Published on 25 August 2024
Introduction
Since the first REIT was listed in the US in 1961, the global REIT landscape has changed. Globally, there were 893 listed REITs as of December 2022, with a total equity market valuation of about $1.9 trillion. Over the past 30 years, this category of assets has expanded, going from 120 REITs in two countries to 893 in 41 different nations and regions. A significant portion of this expansion has come from Asia, where the number of REITs has increased by a staggering 58% since 2015.
The REIT sector has gained popularity as an asset class in India as well. Approximately 397 million square feet (msf) of the over 700 million msf total office asset is REIT eligible, paving the way for significant future REIT listings. These office assets are made more appealing by their high-quality tenants, stable occupancy rates, substantial Pan-India annual net leasing momentum of about 40 msf, and steady rental growth. Investors from around the world have taken notice of the four listed Indian REITs' success, indicating their recognition of the market's potential.
Indian REIT: Prospects and Advantages
The enormous unrealized potential of the Indian REIT market is one of its most notable characteristics. At the moment, only roughly 10% of all Grade A office stock in India is owned by REITs, suggesting substantial potential for growth. Although the main focus has been on Grade A office spaces, recent developments indicate the possibility of diversification into other asset classes, such as hospitality and logistics, and present new prospects for investors and REIT participants. One such development is the establishment of a retail REIT.
Unlike their counterparts in the West, Indian Real Estate Investment Trusts (REITs) provide a distinct blend of stable dividends and room for development. The robust fundamentals of commercial offices in India are what drive the growth in capital value and rents in the Indian office sector. The commercial real estate business has changed as a result of the shift from domestic corporates buying office space for their own use in the early 2000s to IT corporations and Global Captive Centers choosing to lease Grade A office space with a wide range of amenities. Developers now have access to finance thanks to the advent of Global Private Equity, Pension, and Sovereign funds. This has caused the trend from "Build and Sell" to "Build and Lease," guaranteeing a steady supply of assets suitable for REITs. According to estimates, India builds between INR 50 and 60,000 crores worth of commercial real estate per year.
In the upcoming years, local corporations will become a new driving force for office space due to India's growing GDP. The move away from densification and toward institutionally managed Grade A offices is another significant trend. To put things in perspective, the top six Indian cities have an average per capita office stock of roughly 0.5square feet (sf), whereas the US, UK, and Singapore have averages of 16 sf, 6 sf, and 5 sf, respectively. There is significant room for expansion as a result of dedensification. Tenants in India are becoming more attracted to ESG-compliant, sustainable, Grade A office buildings that provide plenty of open areas for collaboration, ideation, and recreation—a trend that has been accelerated by lessons learnt during the COVID-19 pandemic.
The pandemic had an influence on the next two years, even if 2019 was a record year for the Indian office market with the highest-ever net absorption of 47 msf. Following two years of instability, the leasing market saw a significant recovery in 2022, with the second-highest net absorption of 36 msf, demonstrating the importance that occupiers place on office space. The significance of office spaces in India is paramount, considering the country's inadequate infrastructure, scarcity of residential space, and the increasing need for safe, cooperative work spaces.
REITs: Highlights and Challenges
Because they have the ability to generate long-term capital appreciation as well as a substantial, consistent yearly dividend, REITs can be a valuable addition to any investment portfolio. Over the past 20 years, REITs have outperformed other indices, the rate of inflation, and the S&P 500 Index in terms of total return performance.
One advantage of REITs is their ease of purchase and sale, as the majority are listed on public markets, which helps to offset some of the conventional disadvantages of real estate. In terms of performance, REITs provide steady cash flow and appealing risk-adjusted returns. Additionally, a real estate holding can benefit a portfolio since it offers dividend-based income and diversification, with often greater payouts than other types of investments.
The drawback of REITs is their lack of potential for capitalgrowth. They are required under their structure to return 90% of their income to investors. Therefore, the REIT is only allowed to reinvest 10% of its taxable revenue in order to purchase additional shares. A few other drawbacks are that certain REITs have expensive management and transaction fees, and REIT dividends are taxed like ordinary income.
Regulatory Dynamics of REIT
Regulatory changes have played a pivotal role in increasing retail investor participation in REITs. Measures such as reducing the trading lot to as low as one unit have significantly enhanced REIT liquidity, making them more accessible. As of August 2023, the investor base for the four REITs has grown to over 200,000unitholders. However, this number is still small compared to the 30 million mutual fund investors in India.
The government has implemented tax reforms to encourage the expansion of REITs, while regulatory organizations such as SEBI have revised norms to improve governance and transparency, thereby boosting investor trust. Recently, SEBI granted approval for the implementation of a regulatory mechanism governing fractional ownership of real estate assets. This calculated action came after a Consultation Paper (CP) was released on May 12, 2023, suggesting that certain adjustments be made to bring Fractional Ownership Platforms (FOPs) within the jurisdiction of the SEBI (Real Estate Investment Trust) Regulations 2014 .
Indian REIT Association (IRA): The Much-Needed Impetus
REITs are acknowledged as an asset type that produces excellent long-term returns on a global scale. The asset class is still in its infancy in India, and many members of the investing public are ignorant of its advantages. The Indian REIT Association (IRA), which was recently established by the four Indian REITs, aims to promote the expansion and advancement of the REIT industry in India. In order to uphold regulatory requirements while advocating for the interests of investors and businesses, IRA will work closely with SEBI, the main REIT regulator.
Conclusion and Suggestions
Two major aspects in the Indian REIT market are influencing the direction of the industry. First off, floor-wise SEZ denotification may make vacant areas available, which might result in higher occupancy rates, more rental income, and the opening of additional space for REITs, which would raise tax revenues. Second, the drive to incorporate REITs into local equities indices in line with international standards has the potential to increase liquidity and bolster investor trust in these securities.
The rapid expansion of REITs worldwide and the expanding REIT market in India portend a bright future for the nation's commercial real estate industry. Prominent REIT developments like Mindspace Business Parks and Embassy Office Parks have demonstrated the feasibility of this investment vehicle and established a standard for future offerings. Both local and foreign investors stand to gain from this investment option as India continues to explore the great potential of REITs and adjusts to the shifting environment.
*Kuldeep Gautam is a Third Year B.A. LL. B (Hons.) student at National Law Institute University, Bhopal.