economy:

• Attract overseas investment
• Could help in development of capital markets
• Could help bringing in stable long-term flows which are needed to finance country’s Current Account Deficit (CAD)

Is the time of introducing REITs appropriate?

When the draft was withdrawn in 2008, there were concerns about protecting investors’ interest due to difficulties in valuations and scope for malpractices.
The Union Cabinet has recently cleared the much awaited Real Estate (Regulation and Development) Bill which furnishes establishment of a dedicated regulator for realtors. The bill intends to protect buyers’ interest and bring transparency to the sector. Some of the key points are;

• Developers can launch projects only after securing all clearances
• It is mandatory on builders to have a clear mention of carpet area
• Penalties of upto 10% of the project cost if builders found guilty of putting out misleading advertisements and even a jail for repeated misdeeds
• Now developers can take only upto 10% amount in advance without a written agreement.
• It is now mandatory on developers to maintain 70% of the amount collected from investors in a separate bank account for every project.
• Buyers can get full refund with interest in case of delay in projects

Personal FN is of the view that since REITs would majorly invest in completed projects and generate regular cash flows through rents earned; investing in them is relatively safe than investing in an under construct project. Moreover, ticket size for investors would be kept substantially lower at Rs 2 lakh. Investing through REITs would give investors an opportunity to diversify. Now investors would not only get a chance to invest in real estate with less capital but would also get diversification within real estate as an asset class since a REIT would invest across projects and property markets. You may also be able avail benefit of professional management.
However, PersonalFN believes, investors should also consider possible negatives too. Unlike mutual funds, income distributed by REITs wouldn’t be tax free in the hands of investors. Furthermore, despite having in place Real Estate (Regulation and Development) Bill; there is still a scope for manipulations and malpractices. Moreover, there’s no track record of any REIT as of now in India and thus investors shouldn’t jump in right away. A good track record is a pre-requisite for you to invest in it.