The Hindu Business Line : ‘Real estate investment trusts can bring about stability in prices’

Mumbai July 2 With spiralling prices and high interest rates triggering a slowdown in housing stock sale, analysts say real estate investment trusts (REITs) can bring about stability in prices and provide the realty sector better access to institutional and retail capital.

Alternate funding

A REIT operation is similar to what mutual funds provide for stock investment. REITs distribute their earnings which become taxable at the investors’ end. They can be publicly or privately held. Those in public are listed.

Market regulator SEBI has made a policy announcement regarding to real estate mutual funds and operational guidelines are to follow.

Mr Ganesh Raj, Partner, Ernst & Young, India, says from an industry perspective it implies setting up of an institutionalised environment, which is a source of alternate funding.

From an investor’s perspective, units in a REIT are instruments for investment in addition to shares, units of mutual funds and bonds (government or private).

Investment

As REITs are typically permitted to invest in the existing listed and unlisted companies undertaking property development, existing stakeholders in such companies have the option of selling their shares to REITs.

Given the exit option that REMFs could provide to investors holding real estate assets, the same should help making the foreign direct investment climate for Indian real estate investors more attractive.

In October 2006, an Ernst & Young report pegged the global market capitalisation of REITs at over $608 billion, and rising fast. It said in some lesser known REIT markets such as South Africa produced average returns of 34.2 per cent in the past three years. The US is the largest REIT market with 253 public REITs

The Chief Executive Officer of the Singapore-based Asian Public Real Estate Association (APREA — an association of listed real estate companies in the Asia Pacific), Mr Peter Mitchell, in an e-mail response, says, “REITs, particularly if the legislation is properly structured, have a beneficial effect on a country’s property market.

Singapore example

“Singapore is a perfect example. It is felt by some people that REITs have a heating effect on a country’s property market and I understand this has been a reason for some reluctance in both China and India to introduce REIT laws. However, REITs have exactly the opposite effect. If a REIT market is underpinned by appropriate legislation, REITs will have a price stabilising effect on the market. REITs are essentially passive investment fund vehicles whose investors are predominantly institutions.”

REITs also open up realty market to a broader and deeper category of investors - smaller institutions and individuals - who have a chance to invest in high grade real estate. This should, therefore, create an environment where there is more competition with a beneficial flow-on effect on prices.

‘Recycling capital’

REITs also enable property companies whose balance sheets are overweighted with real estate to “recycle capital” by disposing of some or all of its assets to a REIT and redeploying the capital. This has been very successful in Singapore and Hong Kong. China does not yet have a REIT law but one is being considered at the moment and APREA is involved in formulating it.

Moody’s Investors Service and ICRA Ltd in a recent search paper says India will have to push forward on building the regulatory and taxation framework necessary for the emergence of REITs and that they have become in many developed markets the ‘brand name’ of choice for both institutional and retail investors looking to buy into real estate.

Benefits

“Among the important issues are the benefits REITs could bring to India’s commercial property sector through better access to capital - including foreign investment - while they can also help create conditions for building integrated property businesses,” says Mr John Kriz, Moody’s Real Estate Finance Managing Director and co-author of the report.

He, however, feels that the road to establishing an Indian REIT sector may be long, given that the authorities would need to change parts of the country’s legal and tax frameworks.

“The real estate transaction process is cumbersome, and the property industry’s transparency and disclosure levels could be improved,” said the co-author of the report, Mr Vikas Aggarwal, ICRA Senior Vice-President and Head of Real Estate & Construction.

The report also notes that market participants forecast real estate development in India to grow from $12 billion in 2005 to $90 billion by 2015.

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