REIT’s finally made a debut in India, with the
Embassy Office Parks REIT IPO, backed by Blackstone Group LP and Embassy Property Developments Pvt. Ltd. Aimed to raise Rs 4,750 crore by issuing shares in the price band Rs 299-Rs 300, it was subscribed 2.58 times.
REITs are total return investments, with 90 percent of their income to be distributed as dividends plus the potential for moderate and long-term capital appreciation. It will be a game changer for India’s real estate sector as it will be an oncoming of new capital, especially at the time when the industry is facing a huge liquidity crisis. This step will encourage the industry to emulate developed markets like Australia, Canada, Singapore, and the UK. The
REITs will also provide an opportunity for retail investors to own a piece of prime yielding assets across the country.
The current stock across the top seven cities in the country is 67 million sq. ft. of office space, depicting vacancy levels ranging from 6 percent-28 percent. The country is witnessing a phenomenal absorption story, with approximately 56 million sq. ft. absorbed in 2018. The rental for Grade A office space is weighted at Rs 107.51 per sq. ft. per month. The ongoing absorption suggests a further drop in vacancy levels, resulting in rentals to rise further at least in the short-term. Since the relaxation of the FDI norms in real estate, FIIs have been patiently investing in Indian real estate for stable returns. Now with REITs, they stand to gain an alternative route to increase investments in Indian real estate. Given the current environment where the demand for commercial spaces in the country is booming, coupled with favorable taxation norms for overseas institutions, these investors stand to earn 8 percent-10 percent post-tax returns.
A Diversification Tool
The REITs showcase is also a great opportunity for HNIs to diversify their portfolio. As per the amendment from SEBI, as on March 1, 2019, the minimum capital is set at Rs 50,000 in order to attract a larger base of investors. The Embassy REIT is expected to provide an IRR of 15 percent over a period of 3-5 years. Though the return may be similar to that of a mutual fund, the periodic dividend receivable is the main attraction to investors. The dividend yield is expected to be in the range of 8 percent-8.5 percent. The Embassy REIT being subscribed at 3.1 times for retail investors suggests that HNIs are looking forward to experiencing this hybrid product.
Commercial real estate yields are better than the residential yields, and REITs provide an opportunity to investors to hold a portfolio of commercial real estate across varied geographies, which may not possible via means of direct investing for most retail investors. Investing in commercial real estate is capital intensive. REITs provide an opportunity to hold divisible units of prime commercial real estate at minimum investment. The constituent being that of real estate, it provides a natural hedge against inflation. The portfolio will also witness appreciation in the rentals, basis the escalation cycles i.e. usually every 3 years. However, one factor that may be detrimental to such an instrument is the interest rate since real estate is normally negatively correlated to interest rates.
The Tax Angle
From a taxation standpoint, holding the units for more than 3 years will attract long-term capital gains else short-term capital gains will be applicable on appreciation. The periodic income will be taxed basis the structure of the REITs. If the periodic income is in the form of dividends, then they will be tax-free, but if the periodic pay-out is in the form of interest then taxation will be applicable basis the slab rate of the unitholder.
India is also experiencing rapid growth in the warehousing segment. This sector has witnessed the rise of organized players such as IndoSpace, Logo Assetz, Embassy, Allcargo, ESR, etc. The hospitality sector too is at its inflection point, with recent transactions such as Brookfield acquiring Hotel Leela Venture’s assets, the sale of Keys Hotels to Lemon Tree and Blackstone’s potential acquisition of Golden Jubilee hotels. In the near future, we may witness various types of REITs other than commercial REITs such as warehousing REITs, hospitality REITs, etc.
For developers, REITs are providing alternate exit strategies in addition to historical LRDs. With the overwhelming response to the Embassy REITs, developers having large income yielding commercial portfolios may follow suit. The Embassy REIT is the first of many the industry is yet to experience.
Suresh Castellino is executive national director, Capital Markets and Investment Services at Colliers International India.