Real Estate Investment Trust (REIT)

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 Index

Contents
Index ................................................................................................................................................. 2
Introduction ...................................................................................................................................... 3
Description ........................................................................................................................................ 5
Market Data & Product Mechanism Analysis ..................................................................................... 8
Use and Relevance .......................................................................................................................... 12
Benefits of investing in REIT ......................................................................................................... 12
Benefits to the different stakeholders.......................................................................................... 13
Relevance of REITs in India .......................................................................................................... 13
Popularity & Usage of REITs ............................................................................................................. 15
Globally ....................................................................................................................................... 15
India ............................................................................................................................................ 16
Second Order Derivative.................................................................................................................. 19
Future Outlook ................................................................................................................................ 20
References ...................................................................................................................................... 22
Learnings.............................................................................................. Error! Bookmark not defined.

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 Introduction

A REIT is an investment trust that owns real estate assets. It is created by a sponsor, who transfers
the ownership of the assets from a special purpose vehicle (SPV) to a REIT in exchange of its units.
The sponsor is obligated to hold certain units of the REIT. The remaining units are issued to
investors through a public issue of the REIT. The Initial Public Offering(IPO)proceeds accrue to the
sponsor who sells units of the REIT. Subsequently, tenants of the assets owned by the REIT will
pay lease rentals to the SPV that manages the asset. After statutory dues and tax deductions,
lease rentals flow to the REIT and it distributes at least 90% of net distributable cash flows as
dividend to the unit holders. In this way, REITs provide retail investors with an opportunity to
invest in commercial real estate and generate a stable rental income.

Demand side – Investors Supply side – Developers / PEs

 Steady returns  Monetizes the portfolio of operational assets
 Good capital appreciation  Unlocks capital and deleverages balance
opportunity sheets
 Low risk  Improved regulations
 Low ticket size of investment  High credit quality and low cost of capital

How does it work?

In essence, REITs work like any other trust funds which involve the following parties:

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 Growth of an Asset Class

REITs were first established in the United States in 1960 as a means to provide retail investors access
to larger and more diversified portfolios of commercial real estate, similar to mutual funds. Originally
REITs, like mutual funds, were designed as passive investment vehicles. However, over time, reforms
were made to allow REITs to actively manage and operate their portfolios. At first, the REIT model was
slow to catch on, with just over 50 equity REITs formed from 1960 to 1990. However, due to the
savings and loans crisis and the closing of some tax loopholes, growth accelerated in the early 1990s,
with 113 equity REITs launched from 1991 to 1995 and total market cap expanding from $9 billion in
1991 to $50 billion in 1995.

Today, US REITs have a market cap of $972 billion and own more the $1.8 trillion of commercial real
estate (including non-listed REITs) (Exhibit 1). There are 219 REITs in the FTSE/NAREIT All REIT Index
and 26 REITs in the S&P 500 Index. More than 193 trade on the New York Stock Exchange. In addition,
the average daily trading volume has nearly doubled over the past five years, from $3.3 billion in 2011
to $6.0 billion in 2015.

Why should one invest in REITs?

 Professional management
Professional managers manage REITs and they have the expertise beyond the knowledge of
individual investors.

 Liquidity (Unlisted REITs)

Unlike traditional private real estate ownership, unlisted REITs are liquid assets that can be sold
fairly quickly to raise cash or take advantage of other investment opportunities. One of the reasons
for the liquid nature of REITs is that its units are primarily listed and traded on a stock exchange.
 Convenience
Sale and purchase agreements, lawyers’ fees and stamp duties are among the many things real
estate investors have to put up with. Through REITs, investors are relieved of such factors.
 Comfort of regulations
REITs must comply with the requirements of the Guidelines on Real Estate Investment Trusts and
the Guidelines on Islamic Real Estate Investment Trusts, as well as the Capital Markets and Services
Act 2007, which has investor protection as one of its key objectives.

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 Description
REITs allow anyone to invest in portfolios of real estate assets the same way they invest in other
industries – through the purchase of individual company stock or a mutual fund or exchange traded
fund (ETF). The stockholders of a REIT earn a share of the income produced through real estate
investment – without actually having to go out and buy, manage or finance property.

To qualify as a REIT, a company must have the bulk of its assets and income connected to real estate
investment and must distribute at least 90 percent of its taxable income to shareholders annually in
the form of dividends. A company that qualifies as a REIT is allowed to deduct from its corporate
taxable income all of the dividends that it pays out to its shareholders. Because of this special tax
treatment, most REITs pay out at least 100 percent of their taxable income to their shareholders and,
therefore, owe no corporate tax.

REITs have been around for more than fifty years in the US. As of August 2014, India approved creation
of real estate investment trusts in the country. Indian REITs (country specific/generic version I-REITs)
will help individual investors enjoy the benefits of owning an interest in the securitised real estate
market. The greatest benefit will be that of fast and easy liquidation of investments in the real estate
market unlike the traditional way of disposing of real estate. The government and Securities and
Exchange Board of India through various notifications is in the process of making it easier to invest in
real estate in India directly and indirectly through foreign direct investment, through listed real estate
companies and mutual funds. In the budget of 2014, finance minister Arun Jaitley has introduced a
law for setting up of REITs.

REITs generally fall into the following categories:

(i) Most REITs are equity REITs. Equity REITs typically own and operate income-producing
real estate. The market and National Association of Real Estate Investment Trusts
(Nareit)2 often refer to equity REITs simply as REITs.
(ii) Mortgage REITs, on the other hand, provide money to real estate owners and operators
either directly in the form of mortgages or other types of real estate loans, or indirectly
through the acquisition of mortgage-backed securities. Mortgage REITs tend to be more
leveraged (that is, they use a lot of borrowed capital) than equity REITs. In addition, many
mortgage REITs manage their interest rate and credit risks through the use of derivatives
and other hedging techniques. One should understand the risks of these strategies before
deciding to invest in these types of REITs.
(iii) Hybrid REITs generally are companies that use the investment strategies of both equity
REITs and mortgage REITs.
(iv) Public non-listed REITs (PNLRs) - PNLRs are registered with the SEC but do not trade on
national stock exchanges.
(v) Private REITs - Private REITs are offerings that are exempt from SEC registration and
whose shares do not trade on national stock exchanges.

Concept of REIT now exists across Australia, Singapore, Japan, France, UK, etc.

• For real estate developer - Alternate funding mechanism and provides liquidity
• For investor – Access to high value real estate and earn steady returns

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Structure/Value chain stakeholders
REIT will be set up as a Trust under the Indian Trusts Act, 1982. It has to be registered with SEBI. REIT
to hold specified assets:

• Directly or through SPV holding real asset assets; or

• Invest in SPV which have investments in other SPVs which subsequently hold real estate assets
(hold co structure)

Key stakeholders of REIT

• Sponsor to set up REIT and appoint trustee
• Trustees to hold assets on behalf of and for the benefit of investors
• Manager to assume operational responsibility of REIT
• Valuer to ensure fair and transparent valuation
In respect of financial valuation
In respect of technical asset valuation

Eligible investors for REIT

All categories of investors can invest in units of REIT unless restricted by any other regulation
governing such investor, which includes the following:

• Mutual funds (within maximum limit)

• Insurance companies / insurer (subject to certain conditions)
• Banks (overall ceiling of 20 percent of their net worth permitted for direct investment in
shares, convertible bonds/debentures, units of equity oriented mutual funds and exposures
to Venture Capital Funds (VCFs) subject to the certain conditions)
• Strategic Investors such as:
o Infrastructure finance company registered with RBI as a NBFC;
o Scheduled Commercial Bank;
o International multilateral financial institution;
o Systemically important NBFCs registered with Reserve Bank of India; and
o Foreign portfolio investors

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A typical REIT structure works like:
 Money is raised from unit holders through an initial public offering (IPO) and used by the REIT
to purchase a pool of real estate properties.
 These properties are then leased out to tenants.
 In return, the income flows back to the unit holders (investors) as income distributions (which
are similar to dividends)

REIT Investment Assets

Minimum 80%
• Completed and rent and/or income generating properties
• Excluding vacant or agriculture land or mortgage
• Following considered in the definition of Infrastructure will now be allowed under REIT:
o Hotels, hospitals and convention centers forming part of composite real estate projects
o Common infrastructure for composite real estate projects, industrial parks and SEZ

Maximum 20%
 Under construction properties (including part of existing income generating properties owned
by REIT) which will be held by REIT for at least three years after completion;
• Completed and not rent generating properties which shall be held by REIT for at least 3 years
from date of purchase;
• Debt securities in real estate companies whether listed or unlisted,
• Government securities,
• Mortgage backed securities,
• Listed and unlisted equity shares of companies deriving 75% or more income from real estate,
• Money market instruments and cash equivalents,
• TDR and unutilised FSI

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 Market Data & Product Mechanism Analysis
REIT Market Data – Global & India
REITs are a recent phenomenon in the Indian market. It was first introduced by SEBI in 2014 but it
faced great trouble getting off the ground. The first REIT in India was in March 2019, this was nearly 5
years after their introduction. This happened after 5 amendments to SEBI’s original REIT Regulations
of 2014 and multiple tax tweaks.

Embassy Office Parks was India’s first and only listed REIT, it has gained 63% since its listing in March
(as of March 2020 – Pre Virus lockdown), this is against a 10% gain in the NIFTY Realty Index. Globally
the share of REITs in the overall real estate investment is quite significant, for example in the United
States REITs – which were launched in 1961 – constitute 96% of the real estate market. In other
markets such as Singapore, Japan and Malaysia, where REITs were introduced over two decades ago,
account for 55%, 51% and 41% of the total real estate market cap respectively. In India however, the
share is just over 15%. In USA REIT has a market cap of $ 1.2 trillion which accounts for 96% of the real
estate industry’s market capitalization. Globally the market capitalization of REITs is $ 1.7 trillion
dollars. Currently the biggest REIT markets in the Asia Pacific Region are Australia, Japan, Singapore
and Hong Kong. The REIT market in Japan is the largest in the Asia Pacific region with 63 REITs and a
total market cap of $147.2 billion, followed by Australia and Singapore. Typically the underlying assets
in REIT products include office, retail, hotel, industrial and healthcare facilities or a combination of the
above. Japan has the most office REITs in the Asia Pacific region with a total of 12 products. Australia
has the most retail REITs, and Singapore and Japan have the most industrial REITs. In the Asia Pacific
Region, Hong Kong has the highest average dividend yield at 5.7%, with Singapore and Australia at
5.3% and 5.2% respectively. The size of the global REIT market continues to grow, market cap of REIT
regimes around the globe rose by approximately 4% to $1.7 trillion over the past one year, but virtually
all of this expansion is attributable to the approximately $58 billion of equity capital raised by the
industry in this period

Tax legislations continue to evolve across all REIT markets and particularly in nascent jurisdictions
where a broad REIT framework exists but is not practicably favourable enough to see companies

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convert or go public. REIT industry groups from around the world have been actively exploring ways
to refine their existing legislation to make them more attractive and provide the type of tax incentives
to further promote the use of the REIT structure. In India regulations have gone through significant
amendments, the potential investor base has also been widening by permitting insurance, pension
and mutual funds to invest in the product. According to EY Global REIT report, there is an estimated $
405 billion need for infrastructure improvements in India by 2020. In the US, the REIT industry has a
foundation of 50 plus years of tax law that works efficiently, but this may be disrupted by new, broader
tax legislation. Relative to other industries real estate has historically made good use of tax-
advantaged vehicles, including REITs and partnerships.

REIT in India
In India the real estate market has attracted close to $31 billion in investments from 2009-2018 of
which around 40% of it has been invested in commercial office space. The strong office space
absorption trend of the past few years and lowering vacancy has pushed rentals upwards promising
stable rental returns. REITs give retail investors and opportunity to invest in commercial properties
which until recently was only a dream in India. India which witnessed the successful launch of its first
REIT – Embassy Office Parks REIT – a joint venture between Blackstone and Embassy, saw opening of
a fresh investment avenue and unfolded a bright new chapter for the country’s real estate sector. It is
likely to attract more retail investors and global investors as REITs perform better during adverse
primary market conditions. SEBI has reduced the minimum allotment value from the initial INR
2,00,000 to INR 50,000, giving a further push to retail investors to invest in this new vehicle. India’s
commercial office segment has been the favourite asset class of institutional investors over the years.
The estimation of REIT – worthy office space would depend on the asset ownership, size of the
property, lease space and asset quality. Since single ownership and larger space with good occupancy
rates are most likely candidates for REIT, research conducted by JLL estimates that nearly 294 n sq ft
of office, space stock would be eligible for REIT out of total office stock of around 541 mnsq ft. This
would translate to a potential investment of USD 35 bn. Bengaluru has the highest REIT worthy assets
totalling 97.8 mn. Sq ft valued at $ 10.7 billion. It has large quality IT office spaces occupied by
prominent global players. Most of these assets are singly owned by developers of large funds which
make it easier to aggregate the assets and manage them for REITs.

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According to SEBI rules, REITs are t distribute 90% or more of its earnings – be it dividend, interest or
rent – to investors or unit holders at least twice a year. Such income received by the investor under
the Income Tax Act 1961 shall be treated in the same nature and the same proportion as it had been
received or accrued. Thus income received by REITs in the nature f dividend, rent, and interest and
distributed to its unit holder shall be deemed as a dividend, rental and interest income, respectively
in the hands of the unit holder. All the incomes received from REITs shall be exempt from taxation
except the interest income received from the special purpose vehicle by the REIT and rental income
from the property that s owned directly by the REITs. REITs will distribute most of their income in the
form of dividend, which is tax free in the hand of the investor.

Analysis of Product
Since REITs are a recent phenomenon in India there is not any past market data to compare with the
Embassy Office Parks REIT. This REIT offering has 11 commercial assets (office parks and city – centric
offices), four hotels and a solar plant. CRISIL assigned a rating of ‘CRISIL AAA/Stable’ to the non-
convertible debentures of Embassy Office Parks REIT. This rating reflects Embassy REITs comfortable
loan-to-value ratio, driven by low debt and significant deleveraging of underlying SPV; strong debt
protection metrics, supported by a cap on incremental borrowing; and stable revenue from underlying
assets, given high occupancy and geographical diversification. These strengths are partially offset by
susceptibility to volatility in the real sector, resulting in fluctuation in rental rates and occupancy.

India’s top 10 commercial real estate owners alone, which include both developers and funds, have a
portfolio of around 184 million square feet translating into an annual lease rental income over INR
17,000 crore. These assets represent around 30% of Grade A propertiese across major micro markets
in the country. The portfolio of steady cash flows has the potential to raise as much as INR 1.5 trillion
through the REIT route assuming a capitalisation rate of 8.5% and stake dilution of 75%. Investor
interest in the residential segment is declining fast because of limited property price appreciation and
inability to monetise assets, REIT can be a potential investment option, providing assured and ongoing
returns. REITs invest primarily in completed, income yielding real estate assets, are similar to mutual
funds and can be listed and traded on stock exchanges. Developers stand to benefit as REITs provide
upfront cash to asset holders, which will help partly ease the pressure on their balance sheet. They
can use the disinvestment proceeds to reduce debt and sustain construction activity. A slow sluggish
start for REITs in India is in line with developed market counterparts and may be attributed to

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lack of investor familiarity with the vehicle and setting up of a responsive regulatory framework. If
India continues to evolve its REIT regulations in response to market requirements as seen in the case
of Japan and Singapore during the financial crisis and thereafter, we can expect more REITs in the
coming years. However, given the high level of compliance and stringent regulatory requirements for
REITs, developers with smaller commercial portfolios would continue to use lease rental discounting
loans, which are accessible at rates as low as 9%. Furthermore, developers who prefer to retain the
capital appreciation opportunity and not dilute their stake, will not prefer the REIT route.

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 Use and Relevance
Benefits of investing in REIT

(Source: Peter Barnes, 2016)

1. Liquidity: REITs have historically provided:

 Ability to buy/sell like other stocks, mutual funds and ETFs
 Opportunities for tactical asset allocation
 Easy portfolio rebalancing
2. Portfolio Diversification: REITs have historically provided:
 Low correlation with other stocks and bonds
 Higher risk-adjusted returns
 An investment in real, tangible assets
3. Transparency: REITs have historically provided:
 Corporate governance aligned with shareholders’ interests
 Audited financial reports
4. Higher Dividend: REITs have historically provided:
 Dividends & wealth accumulation
 Regular income from rents
 Reduced portfolio volatility

REITs are required to distribute at least 90 percent of their taxable income to shareholders
annually in the form of dividends. Significantly higher on average than other equities, the
industry's dividend yields historically have produced a steady stream of income through a
variety of market conditions.

5. Performance: REITs have historically provided:

 Total returns above the S&P 500 over the past 25 years
 Higher returns than corporate bonds

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 REITs offer investors the benefits of commercial real estate investment along with the
advantages of investing in a publicly traded stock. The investment characteristics of income-
producing real estate has provided REIT investors with historically competitive long-term rates
of return that complement the returns from other stocks and from bonds.

6. Income secured by long leases:

REITs' reliable income is derived from rents paid to the owners of commercial properties
whose tenants often sign leases for long periods of time, or from interest payments from the
financing of those properties.

Benefits to the different stakeholders

(Source: Exploring the new investment world of REIT – Deloitte)

Relevance of REITs in India

There are many reasons which have facilitated the introduction of REIT in India, listed below are few
of the important and the most significant ones which have paved way for REITs.

1. Rise sought after because of changing demographics and increment in urbanization:

According to the assessments of UN, India has the most astounding rate of progress of urban
populace among the BRIC countries. It is anticipated that 843 million individuals will dwell in
Indian urban areas by the year 2050, which is the same in the event that we consolidate the
number of inhabitants in the Japan, Brazil, Russia, US and Germany. More than 300 million
people are relied upon to be added to India's working age populace by the year 2050 (East
Asia Forum,2013). This would add to developing urbanization and the requirement for giving
lodging/convenience offices for this segment, which incorporates the expanding number of
ladies in the work power too.

2. REITs will bring transparency:

REITs will help to streamline the land division by making a straightforward instrument for
bringing account up in the land market. REITs must be enlisted with SEBI which would have
strict control and checking.

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3. Improvement paying off debtor’s value extent:
There will be a change in the obligation value extent in the land market with the presentation
of REITs as it is the wellspring of the unadulterated value capital. This will get the development
in steadier and develop land market.

4. Medium for tending to non-performing assets and resources (NPAs):

REITs can be utilized as a medium to wipe out NPAs/wiped out or old organizations holding
huge estimations of land generally as area. Transfer of such NPAs/organizations to REIT's will
have a double impact—acknowledgment of genuine quality for the land and simplicity in
selling the tired organization after evacuation of the high estimation of land from its books.

5. New parkway for speculation:

REITs is reasonable for those speculators who wish to differentiate their benefits past gold
and value markets. REITs would be capable anticipated that would give a sheltered and
expanded venture alternative at the lower hazard, all under expert administration, which
guarantees the most noteworthy profit for the speculation. A speculator can procure two
sorts of salary from REITs. One is through the capital increases when the units of REITs are
sold on stock trades and the other is through profit pay. The next section analyses various
aspects of REIT an attractive investment.

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 Popularity & Usage of REITs
Globally
REITs originated in 1960 in USA to provide access to all investors, especially small investors, to income-
producing real estate. The growth of REITs has been driven by returns higher than equity markets over
the long term. It has gradually grown to become an alternate investment vehicle with global value
exceeding USD 1.7 tn. To gather a global perspective, we have analysed the international REITs market
in terms of adoption timelines, country-wise share and its evolution as witnessed in USA and
Singapore. We have specifically chosen USA and Singapore for our analysis because USA pioneered
the concept and Singapore is similar to India in terms of investment climate and financial tax reforms.

Country Year No. of REITs Market Cap ($ Bn) % of Global REIT Index
USA 1960 200 1094 64.84%
Japan 2000 61 114 7.24%
Australia 1985 50 90 5.76%
United Kingdom 2007 52 78 5.56%
Canada 1994 47 54 2.92%
France 2003 29 61 2.02%
Hong Kong 2003 9 32 1.87%
Singapore 1999 35 54 1.81%
Germany 2007 6 4 0.26%
European Public Real Estate Association REIT survey 2018

Countries with large and developed real estate markets have attracted both domestic and
international capital, which is a key factor for the growth of REITs. Development of REITs has also been
witnessed in deep and liquid equity and debt markets, as well as markets with a mature and
reasonably open corporate environment.

Large institutional investor classes like pension and insurance funds, private equity funds and
corporate and private investors have led to progressive growth of REITs across asset classes and types.
They have also helped in making the market deeper.

Progressive regulations and tax reforms have influenced the progress of REITs across countries.

Though REITS was introduced in 2000 in Japan (much later than in some other countries like Singapore
and Canada), the aggressive role played by banks and corporations led to faster growth of REITs here.

United Kingdom despite its late start of REITs (in 2007) garnered a larger share of the sector’s market
capitalization, compared with some others like Hong Kong and Singapore, due to it being an
international finance hub drawing large institutional investments in real estate

Key trends defining REIT growth globally

1. Real estate sector saw a period of strong growth due to high liquidity and low interest in
developed nations
2. Adoption of REITs picked up during 1990-2000 period with gradual growth in investments by
banks and financial institutions
3. Growth of REITs in a few countries has been driven by the depth of investment climate;
presence of institutional players has provided depth and maturity to the markets

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 4. Adoption of REIT has been gradual due to lack of clarity on the new instrument and missing
records on returns. However, policy push, product innovations and overall economic
momentum have helped growth.
5. REITs globally have been able to deliver high risk adjusted returns as it strives to deliver the
best of equity and debt market returns
6. REITs have been less susceptible to volatile equity markets have delivered steady returns over
long periods

India
India witnessed the successful launch of its first REIT- Embassy Office Parks in March 2019 and this has
signalled the coming of age of Indian real estate. This first REIT was launched nearly five years after
the regulations were notified in 2014. Two factors- progressive regulations and robust investor
interest have contributed to the success of this REIT. This coupled with lessons from global experience,
enable us to predict the future outlook for REITs in India.

Comparison of Regulations

REIT regulations proposed in 2014 have been progressively reformed to make REITs feasible and
ensure safeguarding investor interest. Besides tax reforms, the listing of REITs and the holding period
of REIT units has also been modified to attract retail investors.

REITs operators who have prudently managed their debt are in a better position to expand and
increase unitholder returns in the future. Indian regulations have been progressive by allowing REITs
to raise debt up to 49% of the value of REIT assets compared with some other countries like Singapore
and Hong Kong.

Various reforms to improve transparency, accountability, and confidence of the investors as well as
end-users has resulted in a paradigm shift in the sector. India’s office market with 541 mn sq. ft. Grade
- A stock has seen average annual demand of 30 mn sq. ft . over last 4 years. In 2018, the office
absorption has exceeded 33 mn sq. ft., with an expectation that the absorption will be even stronger
during 2019 with a forecast number of about 38 mn sq. ft.

This strong demand for office space is attributed to the growing interest from domestic as well as
multinational companies. India offers good quality Grade A office space at competitive rentals when
compared to several matured markets of APAC, EMEA or USA. Bengaluru, Mumbai and Delhi NCR are
the top Indian cities which will lead the office market in terms of overall activity - new supply and
leasing, while the cities such as Hyderabad and Pune are also attracting large number of IT occupiers

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in recent years. These cities are likely to drive the office growth to a large extent owing to their
competitive rents, better infrastructure, and good quality assets.

Growing transparency, urbanisation, healthy economic fundamentals, and positive sentiments are the
key underlying drivers of Indian real estate. All these factors along with proactive reforms are
attracting several investors in a big way to invest in India’s commercial real estate. Emergence of new
office space occupiers, continued demand from IT/ITeS, GCC along with BFSI space is expected to keep
office demand robust over next three years. The mismatch in demand and supply is expected to push
up rentals in prime markets in line with past trends. Apart from demand-supply conditions, the secular
escalation of rentals tracking the inflation/currency deprecation effectively keeps the dollar rentals
unchanged. The optimistic REIT scenario, with a long-term outlook of gradual growth, makes it
imperative to look at the real estate assets which are RIET worthy. We have looked at the commercial
office space in India as the preferred choice for REIT due to the favourable factors discussed above.
While selecting the REIT worthy assets we have used the following criteria, to arrive at the potential
REIT stock and its value based on current market conditions.

Parameters for REITable properties in India

1. Includes operational lease-only projects from top 7 cities

2. Office properties with area greater than or equal to 200,000 sq. ft.
3. Projects with vacancy less than or equal to 20%
4. Assets under single ownership or strata sold assets owned by institutions

India’s Commercial office segment has been the favorite asset class of institutional investors over the
years. This is borne by the fact that nearly USD 17 bn has been invested in the form of direct
investments as well as through entity level investments during 2006- 2019.

Though commercial office space is expected to offer a large opportunity for development of REITs in
India, other asset classes like Retail, Warehousing and Hospitality also offer scope. India’s organized
retail with 253 malls in top cities occupies ~ 80 mn sq. ft. space. Large institutional investors have
already picked up stakes in fully operational malls, while many have invested in greenfield assets. The
retail sector is becoming more and more organized in terms of its mall spaces and would see
emergence of REIT ready space after some years.

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The warehousing and logistics sector, which has undergone a paradigm shift post GST and advent of
new trends in technology, has witnessed a flurry of investment plans by major funds during the last
two years. As per a study by JLL India Industrial Services, 2018 witnessed a 22% y-o-y growth in total
stock in Grade A & B warehousing space in the top eight cities totalling 169 mn sq. ft. compared to
138 mn sq. ft., a year ago. Investments to the tune of USD 5.5 bn have been announced, as the outlook
on returns prospects offered by the sector is positive. JLL expects emergence of REITs in this segment
after a few years. Hospitality sector which is showing signs of growth will also offer options for REITs
in future.

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 REITs Derivative
Specifically, REITs" asset structures differ substantially between equity REITs and mortgage REITs; the
former primarily invest in real estate properties such as shopping malls, apartments and commercial
buildings, while the latter invest primarily in mortgage portfolios. Equity REITs are expected to use
derivatives mainly to hedge financing costs, since their assets lack suitable hedging instruments.

For the mortgage REITs that have substantial gaps between the durations of assets and debt, hedging
might be attractive. On the other band, mortgage REITs may he to some extent naturally hedged, since
both their assets and debt may be sensitive to interest-rate changes. 41 % of REITs use interest-rate
derivatives, although the amount of derivatives, on average, is not high.

The probability of derivatives use is greater for larger REITs and mortgage REITs; the former suggests
that the cost of initiating a hedging program is an important consideration, while the latter implies
that substantial gaps exist between the duration of assets and debt for mortgage REITs.

On the other hand, the level of hedging is greater for smaller firms and firms with higher debt ratio.
Additionally, the level of hedging is weakly related to growth opportunities, suggesting that agency-
cost considerations may be relevant in the decision to use derivatives.

Additional analysis of interest-rate risk and hedging activities finds that mortgage REITs tend to
increase their hedging activities when interest rates decrease, while the opposite is true for equity
REITs.

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 Future Outlook
Advantages

REITs offer a new investment opportunity to retail investors who currently find it difficult to invest in
commercial real estate assets on account of high capital costs and in the residential segment owing to
low/negligible returns.

Unlike other equity investments, REITs provide assured returns to investors through compulsory
dividend distribution. REITs have to mandatorily distribute 90% of the net distributable income as
dividend. Further, there is a potential upside available to the investors based on periodic valuation of
property.

REITs are expected to avail debt to stimulate growth and improve shareholder returns. However, in
order to avoid financial stress, SEBI has imposed restrictions on leverage at 49% of the value of the
REITs’ assets. Also, if the leverage exceeds 25% of the asset value, credit rating and approval from
majority of shareholders are mandatory.

Trustee and manager-monitored operations, rent-generating asset mix (only up to 20% of the total
investment can be towards under-construction assets), listing requirements, mandatory disclosures,
an escrow mechanism with at least 90% income distributed and minimum capital requirements are
provisions embedded to protect the interests of investors, and are expected to create optimism about
REITs as investments and add to their creditworthiness.

India’s Commercial office segment has been the favorite asset class of institutional investors over the
years. This is borne by the fact that nearly US$ 17 bn has been invested in the form of direct
investments as well as through entity level investments during 2006- 2019.

In 2019, REITs posted the best investment performance since 2014, based on resilient economic
fundamentals and an improved outlook for real estate. REITs delivered a total return of 27.9% through
the first 11 months of 2019, according to the FTSE Nareit All Equity REITs Index. Nearly all property
sectors delivered double-digit returns over that time period, led by Industrial REITs (52.4%), Data
Centres (41.1%), Timber REITs (36.9%) and Residential REITs (35.5%).

Investing in REITs reduced risks in a diversified portfolio in 2019. Investment analysts frequently
discuss the importance of diversification to lower the volatility of investment returns, and REITs are
an essential part of many strategies. In 2019, REIT investors enjoyed a clear benefit from diversification
as REITs provided a safe harbour from the trade wars and their impact on multinational corporations
and firms that rely on export markets.

The listing of India’s first REIT, Embassy Office Parks, heralds the institutionalisation of real estate
assets and indicates increased maturity of real estate markets. While the launch of REITs symbolises
that markets have definitely become more professional and transparent, this new investment vehicle
will in turn, ensure further transparency and maturity. This is because mandatory valuation of
properties, regular updates, research coverage and disclosures relating to assets managed by REIT will
be essential, resulting in increased professionalism and transparency in real estate markets.

Growing knowledge of the product will ensure acceptability and gradual increase of retail interest in
this segment. The instrument will enable retail investors to partake of the massive opportunity in the
commercial markets real estate pie, which until now was only a dream. This was largely on account of
lack of access/restricted access to these assets, due to the value and volume of funds required.

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From the developer’s perspective, a large source of funding is opening up. A small percentage of
mutual fund investments made by retail investor getting channelised into REIT, would enable access
to large funds for the real estate developer as well as PE player.

Challenges

REITs, however, do face some operational challenges. The fragmented and opaque real estate market
could pose a hindrance to the expansion of the REIT market in India.

Given the high level of compliance and stringent regulatory requirements for REITs, developers with
smaller commercial portfolios may continue to use lease rental discounting loans, which can provide
funding of 5-6 times the net lease income and are accessible at rates as low as 9% currently.

REITs also currently limit the access of banks and insurance companies to the real estate sector.

Developers who prefer to retain the capital appreciation opportunity and not dilute their stake will
not favour REITs.

India’s commercial office space is expected to dominate the REIT market due to robust growth,
resulting in rising rental yields and steady rise in capital values. REITable opportunity in new office
completions is expected to be 101 mn sq. ft. during 2019-2021 reflecting the huge REIT investment
potential in office space alone. Apart from Office, Retail, Warehousing and Hospitality segments will
offer additional scope for REITs as these sectors are expected to see growth in scale and enhanced
investor interest over the years.

However, due to the COVID 19 crisis, investment in REIT would face major challenges. The growth of
REITs as an investment vehicle would hinge upon the policy push given. Tax efficiency resulting from
investment in REITs will help Indian REIT players compete with other countries to attract investors.
Firstly, tax benefits provided to investors and REIT sponsors would be crucial for the growth of the
REIT market and the policy needs to be consistent in this regard. Secondly, the current regulations
permit only rent yielding assets for listing under REIT. Residential real estate segment (which accounts
for 85 percent of the total under construction real estate value) is effectively left out. Regulations that
will help to bring this segment under REIT need to be evolved for Indian real estate.

Despite certain challenges in terms of investor awareness about the product currently, interest is
expected to increase over the years, based on our understanding of other REIT markets. And the
success of this first REIT is a definite promise that there will be many more in the offing.

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 References
 https://www.reit.com/what-reit
 https://www.investopedia.com/articles/mortgages-real-estate/10/real-estate-investment-
trust-reit.asp
 https://www2.deloitte.com/content/dam/Deloitte/in/Documents/tax/in-tax-reit-talk-
book.pdf
 https://www.reit.com/investing/financial-benefits-reits
 CRISIL Report – India’s REIT Opportunity 2019
 EY Report – Global REIT Market
 Savills Report - REIT Market 101 2019

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