India's first REIT launching soon: Here is what an investor needs to know

Simply put, REITs resembles a mutual fund, wherein several investors pool in funds with real estate as the underlying asset class..

Indian investors will soon get a new investment option in the form of real estate investment trusts or REITs. Embassy Office Parks, a joint venture of US private equity firm Blackstone Group and Embassy Group, has filed its draft offer document with the Securities and Exchange Board of India (Sebi) for its Rs 5,000 crore REITs issue.

Simply put, REITs resembles a mutual fund (MF), wherein several investors pool in funds with real estate as the underlying asset class. Also, similar to MFs, REITs will be available in demat form and will be regulated by SEBI. That is where the similarities end. This is because the structure and the working of a REIT is completely different from a mutual fund scheme.

Let us now see what exactly REITs are and how they work.

Retail investors and REITs

Currently, as per the REIT guidelines, the minimum investment has been kept at Rs 2 lakh per investor. However, once they get listed on the stock exchanges, trading will allowed for a minimum lot of Rs 1 lakh. As of now, it appears that REITs are deliberately being kept away from retail investors. One can, however, buy and sell them through stock exchanges in a lot of Rs 1 lakh, which by itself provides liquidity to an otherwise illiquid asset, i.e., real estate.

Where REIT invests your money

SEBI rules specify the areas where investors' money can be put in by a REIT. As per the rules, at least 80 per cent of the value of the REIT assets shall be in completed and revenue generating properties. The balance 20 per cent may go in developmental properties, mortgage-backed securities, corporate debt of the real estate sector, equity shares of companies deriving not less than 75 per cent of their operating income from real estate activity, government securities and money market instruments or cash equivalents.

Earnings of a REIT

As per the SEBI (Real Estate Investment Trusts) Regulations, 2014, a REIT shall invest only in commercial real estate assets, either directly or through special purpose vehicles (SPVs). As a real estate developer, there is rental income which it earns by leasing its own commercial properties or earns capital gain on selling some of their properties. In a REIT, all such income flows into an SPV or a standalone trust and by launching a REIT Fund, developers can mobilise resources for further development or may use the proceeds to repay debt.

What REIT investors earn

Income earned by REIT could be through rentals or capital gains or both, and it gets distributed to unit holders. But, how will this income be taxed in the hands of the investor?

"Such income received by the investor under the Income Tax Act, shall be treated in the same nature and the same proportion as it had been received or accrued to the REITs. Thus, income received by the REITs in the nature of dividend, rent, interest and distributed to its unit holder shall be deemed as dividend, rental and interest income respectively, in the hands of the unit holder," says Suraj Nangia, Partner, Nangia Advisors LLP. SEBI rules clearly states that the REIT shall distribute cash flows to its investors at least on a half yearly basis.

Return expectation

It remains to be seen how much return Indian REITs are able to generate as and when they are launched. According to industry estimates, the rental yield from a commercial property is in the range of 7-9 percent, while the capital appreciation can be expected to be between 4-7 percent over a long term.

Taxation

Budget 2015 provided pass-through status to the rental income arising to REITs from real estate property directly held by it. And later on another rule on dividend distribution tax (DDT), turned to be in the favour of REIT investors. "Vide Finance Act 2016, the government had provided relief to investors by eliminating the requirement of payment of DDT on sums paid to REITs," says Nangia.

Once the distributed income is received by a REIT unit holder, it shall be deemed to be income of such unit holder and shall be charged to tax. "The nature of incomes such as interest and rental income does not change when received by the investors and it is taxed as interest income and rental income in the hands of investor," informs Nangia.

Unresolved tax concerns

There are two important taxation issues that remain unresolved. "The non-resident investors are subject to a mere 5 percent tax on the interest income while the same is charged to tax at 30 percent in the hands of resident investors. And, the other issue that requires consideration is regarding the taxability of capital gains accruing to REITs upon transfer of assets or shares in SPV. This remains a vital issue as the investors desire a complete pass through for capital gains," explains Nangia.

What you should do

Investing in real estate always requires a considerably high amount of funds. Further, it's an illiquid investment. With the coming of REITs, these two drawbacks are taken care of comfortably. REITs provide easier access to funds to builders and an opportunity to retail investors to diversify portfolio by investing in real estate.

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