capstone project on reits- dhara badiani khr2009pgdmf012
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REITS- Right forINDIA?
2011
Dhara Badiani
Capstone Project Submission
2/26/2011
Submitted By:
Dhara Badiani
KHR2009PGDMF012
PGDM Finance 2009-11
Submitted To:
Prof. Bharat Shah
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CONTENTSAcknowledgement Page 3
Executive Summary Page 4
1.0 Introduction Page 6
1.1 REIT Concept Page 8
1.2 Literature Review Page 11
1.3 Choices Available for REIT Investors Page 13
1.4 Advanatges and Disadvantages to REIT investors Page 14
1.5 Methodology Page 15
2.0 Comparison of Features of REF, REMF, REIT Page 17
2.1 SEBI Guidelines for REMFs Page 19
2.2 REIT Structure of Different Countries Page 20
2.3 Performance of REITs in Different Countries Page 23
2.4 Draft Guidelines on REIT by SEBI Page 33
2.5 How REIT and REMF complement each other Page 33
3.0 Readiness of India for REITs/REMFs Page 34
3.1 Hurdles in the Introduction of REIT/REMF in India Page 24
4.0 Study of Time Variation of Systematic Risk of REITs in USA Page 40
5.0 Singapore BTs- Pseudo REITs Page 43
5.1 Indian Properties based BTs in Singapore Page 43
5.2 Overview of Proposed BT of DLF Page 46
6.0 Conclusions Page 51
7.0 Recommendations Page 52
Bibliography Page 54
Appendix Page 56
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ACKNOWLEDGEMENT
I owe a great many thanks to a great many people who helped and supported me during the
writing of this report. My deepest gratitude to Professor Bharat Shah, the Guide of the project
for guiding and correcting various documents of mine with attention and care. He has taken
pain to go through the project and make necessary correction as and when needed. I would
also thank my Institution and my faculty members without whom this project would have been
a distant reality. I also extend my heartfelt thanks to my parents and well wishers.
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Executive Summary
Thereal estate companies are involved in construction projects withlong gestationperiods.
Funding such projects (residential,commercial,retail,hotel etc.) is a mammoth task in itself.
These projects may be part of the developmentbusiness or the annuitybusiness of thereal estate firm. Unlike developmentbusiness, in the annuity business the construction is
not sold out but rented, providing regular stream of cash. For projects forming part of
development business, the advance payments received from clients at different stages of
completion is a source of fund for real estate companies. However, rental properties of
annuitybusiness only reap benefits once constructionis over and rent start to pour in. As it
is well known that India is the second fastest growing economy after China and such an
economy is in dire need ofresidential,commercial,retail,hotel,hospital space etc. REITS,
fundamentally, acquire constructed real estate properties and thereafter draw
rental income from real estate properties thereby facilitating the annuity business
of their sponsor.
At the moment India does not have official guidelines on REITs (draft SEBI Guidelines of 2007
not made formal until now). Other avenues of investment in real estate include Real
Estate Funds (REF) as well as Real Estate MutualFunds (REMF). These funds are not exactly
meant for catering the sameriskclass of investors as REIT. REIT is meant for retail investors
not in a position to invest directly into the illiquid real estate assets. Moreover, REIT
stock/units are behavinglesser as general stock and more as real estate assets with the
passage of time. This is shown by studying the time variation of systematic risk (beta) of
REIT.
Currently REITs are operating in more than a dozen countries with slight variations in the
REIT framework. There are severalhurdles in the introduction ofREITs in India. Real estate in
India is a largely unorganized sector withsmall local players dominating the scene. Lack of
clear land titles, high stamp duties and absence of regulatory authority for real estate
are some of the factors acting as deterrents for REIT.
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Under the prevailingconditions in India, Indian real estate firms such as Indiabulls Real
EstateLtdandnow DLF Ltd are setting up listedBusiness Trusts in Singapore,which are not
exactly REITs but voluntarily adopted features similar to them. Another international real
estate firm, Ascendas, has an Indianproperty based business trust listedin Singapore. As a
result all the profit earned from the underlying incomeearningproperties of the trusts is
repatriated to Singapore and the Indian retail investors are not enjoying the fruits ofthe
organisedincomebearingreal estate properties in India.
1.0 Introduction:
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The Real Estate Industry in India is passing through difficult times. The woes of the Real Estate
industry are multifarious. Global recession which took root in 2007 has shown that the real
estate market globally as well as in the Indian scenario is quite vulnerable. The real estate
companies finance their projects from loans from banks, Private Equity players, IPO route,
sale of Treasury stocks, advances and installment payments from real estate buyers. About
three years ago, the governments easy money policy led to developers embarking on an
unprecedented expansion spree. Unfortunately, the onset of the economic slowdown
butchered sales (60% fall in demand from May 2008 to November 2008) as buyers stayed
away and banks became averse to lending. The IPO route became unfeasible as was
demonstrated by the cancellation of the Emaar MGF IPO in February 2008 due to falling
stock market. Private Equity players became inactive and sales of Treasury stocks become
unviable. Hence, several real estate companies began defaulting on Debt Mutual Funds
payments and bank loans. As part of the austerity measures real estate companies have been
forced to cut their debts drastically as banks have become extremely cautious and are lending
on a very selective basis. Since, real estate companies are not banks favorite borrower; the
builders have to rely on other sources of finance.
With the revival of the stock market in 2010 an increased corporatisation of the real estate
companies is on the cards. As many as 10 companies including Emaar MGF Land, Lodha
Developers, Sahara Prime City and Ambience have obtained permission to raise 15000 crore
from the primary market.
Developers have also been successful in raising equity through the qualified institutional
placement (QIP) route. Companies that have raised money through the QIP route include
Unitech Ltd (US$325 million), Indiabulls Real Estate Ltd (US$550 million), Housing
Development and Infrastructure Ltd, Sobha Developers Ltd and Orbit Corp. Ltd. Institutional
investors have asked the real estate companies to first repay their high interest debts and
afterwards take on new projects in order to achieve the goal of debt reduction.
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For commercial projects, developers are financing new projects by rent/lease discounting
agreements with banks. Under a lease or rent discounting agreement, banks lend to
developers for new projects against rents they directly realise for completed projects, which
also is mortgaged with the bank. Thus, banks are assured of guaranteed cash flows and also
have physical assets in case of defaults. However, this source is only for those developers
which have one or more completed projects on lease such as DLF Ltd.
During recession in 2008-09, developers could not source adequate finance for their
commercial projects and had to shift from commercial projects to middle income housing
projects. Developers had shifted their focus from commercial, retail and hospitality projects
to residential sales during the slowdown. DLF and Unitech led the way, saying they would
concentrate on mid-income homes, and suspended other projects. The reason for shifting
focus was because residential projects are financed by advances from buyers while
commercial projects are mostly financed through internal accruals and banks. By launching
housing schemes, the developers could raise finance for sustaining their existing operations
(projects under construction).
Real Estate Investment Trusts (REITs) can provide cash strapped real estate companies in
India with a big window for mobilising funds especially for commercial projects such as retail,
office, hospitality and healthcare. Although REITs have been prevalent in other countries like
USA, UK, Australia, Singapore etc. for many years the same has not happened in India. To
answer this perplexing issue it is imperative to examine the various facets of REITs i.e. the
structure/anatomy of REITs, the various models being followed in different countries,
hurdles of bringing REITs/Real Estate Mutual Funds (REMFs) how companies (Indiabulls,
Ascendas, DLF) are listing Indian properties REITs abroad and the stability/volatility of REIT
(REIT-beta) stocks over significant period of time.
1.1 The REIT concept:
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Real Estate Investment Trust (REIT) is a corporation or trust that uses the pooled capital of
many investors to purchase and manage income generating property (equity REIT) and/or
mortgage loans (mortgage REIT) and/or mixture of both (Hybrid REIT). REITs are traded on
major exchanges just like stocks. They may be granted special tax considerations. REITs offer
several benefits over actually owning properties. There is no minimum investment with REITs.
REITs do not necessarily increase and decrease in value along with the broader market.
However, they pay yields in the form of dividends no matter how the shares perform. REITs can
be valued based upon fundamental measures, similar to the valuation of stocks, but different
numbers tend to be important for REITs than for stocks.
A Real Estate Investment Trust (REIT) is a company that invests its assets in real estate holdings.
It buys, develops, manages and sells real estate assets. You get a share of the earnings,
depreciation, etc. from the portfolio of real estate holdings that the REIT owns. Thus, you get
many of the same benefits of being a landlord without too many of the hassles. You also have a
much more liquid investment than you do when directly investing in real estate. The downsides
are that you have no control over when company will sell its holdings or how it will manage
them, like you would have if you owned an apartment building on your own.
REITs allow participants to invest in a professionally managed portfolio of real estate
properties. REIT qualify as pass through entities, companies who are able to distribute the
majority of income flows to investors without taxation at the corporate level (providing that
certain conditions are met). As pass through entities, whose main function is to pass profits on
to investors, REITs business activities are generally restricted to generation of property rental
income. Another major advantage of REIT investment is its liquidity (ease of liquidation of
assets into cash), as compared to traditional private real estate ownership which are not very
easy to liquidate. One reason for the liquid nature of REIT investments is the its shares are
primarily traded on major exchanges, making it easier to buy and sell REIT assets/shares than to
buy and sell properties in private markets.
Essentially, REITs are the same as stocks, only the business they are engaged in is different than
what is commonly referred to as stocks by most folks. Common stocks are ownership shares
generally in manufacturing or service businesses. REITs shares on the other hand are the same,
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just engaged in the holding of an asset for rental, rather than producing a manufactured
product. In both cases, though the shareholder is paid what is left over after business expenses,
interest/principal, and preferred shareholders dividends are paid. Common stockholders are
always last in line, and their earnings are highly variable because of this. Also, because their
returns are so unpredictable, common shareholders demand a higher expected rate of return
than lenders (bondholders). This is why equity financing is the highest cost form of financing for
any corporation, whether the corporation is a REIT or mfg. firm.
An interesting thing about REITs is that they are probably the best inflation hedge around. Far
better than gold stocks, which give almost no return over long periods of time. Most of them
yield 7-10% dividend yield. However, they almost always lack the potential for tremendous
price appreciation (and depreciation) that you get with most common stocks. There are
exceptions, of course, but they are few and far between.
If you invest in them, pick several REITs instead of one. They are subject to ineptitude on the
part of management just like any companys stock, so diversification is important. However,
they are rather conservative investment, with long term returns lower than common stocks of
other industries. This is because rental revenues do not usually vary as much as revenues at a
mfg. or service firm.
The Real Estate Investment Trusts must periodically review the property portfolio to find out
which assets are likely to generate less than average cash flows in future. Such assets should
be disposed and the proceeds can be used for any of the following:
Reinvest in properties with higher prospects
Repay debt to strengthen the Balance Sheet by, as per the Pecking Order Theory
Repurchase the shares from the investors
To qualify as an REIT, in most countries, a real estate company must agree to pay out in
dividends at least 90% of its taxable profit. By having REIT status, a company avoids corporate
income tax. A regular corporation makes a profit and pays taxes on the entire profits, and then
decides how to allocate its after-tax profits between dividends and reinvestment; an REIT
distributes all or almost of its profits and gets to skip the taxation.
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Typical structure of REITS:
1.2 Literature review:
The Draft Securities and Exchange Board of India (REIT) Guidelines of 2008 provide thetheoretical background for the introduction of REIT in India. The main basic concepts are as
follows:
1. REIT is a trust registered under the Indian Trusts Act, 1882 with the object of
organising, operating and managing real estate collective investments.
2. Real estate is defined to include land or buildings (irrespective of whether free hold or
leasehold), car parks and other assets incidental to ownership of real estate such as
fittings, fixtures, etc. However, REITs are not permitted to acquire vacant land.
3. Person setting up a REIT is called a Sponsor.
4. REITs are managed by its trustees. Trustees could be a scheduled bank, trust
company which is a subsidiary of a bank, a public financial institution, insurance
company or a body corporate. Individuals cannot act as trustees.
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townships, housing, built-up infrastructure and construction development projects (which
would include, but not be restricted to, housing, commercial premises, hotels, resorts and
hospitals). Foreign Direct Investments in the real estate sector in India would also contribute
towards making the sector more organized. Besides increasing professionalism in the sector, it
would bring in advanced technology and help in the creation of healthy and competitive market
environment for both domestic and foreign investors.
The availability of built up property which is essential for REITs will be fuelled by
investments made by foreign developers in addition to Indian developers due to the
relaxation of the FDI policy.
If the hurdles are removed and the SEBI guidelines become crystal clear then the potential for
REITs as a complement to REMF would be significant for rented properties.
1.3 Choices available for REIT investors:
There are different varieties of REITs possible. An ordinary investor can easily be confounded by
the investing options available. It is therefore imperative for an investor to first understand the
different REITs and then accordingly invest depending on the risk appetite and the economic
conditions. The REITs can be broadly classified into:
1. Equity REIT
a. Retail REIT - There are a number of specialties in Retail REITs, including malls and
shopping centers.
Since the cost of construction is significant, measured in tens or hundreds of crore ofrupees, there is controlled expansion making excess supply a lesser concern in Tier II
and Tier III cities. Investors before deciding to invest in retail REIT has to see whether
the locations of the malls and shopping centers are in such neighborhoods which are
economically advanced and centrally situated so as to pull crowds and sustain high
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rentals. In economic recession such REITs may take a beating as high cost merchandise
by branded suppliers will not be in much demand.
b. Residential REIT - This type of REIT specializes in apartment buildings and/or other
residential properties leased to individuals.
In a scenario of expanding population, the demand for leased accommodation is
expected to be significant in all types of cities.
c. Industrial/office REIT- The office/ industrial sector has historically been the largest.
Office/industrial rental agreements are normally for a long term. As a result agreements
entered at the time of economic downturn are locked at less profitable rates for many
years. However at the time of high demand and short supply lease agreements are at
profitable rates. Office REITs are cyclical whereas industrial REITs generate steady and
predictable cash flows because of high lease renewal rates and low capital expenditure
and maintenance rates.
d. Healthcare REIT- They build, acquire and lease specialty buildings such as hospitals,
nursing homes, medical centers and assisted-living facilities.
List of clientele for such specialty buildings is limited and once a user leaves, the
custom made building may have to renovated/remodeled before becoming useful
for another user. Requirement of assisted living facilities (old age homes) is low in India
and neighboring countries compared to developed countries.
e. Hotels and Resorts REIT- target client is hotels, resorts and serviced apartment chains.
The hotel and resort sector is closely tied to the economic, political and social condition
of the geographic area to which it is catering. When times are bad, people travel less for
business and pleasure, cutting right through the bottom lines of the companies. As a
result investors in Hotel REITs have to concern themselves not only with overbuilding
but also with the economic, political and social condition of the region in which the
hotel is situated.
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1.4 Advantages and Disadvantages to REIT investors:
Advantages:
-- In order to qualify as a REIT for tax purposes, a company must return at least 90% of earnings
to its shareholders in the form of dividends. Because of this, the average REIT boasts a roughly
+6% annual dividend yield.
-- REITs aren't as highly correlated with the major indices as most industries are. As such, they
may provide your portfolio with some much-needed diversification and should help to smooth
out your overall returns, particularly during market downturns.
-- REITs own hard, tangible assets such as land and buildings, and often sign their tenants to
long-term lease contracts. Because of this, REITs tend to be some of the most stable companies
on the market.
Disadvantages:
-- Because they can only reinvest up to 10% of their annual profits back into their core business
lines each year, most (but not all) REITs tend to grow at slower clip than the average stock on
Wall Street. Over time, history has shown that the average publicly traded REIT tends to post
annual earnings growth several percentage points below that of the S&P 500.
-- Although the business tends to be a fairly stable one, REITs are not without risk. For example,
their dividend payments are not guaranteed and the real estate market is prone to cyclical
downturns.
-- Since they already enjoy a unique tax-advantaged status versus other firms (more specifically,
they are allowed to deduct the dividends they pay out from their taxable income), from an
investor's perspective, roughly 2/3 of all dividends paid by REITs do not qualify for the new
lower 15% tax rate implemented by congress last year. By contrast, the vast majority dividends
paid by non-REITs are taxed at this new low rate.
1.5 Methodology:
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The fundamental issue of whether REITs shall be beneficial for the Indian economic scenario
will be addressed by
Investigating the features of REITs in various countries who have already adopted
such investment schemes
Examining existing Real estate investment schemes in India such as REMF and REF
and how REIT can complement them
Understanding the hurdles that REIT would face in the Indian economic/legal
environment
Comparison of the performance of REIT stock versus overall stock indices and
analyse for structural change in systematic risk of REIT investment, and
Looking at the impact of delay in introducing REIT in India leading to companies with
investment in Indian rental property establishing REIT like Business Trusts in
overseas market such as Singapore.
To compare the regulations enacted for implementation of REIT regimes in different
countries the official guidelines of different countries having REIT were studied and a
comparison table was prepared to highlight the similarities and differences on key issues which
effect the operation and success of REIT entities. Moreover the facts and figures for the
comparative performance of REITs have been taken from the highly specialised and
analytical reports of consultancy firms such as Ernst & Young, KPMG, and Standard & Poors.
The existing forms of real estate investments in India were examined by studying the
guidelines and operations of Real Estate Funds (REFs) and the guidelines of new Real Estate
Mutual Funds (REMFs). The official documents from SEBI for the draft regulations and
guidelines on REITs. REFs which are essentially for institutional investors and HNIs are not listed
on the stock exchanges for the first three years of their existence. The published interview of
Subject Matter Expert (SME) was referred for comparison of different forms of investments.
The performance of REIT in US in the last 38 years was evaluated using a model which
characterizes the volatility in terms of beta. The fluctuation in beta over four decades was
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calculated using raw data published by NAREIT, NYSE and the US government Treasury bill
statistical data. These input data were fed into a regression model to determine the
volatility parameter beta and structural change over time.
2.0 COMPARISON OF FEATURES OF REF, REMF, REIT:
REITs have been in vogue for nearly three decades in USA and Australia, nearly one decade in
Singapore and few years in UK. Why is it that REITs have not been introduced in India as yet?
Apart from REIT, other methods of investing in Real Estate sector in India are through Real
Estate Funds (REF) and Real Estate Mutual Funds (REMF). To an ordinary investor there is
confusion as to what are the differences among REIT, REF and REMF. It is of paramount
importance to understand the basic or conceptual details of these alternatives to appreciate
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the benefits they can provide to different types of investors. In fact one can state that these
three investment schemes are not alternatives, but complement each other.
REFs are not new to India but their presence is not felt by the retail investors. The reason is that
these REFs are open for investment only to institutional investors such as corporations, pension
funds, private equity firms etc., in addition to High Net-Worth Individuals (HNIs) with a
minimum investment of Rs 5 lakh. REFs are also called Realty Venture Funds (Kshitij Venture
Capital Funds, DHFL Venture Capital Fund, and Milestone Real Estate Fund). Many of the
existing REFs in India have minimum investment amount way above the SEBI
requirements. For instance minimum investment amount for HDFC Real Estate Fund is Rs 5
crore, for Kshitij Venture Capital Fund it is Rs 2 crore, for Birla Sun Life it is Rs 25 lakhs (HNIs)
and Rs 1 crore (institutional investors), and in case of DHFL Venture Capital Fund it is Rs. 2 crore
(HNIs) and Rs. 10 crore (institutional investor). In UK, REFs are known by the name of Pooled
Managed Vehicles (PMV). The PMVs are a limited partnership of private equity players,
pension funds, HNIs etc
REMFs are in between REFs and REITs. Securities and Exchange Board of India (SEBI) has
introduced guidelines for REMFs in India in 2008. Although initially several groups expressed
interest in REMFs only few have approached SEBI for permission. HDIL and Kumar Housing
Corporation are a few groups who have sought approval to launch REMFs but yet not gone
ahead with the actual launch.
REITs have been introduced in major countries such as USA, Australia, Japan, Singapore, UK etc.
it is necessary to examine what is so special about REITs that so many nations have adopted the
REIT legislation. It is necessary to study the models of REITs in these countries and compare
the same with SEBI guidelines for REMFs and REITs. Only after such a comparison is
made, it will be possible to arrive at a conclusion whether REITs have something more to
offer than REFs and REMFs. In other words we can justify that REITs have something additional
to offer as compared to REFs and REMFs.
Table No. 1
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Basis REF REMF REIT
Who can invest Institutional investors
and HNIs
Retail investors in
addition to institutional
investors and HNIs
Retail investors in
addition to institutional
investors and HNIs
Where can invest Invest at project level,
undertaking
construction and
development of Real
Estate properties
Invest in properties
under construction by
buying stake in
companies undertaking
such construction. In
addition must hold at
least 35% completely
constructed real estate
assets
Invest in constructed
property
Purpose of
Investment
Seek capital gains Seek capital gains Seek regular rental
income from owned
properties
Taxation The Income from aninvestment in Venture
Capital Undertaking is
tax exempt
Confusion whether to betaxed as Equity Oriented
Funds or Debt Oriented
Funds
Must distribute 90% oftaxable profits in order
to gain exemption from
corporate taxes
Listing Not listed initially. Listed
after 3 years from the
date of issuance of
units.
Listed on Stock
Exchanges. NAV
declared daily.
May or may not be
listed depending upon
the country of concern.
In US and Australia both
listed and unlisted REITs
are prevalent. Whereas
in Singapore and UK all
REITs must be listed.
Hence, REFs are not meant for retail investors and are not a means to get regular income.
REMFs are meant for retail investors but do not guarantee regular income. REITs are meant for
retail investors and guarantee regular income as well. REITs come closest to directly owning a
rental real estate property which is many times not possible for small investors.
2.1 SEBI guidelines for REMFs:
1. Existing Mutual Funds are eligible to launch REMF, if they have adequate number of
experienced key personnel/directors in the field of real estate.
2. Sponsors setting up new Mutual Funds, for launching only REMF should have been
carrying on business in real estate for a period not less than five years.
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3. REMFs should be close ended and their units should be listed on a recognized stock
exchange, thereby providing liquidity to investors. NAVs of such schemes have to be
declared daily.
4. At least 35% of the net assets of the scheme shall be invested directly in real estate
assets. Balance may be invested in mortgage backed securities, securities of companies
engaged in dealing in real estate assets or in undertaking real estate development
projects and other securities. Taken together, investments in real estate assets,
real estate related securities (including mortgage backed securities) should not be less
than 75% of the net assets of the scheme.
5. Each asset valued every 90 days from date of purchase for computation of NAV. To
avoid concentration risk, caps have been imposed on investments in a single city, single
project, securities issued by sponsor/associate companies etc.
The guidelines show that the regulator has christened REMFs with the role of REIT by adding
the clause which stipulates that REMFs must compulsorily invest at least 35% in completely
constructed real estate assets. For launching REMFs, Mutual Fund companies will need key
personnel who are highly experienced in the real estate sector and have the foresight to judge
the right real estate property investment. Such individuals are limited in number and their
responsibility of managing completed constructed assets will divert their focus from Mutual
Funds traditional role of investment in securities. Also since the constructed properties will be
valued every 90 days from the date of purchase and NAVs have to be declared daily, the NAVs
may not represent the true value of the unit at all times. It would have been much more
sensible if REMFs would be able to invest in REITs instead of directly investing in real estate
assets. This way mutual funds would have be able to operate to their potential in their core
business of investing in stocks and securities. However, this is not a possibility right now as
India does not have operating REITs.
The above analysis shows that REFs and REMFs cannot completely fill in the shoes of REITs. In
fact UK which was having PMVs similar to REFs also chose to introduce REITs in 2007. In order
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to appreciate the similarities and differences between the REIT operating in various countries a
comparison table has been made as shown below:
2.2 REITs Structure of different countries
Table No. 2
Country USA Netherland Australia Canada Belgium
System REIT FBI A-REIT C-REIT SICAFI
Date Established 1960 1969 1971 1993 1995
Collective
Investment
Scheme
No Yes Yes Yes Yes
Listed/Unlisted Both Both Both Both Only listed
Closed-end or
Open-end
Closed Closed Closed Both Closed
Fund Vehicle Corporation,
Trust
Corporation,
Trust
Trust Trust Corporation
Investment in
Real Estate
At least 75% 100% At least 50%
revenue from
rent
At least 80% 100%
Development Yes,
investment in
and active
development
of properties
Only
investment in
development
projects
Only if
stapled
security
structure is
used
Only with
business REIT
Only if
development
property if
owned for
over 5 years
Dividend
requirement
At least 90% 100% None None At least 80%
Conduit
Structure
Pay through Tax free Pay through Pay through Tax free
REIT Taxation Corporation
tax (35%) of
unallocated
amount
0% tax of
taxable
income
Trust tax
(30%) of
unallocated
amount
Trust tax
(29%) of
unallocated
amount
Corporation
tax (33.99%)
and value
added tax
(3%);
however
rental
income and
capital gainsare not
taxed.
Gearing Limit No statutory
gearing limit
The maximum
permitted
debt leverage
equals the
sum of 20% of
There is no
statutory
gearing limit
applicable to
A-REITs
There are no
gearing
restrictions
on REITs
Outstanding
debt cannot
exceed 65%
of the asset
value
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non-real
estate assets
and 60% of
real estate
investments
Table No. 3
Country Singapore Japan France Hong Kong UK
System S-REIT J-REIT SIIC H-REIT UK-REIT
Date
Established
1999 2000 2003 2003 2007
Collective
Investment
Scheme
Yes Yes No Yes Yes
Listed/
Unlisted
Both Both Only listed Only listed Only listed
Closed-end or
Open-end
Closed Both (Only
closed exist)
Closed Closed Closed
Fund Vehicle Corporation,
Trust
Corporation,
Trust
Corporation Trust Corporation
Investment in
Real Estate
At least 70% At least 75% None At least 75% At least 75%
Development Only
investment in
developmentprojects
No Limited to
20% of total
assets
No Limited to
25% of total
assets
Dividend
requirement
At least 90% Over 90% At least 80%
of rental
earnings,50%
of capital
gains, 100% of
dividend
income
At least 90%
of PAT
At least 90%
Conduit
Structure
Pay through Pay through Tax exempt Pay through Tax exempt
REIT Taxation Corporationtax (20%) on
unallocated
amount
Corporationtax (30%) of
unallocated
amount
Corporationtax (33.03%)
and value
added tax
(3.3%) of non-
exempt
earnings
Businessincome tax
(17%) charged
on special
purpose
vehicles
Corporatetax on non
tax exempt
earnings
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Gearing Limit 35% of gross
asset value
There is no
statutory
gearing limit
45% of gross
asset value
Interest
coverage
ratio must
be 1.25
or greater
All REIT regimes permit REIT to buy properties as long term investments for the purpose of
deriving rental income from them. However, many limit their capability to perform non-core
real estate related activities such as:
Develop for own use- Where the REIT holds the real estate for long-term investment
purposes, but undertakes periodic developments to extend the building, add new
floor-space or modernize the fit-out.
Buy/Develop for resale- Where the REIT acquires real estate primarily to resell it at a
profit. This may include acquiring vacant land that is developed and/or subdivided prior
to sale.
Provide allied services: where the REIT provides non- rental services, such as cleaning
and food services for tenants, building and management, property leasing or fund
management.
Table No 4: Non core activities permitted in different countries:
Country Develop for own
use
Buy/Develop for
resale
Service provision
US Yes No Qualified
Australia Yes No No
UK Yes Qualified Qualified
Netherlands Yes No No
France Yes Qualified Qualified
Belgium Yes Qualified Yes
Canada Yes No Qualified
Hong Kong Yes No No
Japan No No No
Malaysia Yes No Qualified
South Korea Yes Qualified Qualified
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Singapore Yes No No
Qualified: May or may not be permitted depending upon the circumstances
2.3 Performance of REIT in different countries:
2.3.1 Market Capitalization:
The REIT market was soaring high until the mid of 2007, when the sub-prime crisis broke out in
the US. The global market capitalisation for 16 REIT countries in June 2006 was US$ 721 billion
which rose to its peak in June 2007 at US$ 829 billion. After that, there had been continuous fall
in REIT market capitalisation until June 2009, when it reached its lowest. Between June 2009
and December 2009 there has been rise in the market capitalisation from US $ 430 billion to US
$ 586 billion which is still below its peak level of 2007 by 30%.
Graph A:
Source: Ernst & Young Global REIT Report 2010
Only a handful of countries had risen in market capitalisation between 2007 and 2009,
namely Singapore, Hong Kong and Malaysia among others. Though Singapores market
capitalisation dropped by 11% from June 2007 to June 2008, it recouped and rose by 18% from
721
829
624
430
586
0
100
200
300
400
500
600
700
800
900
Jun/06
Sep/06
Dec/06
Mar/07
Jun/07
Sep/07
Dec/07
Mar/08
Jun/08
Sep/08
Dec/08
Mar/09
Jun/09
Sep/09
Dec/09
Global REIT Market Capitalisation
Market Capitalisation in US$
billions
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June 2008 to December 2009, highest for any country. Singapore saw a flurry of capital raising
activities in the form of placements of new units and rights issue. Both Hong Kong and Malaysia
rose in market capitalisation for the two consecutive years. On 30 June 2009, the Malaysian
government announced the liberalisation of Foreign Investment Committee (FIC) guidelines for
property purchases by foreigners, and the allowance of 100% foreign ownership in fund
management companies. These new measures spurred interest on the part of foreign and local
institutional property funds and REITs in coming into the market within the short-term future as
already the Malaysian are trading at an 8% discount to their Net Asset Value. As a result of the
delistings and widespread price correction, the total market capitalisation of South Korean-
REITs listed on the stock market slumped US$187 million as of the end of 2008 from US$410
million in June 2008 and further to US$133 million in December 2009.
Chart A:
Table No. 5: Change in market capitalisation:
1
10
100
1,000
10,000
100,000
1,000,000
US$Millions
Market Capitalisation
Year 2007
Year 2008
Year 2009
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From 2008 to
2009
From 2007 to
2008
Country Rose/Fell by Rose/Fell by (%)US -8% -23%
Australia -9% -31%
France -11% -3%
UK -10% -28%
Japan -23% -22%
Singapore 18% -11%
Canada -8% -15%
Netherlands -8% -9%
Hong Kong 8% 1%
Belgium -2% -3%
Malaysia 1% 5%
South Korea -68% -32%
Despite the inclusion of six Australian REITs in the population, market capitalization decreased
to 30.52% to US$78 billion on 30 June 2008 compared to US$112 billion on June 2007. For
several years AREITs have invested (in most cases successfully) in US properties, mainly in the
retail and office sectors, and industrial to a lesser extent. Most recently, AREITs have invested in
various European markets as well as into Asia. Approximately 55% of Australian REITs have
offshore investment exposure. As a result despite having strong local economic conditions,
Australian REITs have performed poorly in the last three years.
Table No. 6: Number of REITs in different countries
Country 2009 2008 2007 2006
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US 142 148 169 253
Canada 30 33 26 33
UK 20 19 14 NA
France 44 42 48 30
Netherlands 6 8 7 9Belgium 15 14 17 13
Australia 57 64 58 58
Japan 41 42 41 38
Hong Kong 7 7 7 4
Malaysia 12 13 13 11
Singapore 20 20 16 11
South Korea 3 6 6 11
Total 427 451 448 484
Source: Ernst & Young Global REIT Report 2010
2.3.2 Gearing Ratio
Chart B
Source: E&Y Global REIT Report 2007, 2008, 2010
All the countries in this study except US, Canada, Japan and South Korea follow valuation of
properties at fair value under the IFRS. These four countries value properties at cost. Total
assets are higher on a fair value basis than under cost accounting. Thus, for REITs adopting the
fair value basis, lower balance sheet gearing ratios are expected. When REITs select the fair
0
0.1
0.2
0.3
0.4
0.50.6
0.7
0.8
Gearing
Yr. 2009
Yr. 2008
Yr. 2007
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value method, the increase or decrease in the assets value is recognized through that entitys
operating profit each reporting period. In FY2008, majority of the countries using fair value are
faced a devaluation decrement in their operating profit, reflecting the fall in property values.
Conversely, REITs measuring property at cost will not have to adjust their operating profit,
unless the assets recoverable amount fell below its initial cost. As a result, for many countries
following IFRS this was one of the reasons for rising gearing ratios.
However, it is noticeable that Singapore, despite following IFRS, witnessed small fall in the
gearing ratio for FY 2008. For the same period, in France six REITs were delisted, resulting in a
lower gearing.
The reduced gearing levels across most major REIT markets from June 2008 to December 2009
highlight the extent to which REITs have been recapitalizing to repair their balance sheets. The
falling gearing percentages have been achieved against a backdrop of substantial drops in asset
values meaning absolute debt levels have been considerably reduced. Some of the reduction
could be attributed to secondary offerings or to selling assets to repay debt. Interestingly, in
Europe, UK recorded increased gearing levels, suggesting the level of recapitalization has not
matched the falls in asset value. On the other hand, Japan, whose recapitalization is relatively
small compared with some other markets, has shown a decline in gearing levels possibly
reflecting the relative quantities of asset write- downs coupled with the failure of some more
highly geared REITs in the last 18 months.
2.3.3 Beta/Volatility
Chart C
Source: Ernst & Young Global REIT Report 2010
0
0.2
0.4
0.6
0.8
1
1.2
1.4
Beta as of 31 December 2009
Beta
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The effect of the financial crisis is clearly visible from the increased volatility of REIT stocks.
Almost all the countries have witnessed risen beta from 2007 to 2009. Australia has seen the
highest jump in beta for this period (0.59 in 2007) (0.95 in 2008) (1.17 in 2009) due to high
exposure to US property market in addition to dominance of Stapled Securities. The stapled
security concept has been on the Australian REIT scene for decades, but in the last few years ithas risen to become the dominant structure in the AREIT market. Basically, an active business
company is stapled to a passive property trust under this structure. The advantageous taxation
treatment is maintained; however the stapled security can engage in higher-risk/return
business activities related to the property industry.
In the case of UK, listed property companies have converted into REITs, hence more exposure
to property development activities.
Japan has a high beta of 1.02. Japan has weak economic and real estate fundamentals, an aging
population and strong dependence on exports to US and Europe. The J-REIT Index fell 8.2%
during the second half against a 5.9% gain in the Nikkei 225 Index.
Singapore with a beta of 0.97 is higher relative to other Asian markets due to high exposure
oversees investment. Approximately 85% of Singapore REITs have offshore investment.
2.3.4 Rate of Return
Below is the total rate of return of REITs in different countries over one-year and three-years
for the year ended on 31 December 2009. This figure records both the income return (i.e.,
distributions) and capital appreciation on the relevant countrys stock exchange (i.e.,
movement in market price) for the year to 31 December 2009.
Chart D
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Source: Ernst & Young Global REIT Report 2010
Chart E
Source: Ernst & Young Global REIT Report 2010
0
10
20
30
40
50
60
70
80
90
Return(%)
Total Rate of Return for 1 year ended
on 31 Dec 2009
-30
-25-20
-15
-10
-5
0
5
10
15
Return(%)
Total Rate of Return for 3 years
ended on 31 Dec 2009
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In the last three years globally, REITs experienced a drop in market capitalization and negative
rate of return. The Asian market (excluding Japan) had milder decline and have recovered
quickly. For instance the total rate of return of Malaysia, Hong Kong and South Korea are
positive in the three year period. These Asian countries outperformed Australia, UK and US.
This difference in return can be attributed to:
Most Asian countries following traditional passive investment model (with lower
perceived risk profile) as compared to developed countries. Traditional model
entails investment in rental earning completely constructed real estate
properties as opposed to developmental property (in properties under
construction, development).
Notion that Asian countries are a promising market as far as long term growth is
concerned.
In UK REITs are predominantly listed property groups that converted to REITstatus. As a result, they are more exposed to property development risks than
most of their international counterparts. Similarly, Australian REITs were
relatively more exposed to project development and international investments.
It is believed that the REITs are themselves to be blamed for the problems during the financial
crisis. Many REITs decoupled their payout ratios from their underlying earnings in order to
maintain their share prices. This encouraged them to borrow in order to pay dividends and
resulted in Creeping Leverage. When the crisis occurred and the market capitalization as well
as Gross asset value of REITs fell, and they started exceeding their gearing limits, the problems
exacerbated.
In this next chart the annualised returns of REITs are compared with those of S&P Global Broad
Market Index (BMI) for different time periods viz. one-year (September 2008-September 2009),
three-years (September2006-September 2009), five-years (Sept 2004-September 2009) and
ten-years (September 1999-September 2009).
The S&P Global BMI (Broad Market Index) is index measuring global stock market performance
of approximately 11,000 companies in 46 countries, and is calculated daily in seven standard
currency offerings: USD, Euro, GBP, JPY, AUD, CAD, and LCL.
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Chart F
Source: S&P REIT Report-Q3-2009
Chart G
Source: S&P REIT Report-Q3-2009
-20
-15
-10
-5
0
5
10
15
1 year 3 year 5 year 10 year
Return(%)
Annualized Return (%)
S&P Broad Market Index
S&P Global REIT Inbex
-20
-15
-10
-5
0
5
10
15
1 year 3 year 5 year 10 year
Annualised Return (%)
S&P Broad Market Index
S&P Global REIT Inbex
S&P Global Property Index
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Chart H
Source: NAREIT
It can be seen that REITS outperformed other benchmarks over the 30-Year and 10-Year time
period. However, over the last 5 years the annualised return from Global REITs Index has been
lower than that of broad Market Index (BMI). The annualised return for the 3-Year from S&P
BMI and the S&P Global REIT Index was negative. This means that in spite of the short term
poorer performance of Global REIT as compared to Global BMI, the 10-Year annualised return
(which includes years of bad performance) of Global REIT is much better than that Global BMI.
This shows that the short term downfall in Global REITs which was precipitated by the subprime
crisis in USA was an aberration and the resilience of REITs has been demonstrated.
2.4 Draft guidelines on REIT by SEBI
Table No. 7
Country India
Listed or Unlisted Only listed
Closed-end or Open-end Closed
Fund Vehicle TrustDevelopment Prohibited from investing
in vacant land or engaging
in property development
activities
Dividend requirement At least 90% of PAT
Gearing Limit 20% of total asset value
Investment in Real Estate 100%
0
2
4
6
8
10
12
Dow Jones
Industrial
NASDAQ
Composite
S&P 500 Equity REITs
Return(%)
Compund Total Annual Return (%)
from Dec 71 to Dec 2008
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We can see that the draft guidelines are silent on many issues such as the REIT taxation,
minimum income from rental sources, gearing restriction etc.
We see that the draft model is similar to Hong Kong Model with respect to listing, closed-end
structure, organisational structure (trust), dividend distribution requirement and prohibition
from undertaking property development activities.
Shutting out open-ended schemes for REIT is logical given the peculiarities of its investments
real estate. In an open-ended scheme, the flurry of day-to-day entries and exits would
necessarily call for computation and publication of Net Assets Value (NAV) daily, which is not
possible with a REIT, given that unlike in the case of shares for which daily quotations are
available, it would simply not be possible to call upon the valuer to do valuations afresh every
day. More important, a REIT simply cannot stand redemption pressures, so common with open-
ended schemes, given that its investments are locked in immovable properties and that the
rental income by itself would often not be enough to handle such pressures.
Currently the draft guidelines are not specific on the issue of REIT taxation. Ideally, REITs should
be pass-through for tax purposes.
2.5 How REIT and REMF complement each other
Real estate mutual funds (REMFs), as per SEBI, would be permitted to invest both in real estatedirectly as well as in securities, including mortgage-backed securities and shares of companies
owning/developing real estate. As opposed to that, under the draft regulations, REITs are
permitted to invest only directly in real estate. SEBI wants to keep REITs away from financing
properties that are under way beyond 20 per cent of the funds mobilised by a scheme.
The return profile under both these investment approaches would also differ. Whereas, REMFs
can take development risk and trade in securities, therefore having a potential for higher
returns, albeit with a higher risk, REITs would generally invest in stabilised income-yielding
assets with lower returns and commensurate risk.
In a manner, units of REIT can be likened to fixed-income schemes of mutual funds and those of
REMF to growth and balanced funds.
The above analysis demonstrates that just as growth funds, debt funds and balanced funds can
co-exist, similarly REITs and REMFs can co-exist. Hence they complement each other.
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3.0 READINESS OF INDIA FOR REITS/REMFS
In this section we identify the requirements for successful implementation of REITs and the
current situation prevailing in the country.
Table No. 7
Pre-requisites Current Status
REITs for different property types such as retail,
residential, industrial/office, healthcare, hotel and
resorts, storage wherein each property types requires
specialised management skills
India lacks organised real estate market for different
types of properties except for office space for
earning rental incomes
Legal structure is needed in order to organize,
systemize and regularize the real estate sector
No uniform tax structure across states
No land title certification provided
No real estate regulator
REITs require portfolio management expertise andleasing and development expertise are necessary to
maximize revenue
Lack of Real Estate trained personnel Lack of Real Estate education at corporate and
university level
3.1 Hurdles in the Introduction of REIT/REMF in India
3.1.1Unclear tax rules-It is unclear whether REMF would be treated as Equity Oriented Funds(EOFs) or not. EOF do not pay long term capital gains tax Moreover, dividends from EOF are
totally tax free. The draft guidelines of SEBI on REITs are silent on the issue of taxation. This is a
major bone of contention as tax benefits are crucial for the success of REITs/REMFs in India. It
may be noted that REITs in the US only took off after tax benefits were extended to the
investors.
3.1.2 High Stamp Duty- Stamp duty rate differs from state to state. It is very high in most of
the states viz. Haryana (12.5%), Karnataka (10.5%), Maharashtra (10%), Orissa (14.7%),
Rajasthan (10%), UP (10%). This impedes the volume of real estate transactions in India. Under
Jawaharlal Nehru National Urban Renewal Mission (JNNURM), one of the mandatory reforms is
to gradually reduce the stamp duty to 5% in order to increase the flow of property transactions
in the market.
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Rationale for rationalisation of stamp duty:
High stamp duty leads to undervaluation of real estate property which results in loss of
revenue and increases the circulation of black money in real estate transactions.
Existence of high duty rates in some states and low or moderate duty rates in otherslead to diversion of economic activity, which is often unhealthy and economically
inefficient.
JNNURM envisages a four step exercise:
1. Fixing of the guidance value by a professional independent body.
1. Statutory backing to the guidance value.
2. Gradual reduction and elimination of the stamp duty remission to certain group of
individuals, business and industries. Such remissions reduce the revenue productivity of
stamp duty.
3. Widening the scope of the definition of the word Conveyance to widen the tax base
and further reduce stamp duty rate without loss of revenue to the state government.
Expected Outcomes:
An environment that will have a broad-based development of the real estate market,
with enhanced flows of FDI and NRI investment.
Purchase and sale of properties to become convenient for traders, developers and the
common man, resulting in an increase in the volume of transactions and economicactivities.
Legal and administrative remedies proposed along with rationalization of rate of duty to
result not only in checking evasion and avoidance of duty but also in enhancing revenue
from other taxes like property tax and wealth tax.
The temporary loss in revenue from stamp duties, if it occurs, to be compensated by
better valuation, checking of non-registration of property transfers, and increase in the
volume of registered documents.
3.1.3 Poor land title records- Land is a State subject in the Constitution, and the systems of
land records management vary from State to State, often even within a State, depending upon
their historical evolution and local traditions. Although these systems are diverse in form, they
have an underlying unity of themes and objectives and they also suffer from a largely
common set of problems.
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Several departments are involved in managing land records in most of the States, and the
citizen has to approach 3 to 4, or even more, agencies for complete land records, e.g., Revenue
Department for textual records and mutations; Survey & Settlement (or Consolidation)
Department for the maps; Registration Department for verification of encumbrances and
registration of transfer, mortgage, etc.; the Panchayats (in some States, for mutation), and themunicipal authorities (for urban land records), leading to waste of time, exposure to rent
seeking, and harassment.
These departments work in a somewhat stand-alone manner, and updating of records by any
one of them makes the records of the others outdated. Thus, the records are almost always
outdated and dont reflect the ground reality. Also, there is no integration of textual and spatial
records, making it difficult to give maps-to-scale with the records of rights (RoRs).
The most important activity for updating the records, i.e., survey has been neglected by most of
the States. Original survey for cadastral mapping has not taken place in many parts of the
country. Also, the earlier technology of lattha and chains for survey is cumbersome, painfully
time-taking and costly, and there is need for adopting modern technology across the country.
Further, the Registration Act, 1908 provides for registration of deeds and documents, not titles.
Merely the transaction is recorded, and the transfer of ownership title remains presumptive
only. Also, there is significant time lag between registration and mutation, giving rise to scope
of fraudulent transactions in land, disputes, etc.
Problems in land records management have been faced in other countries also, but respite has
come through introducing the system of conclusive titles, also popularly known as the Torrens
system.
Australia, New Zealand, the UK, Switzerland, Canada, the USA, Singapore, and also developing
countries such as Kenya, Malaysia, etc. have successfully introduced this system.
Kenya is a case in point. The British applied the Indian Registration Act, 1908 as it was, to Kenya.
But, after its Independence, Kenya amended the Act and introduced the Torrens system.
Pondicherry is an example of the system of conclusive titles from within India itself. The French
introduced the Torrens system there. However, after Independence, Pondicherry had to regressfrom conclusive titles to the presumptive titles system prevalent in India due to the provisions
of the Registration Act, 1908.
The system of conclusive titles is based on 4 basic principles: (i) a single agency to handle land
records (including the maintenance and updating of the textual records, maps, survey and
settlement operations, registration of immovable property mutations, etc.); (ii) the mirror
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principle, which states that, at any given moment, the land records mirror the ground reality;
(iii) the curtain principle, which refers to the fact that the record of title is a true depiction of
the ownership status, mutation is automatic following registration, there is no need of probing
into past title transactions, and title is a conclusive proof of ownership; and (iv) title insurance,
which refers to the fact that the title is guaranteed for its correctness and the party concernedis indemnified against any loss arising because of inaccuracy in this regard. At the moment, land
records in India dont reflect any of these principles.
The centre launched the Computerisation of Land Record (CLR) scheme in 1988-89 to provide
land owners with computerised copies of ownership, tenancy and updated copies of records of
rights (RORs) on demand. However until mid 2008 only 13 out of 35 states and Union
Territories were in a position to provide RORs on demand. In 2008, CLR was merged with
Strengthening of Revenue Administration and Updating of Land Records (SRA&ULR) to form
National Land Records Modernisation Programme (NLRMP) with the ultimate goal of
introducing a system of conclusive titles with title guarantee in India. Jawaharlal Nehru National
Urban Renewal Mission Scheme has initiated steps to set up land titling tribunals and land
titling appellate tribunals in cities.
3.1.4 Rent Control Act favouring tenants- The real estate scene in India is flawed by land
market distortions. The most glaring ones include inflexible zoning, rent and tenancy laws.
Zoning laws, rent controls and protected tenancies have been detrimental to the healthy rental
trends in India. They have put a freeze to land in city centres that could be otherwise made
available for new retail outlets and flats.
These laws also gloss over operational inefficiencies and scuttle competition. Tenants residing
could not be evicted for a long time and would not surrender their cheap tenancies on their
own volition. The renovation of buildings could hardly happen. One such act favouring the
rental property market in India is the Rent Control Act.
The Rent control Act needs to be repealed to protect the owner and his/her property from the
tenant. Areas of focus should be:
Terminating old tenancies
Removing constraints on increase in rentals
Empowering owner to reclaim their properties without any court proceedings
Allowing the market forces to determine the rental amounts
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If these laws are enacted and strictly enforced there is every chance that more investors
will want to enter the real estate market to utilize the rental fees as income. This is
especially true for the commercial sector. The tax laws also need to be revised so that
renting of properties becomes a financially viable option.
3.1.5 Absence of Real Estate Regulation - The real-estate industry has traditionally been
plagued by a lack of transparency in its working and speculative nature. There is no regulatory
body to certify property developers and regulate property transactions. This coupled with
archaic property laws, high stamp duty rates, lack of computerized land records and clear titles
have led to inaccurate reporting, non transparency of information, property disputes and a
thriving parallel economy. Also, due to the unorganised nature of the real estate sector, lack of
yield-generating assets of institutional quality into which REITs and REMFs can invest is a major
challenge. It is therefore essential that state level regulators (land being a state subject) are setup to oversee these issues and provide an enabling framework so as to facilitate REITs to
become an effective tool for institutionalizing real estate in India.
3.1.6 Not well defined Valuation Methodology- It is a known fact that property valuation
methods in India are as varied as the property laws in different states. In absence of any
prescribed standard, guidelines or reporting formats, valuers have a lot of flexibility in tweaking
the assumptions, calculations and approaches.
NHB Residex database should be expanded from present coverage of 15 cities to all the Tier I, II
& III towns and cities. As most of the SEZs are cropping up in and around Tier II & III cities, real
estate development for residential and hospitality is on the increase. Launch of Residex in more
cities along with an additional index for commercial property, will enable proper valuation of
assets acquired by REITs.
3.1.7 Service tax on commercial rentals- The High Court of Delhi had ruled that renting of
commercial property would not be subject to the levy of service tax. However, the Budget of2010 has amended the scope of Renting of Immovable Property Service to directly overrule
the High Court judgment and to explicitly cover the activity of mere renting as well and this has
been done with retrospective effect from 1st June 2007. Moreover, renting of vacant land
where the agreement of contract between lessor and lessee provided for undertaking
construction of building/structure on such land for furtherance of business or commerce during
the lease period will also be subjected to service tax.
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Construction of real estate complexes will now attract service tax, unless the entire
consideration for the property is paid after the completion of construction, that is, on obtaining
the occupation certificate from the concerned authorities.
Service tax will now also be levied on additional services provided by a builder to buyers forextra charge like preferential location, internal and external development of complexes.
Service tax on the activity of construction would primarily mean, buyers paying higher price for
property which is under construction.
Pursuant to the Delhi High Court judgment, most industry players refrained from paying service
tax pursuant to such transactions. This amendment would have a significant impact on both the
real estate sector as also sectors which rely on lease of immovable property for running their
business. Further, retrospective nature of the amendment will now result in an adverse impacton the sector and may lead rise to a large amount of litigation.
In an industry where agreement of contract between lessor and lessee providing for
construction of building/structure on vacant lands are a common phenomenon, an imposition
of service tax on such transactions is not likely to go down too well with the real estate sector.
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4.0 STUDY OF TIME VARIATION OF SYSTEMATIC RISK OF REITS IN USA
Diversification of stock portfolio and diversification of asset portfolio are two different things. In
the former, the investor primarily holds a single type of asset (i.e., stock) for differentcompanies, thereby reducing the unsystematic risk (company specific risk). What about
systematic risk or market risk? In order to reduce systematic risk diversification of asset
portfolio is required. Different asset classes are exposed to different types of market risks and
by diversifying among different asset classes there is reduction of exposure to systematic risks.
The following section shows the declining systematic risk of REIT from 1972-2006, reflecting
acceptance of REITs as an important asset class in investors portfolios. However, from 2007
onwards the systematic risk of REIT started rising owing to the financial crisis resulting from
bursting of the real estate bubble.
The systematic risk has been evaluated for the NAREIT Price Return Index using the CAPM
framework. The REIT-beta has been calculated for various periods and subsequently Time
Varying Coefficient (TVC) has also been calculated. Analysis has been made to identify
structural change in beta over time (using dummy variable approach).
Past studies on REIT-Beta
Tsai, Chen and Sing (2007) find that investors might treat REITs like normal stocks result in REITs
behave more like stocks than real estate. As time pass by, people more and more realize what
REITs real is; the cash flow and the inflation-hedging characteristics of REITS are different to
other securities. Therefore, the longer the real estate being securitized, the more investors
realize what the asset securitization is, the more like underlying asset, real estate, they will
behave. For that reason the beta has structural changes.
In the present study the systematic risk of REITs has been calculated for the period 1972-2010
using the CAPM equation as follows:
Rnareit,t Rf,t= + nareit (Rm,t Rf,t)
Where:
Rnareit,t = Monthly return on NAREIT on time t
Rf,t = Monthly yield of Treasury Bill on time t
Rm,t = Monthly NYSE return on time t
nareit = Systematic risk of NAREIT
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= abnormal return under prevailing market risk
In the above equation the nareit (REIT-beta) represents the volatility, or systematic risk of REIT
stocks in comparison to the market as a whole.
Calculation of REIT-beta for various sub periods:
Table No. 8: Systematic risk for the sub period 1972-1980
Variable Coefficient Std. Error t-statistic P-Value
-0.46 0.43 -1.08 0.28
nareit 0.89 0.09 9.99 0.00
Table No. 9: Systematic risk for the sub period 1981-1990
Variable Coefficient Std. Error t-statistic P-Value
-0.96 0.22 -4.44 0.00
nareit 0.51 0.05 10.94 0.00
Table No. 10: Systematic risk for the sub period 1991-2006
Variable Coefficient Std. Error t-statistic P-Value
0.14 0.24 0.56 0.58
nareit 0.42 0.07 6.17 0.00
Table No. 11: Systematic risk for the sub period 2007-2010
Variable Coefficient Std. Error t-statistic P-Value
-0.46 0.95 -0.49 0.63
nareit 1.43 0.16 9.03 0.00
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It is visible from the above tables that the beta declined for the first three sub periods (i.e.,
1972-80, 1981-1990 and 1991-2006). However, there was an increase on the REIT-beta for the
last sub period (2007-2010).
What led to the increase in the volatility of REIT-beta for 2007 onwards?
From the above analysis of time varying systematic risk of REIT, the calculated statistics show
that REIT-beta declined over the period 1972-2006. It can be concluded that there was acontinually declining beta indicating the structural change from its behaviour as a stock to its
behaviour as a real estate. However, the increase in REIT-beta from 2007-2010 can be viewed
as an aberration resulting from the burst in the property bubble which was initiated by the sub-
prime crisis in the USA.
Sub Prime Crisis
Dislocation of Credit Market
Exposed the vulnerability of illiquidasset class
Real Estate firms unable to obtainfinance from banks
REIT investors sold down theirpositions- albeit at a price
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5.0 SINGAPORE BUSINESS TRUSTS- PSEUDO REITS
Although there is no gearing limit for a Business Trust, it can impose upon itself the
same gearing limits as a REIT. Therefore, a business trust may have a gearing limit of35%, and up to 60% if it has a credit rating, which is the norm of MAS for Singapore
REITs. However unlike a REIT, it can also have a gearing limit of 60% without a credit
rating if there is approval from its unit holders.
A Business Trust does not have a minimum payout ratio. However, some business trusts
follow the REIT requirement of paying out at least 90% of income.
A Business Trust does not have a limit on property development activities. For REIT, the
limit is 10%, and the major part of its business should be in the form of property rental.
However, some business trusts have imposed a limit on property development activities
upon themselves, but instead of 10% it can be higher.
5.1 Indian Properties based Business Trusts in Singapore
5.1.1 Ascendas India Trust
It was the first Indian Property based Trust listed in Singapore. It is engaged in rental of office
space to IT and ITES sectors in India. The historical performance of the stock price is shown
below:
Graph B
Source: SGX REIT Data
The trust was listed in SGX on 1 August 2007 at an offer price of S$1.18. Ascendas India Trust
(a-iTrust) had the advantage of being another Trust under the Ascendas brand name, the other
0
0.2
0.4
0.6
0.8
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1.2
1.4
1.6
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Ascendas India Trust
Price
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being the highly successful Ascendas REIT at that time. On top of that, it was listed when the
market was extremely euphoric, and on retrospect, just 2 or 3 months before the all time peak
of the market. So it was not surprising that it was able to achieve a closing price of S$1.55 on
the first day of trading. The stock eventually peaked at S$1.7 about 3 months later. In the
prospectus the projected annual DPU was about 6.85 cents. At S$1.7, the yield was only about4%.
The peak of its stock price was about S$1.70 around Nov 2007. However, its stock price started
to move down from above the S$1.10 level in May 2008 to around the 0.70 level within a
relatively short time, even before the collapse of Lehman. The stock price bottomed around
0.38 in Oct 2008. It was due to the depreciation of rupees and conditions of the Indian
economy at that time.
The stock price started to move up in a significant way around May 2009 after the Indian
General Election 2009, when Manmohan Singh, who is pro-economic reforms, was re-elected
as the Prime Minister. The stock price was up from around S$0.5 level to the S$0.7 level.
Following this, the stock maintained a general uptrend along with the broader market.
Another significant movement of the stock price was in the August 2009 period, when it moved
down from 0.85 to around S$0.745. This was due to significant selling by the substantial
shareholder Great Eastern, which reduced its stake from 5.99% to 4.95%. But the stock price
rebounded quite quickly to above the S$0.8 level soon after.
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5.1.2 Indiabulls Property Investment Trust (IPIT)
Graph C
Source: SGX REIT Data
Source: Corporateinformation.com
Indiabulls Properties Investment Trust (IPIT), subsidiary of Indiabulls Real Estate, listed at its
issue price of S$ 1 on the Singapore Exchange on 11 June 2008. The stock hit a low before
closing the day at S$ 0.90 per share, drop of 11% below its issue price on first day.
00.10.20.30.40.50.60.70.80.9
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The stock price fell to its lowest at S$0.14 in October 2008.By May 2009 it rose to S$0.365.
Thereafter, in spite of the improvement in Indian there has not been much price movement.
Stock price ranged between S$0.20 and S$0.30 in the last six months.
IPIT has not distributed any dividend since its inception. As it is, the trust was listed at a verycritical time when the financial crisis was at its peak and investor confidence was at its low.
Moreover, the two commercial properties in the asset portfolio are not complete and are not
rented out. One of the commercial properties, namely Elphinstone Mills is likely to be
completed by mid of 2010 and hence not contributing rental income. Moreover leasing
remained slow in the 2008-09 and the accelerated decline in demand for office space in its key
target markets of the banking, finance, security and insurance sectors might result in the trust
being unable to lease the properties at the forecast rates. IPIT posted a net property loss of
$568,000 for the period May 7, 2008, to March 31, 2009, instead of the net property income of
$103.3 million it had forecast for the April 1, 2008, to March 31, 2009, period in its listingprospectus. The future of the stock of IPIT is dependent on the rental income it is able to derive
after the completion of its projects.
5.2 Overview of DLF Office Trust (DOT), Proposed Business Trust of DLF
Singapore based Business Trust registered by the MAS
Investing directly or indirectly in a portfolio of income producing Real Estate assets,
used primarily as office, IT or ITES and other related purposes, with main focus in India
Developing and co-developing real estate used for office, IT,ITES with the objective of
holding such properties upon completion
Key provisions of Property Fund Guidelines have been incorporated in the Trust deed in
order to create a REIT like Business Trust in order to enhance the stability of distribution
to unit holders of DOT
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5.2.1 Structure of Proposed Business Trust of DLF in Singapore
Distribution Holding of Units
Acts on behalf of unit holders
Distribution Ownership
Management and Trustee Fees
Distribution Ownership
Marketing and Lease Management Fee
Marketing and Lease Management
Income Ownership
Unit holders
The Trust
Special Purpose Vehicle
DAL India
Properties
The
Trustee
Manager
DLF Commercial
Developers Limited
(Marketing and Lease
Management Services
Provider)
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5.2.2 India related risks for DOT
1. Properties located in India are subject to Indian laws and policies relating to Real Estate
and the prevailing political and economic conditions in India. The value of the properties
could be affected local market conditions such as oversupply, competition from otherSEZs or IT parks.
2. Land title in India is uncertain and no assurance of clean title
3. Buildings and other consents may not be granted
a. Properties require construction, environmental and zoning permits. However,
there is no assurance that the permits will be granted on time or for that matter
at all only keeping in mind the track records of Indian issuing authorities.
b.
Infrastructural support such as roads, electrical power, telecommunications,water and waste treatment require additional approvals and consents from the
local service providers
4. DOT has a portfolio of income generating properties situated in different states and
localities, subject to local and municipal laws which wary from location to location and
from time to time and ensuring compliance is time consuming and costly.
5. SEZ status can be revoked if DAL India or DLF fail to comply with the SEZ laws of India.
6. The distributable amount available with DOT for the unit holders is susceptible to
foreign exchange fluctuations. Since the income of DAL India is denominated in Indian
rupees, any decrease in the value of rupee will adversely affect the amount of dividend
available for unit holders in Singapore.
7. Hostilities emanating from within as well as outside the country in the form of terrorism
and extremism may damage the reputation of India in the eyes of its business partners
many of whom are MNCs. India may stop attracting MNCs as a favourable destination
for setting up offices and commercial units. This will negatively affect the income of
DOT.
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5.2.3 Key Indian tax risks
1. The property may be subject to Capital Gains if disposed of by DAL India which will
reduce the available income for repatriation from DAL India.
2. No tax benefits can be extended to any construction activity outside the SEZ premises
including water pipeline connections from the source to the SEZ.
3. Bond cum Legal undertaking shall be signed by:
o The units operating from the SEZ, which have to ensure that the value of their
exports is higher than the value of their duty free imports including capital
goods, spares, raw materials, components and consumables including fuels.
Hence there should be net positive foreign exchange earnings by the unit.
5.2.4 Trustee manager
5.2.4.1 Roles and Responsibilities of Trustee-Manager are:
Treat unit holders who hold units in the same class fairly and equally
Ensure that all payments out of the trust property are made in accordance with
The Business Trust Act (BTA) and the Trust deed
Report to the authority any contravention of BTA and Securities and Futures
Regulations
Ensure that the Trust property is properly accounted for
Ensure that the Trust Property is kept distinct from the property held
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