Real Estate Investment Trusts (REITs)
The concept of REITs is new in India. But like most other novel financial instruments, there should be no problems for this new concept to be accepted. Real Estate Investment Trust (REIT) is a company dedicated to owning and, in most cases, operating income-producing real estate, such as apartments, shopping centers, offices and warehouses. A REIT is a company that buys, develops, manages and sells real estate assets and allows participants to invest in a professionally managed portfolio of properties. Some REITs also are engaged in financing real estate. REITs buy, develop, manage and sell real estate. REITs are pass-through entities or companies that are able to distribute the majority of income cash flows to investors, without taxation, at the corporate level. The main purpose is to pass the profits to the investors. Hence initially, the REIT’s business activities would generally be restricted to generation of property rental income.

REITs were created by the US Congress in 1960 and played a limited role in real estate investment for more than 30 years. They were initially constrained because they were permitted only to own real estate, not operate or manage it. Since 1992, however, the REIT marketplace has grown dramatically. The main reason for the growth was the benefit of REITs to have only one level of taxation. The limitation on the REITs was that less than 10% of the earnings could be retained by the entity. The economic success story of REITs is based on enabling all investors’ accessibility to income producing commercial real estate as well as liquidity to buy and sell shares of diversified portfolios of properties – from shopping malls to apartment complexes.

REIT offers investors an innovative option for trading in real estate stocks. It collects dividends from capital appreciation and rental income. It also offers a route of raising more money for the real estate business. Many private real estate companies used REITs to access capital through the public market place. A REIT operates like a mutual fund, where investments of individual investors are invested in real estate, rather than stocks of companies. REIT is one of the most popular forms of investment tool in developed markets such as the US, UK and Australia. In the US, there are over 300 publicly traded REITs whose assets total over USD 300 billion and whose daily share transaction volume has reached over USD 260 million. The New York Stock Exchange lists over 150 REITs. In fact, now that the volatile stock markets all over the world have been declining, 27% of the shifting capital from equities is going to real estate. Figure I clearly shows this trend.

The US has the most developed REIT market. There, in order for a company to qualify as a REIT, it must comply with certain provisions within the Tax Code. A REIT must:

Be an entity that is taxable as a corporation;

Be managed by a board of directors or trustees;

Have shares that are fully transferable;

Have a minimum of 100 shareholders;

Have no more than 50 percent of the shares held by five or fewer individuals during the last half of each taxable year;

Invest at least 75 percent of the total assets in real estate assets;

Invest at least 75 percent of gross income from rents from real property, or interest on mortgages on real property;

Have no more than 20 percent of its assets consist of stocks in taxable REIT subsidiaries;

Pay dividends of at least 90 percent of its taxable income in the form of shareholder dividends.

 REITs are not partnerships as in corporations but use partnerships to engage in joint ventures. The advantages of REITs over partnership companies are numerous. They include a high degree of liquidity, since they are listed and traded on stock exchanges, there is no minimum investment amounts, reinvestment plans include some at discounts, ability to leverage property investments without incurring any taxes, investors re-elect directors, stock exchange rules or state laws require majority of directors to be independent of management, beneficial owners over 100 shareholders at least and finally REITs cannot pass over losses on to investors.

In India, this concept is still a couple of years away, as SEBI, RBI and the Finance Ministry brings forth a blueprint for REITs in India. This requires a favourable legal, regulatory, accounting and tax system and environment. Like securitisation, REITs provide the process through which illiquid assets are transferred into a more liquid form and distributed to a broad range of investors through the capital market. The introduction of REITs in India would provide a further boost to the real estate industry. This would result in increased rental housing generation and also raise cheaper funds for this sector. REIT would certainly provide an impetus to the housing industry in India.

For more support and tips, feel free to write to us at: research@indiaplot.com