There has been a massive stream of positive waves, thanks to a majority government at the centre. And the expectations from the new government has triggered a positive sentiment amongst the investor and business community. Add to this, India being amongst the leaders in GDP growth as compared to other developing nations and a young population with higher propensity to spend, and the stage is set for fueling this growth further.
And if that’s not enough, a recent survey of 159 top multinational companies by United Nations Conference on Trade & Development (UNCTAD) has identified India as the third most attractive destination in the world after China and United States for investment during the 2013-2015 period. The growth rate of new enterprises being registered in India is on the rise every year, thus giving a boost to the commercial real estate sector.
IT/ITES sector in commercial real estate has particularly shown a striking growth in the last decade, boosted by a thrust from policy makers to push this sector. For example, the change in policy that allowed companies to house their back-office functions in IT buildings led to many non-IT firms shift their large back-end office functions in relatively inexpensive IT buildings. Certain developers, who had significant land parcels in the suburbs, utilised this opportunity to offer commercial space at reasonable rentals. This created a favorable situation for those investing in income yielding properties (pre-leased proposals) with returns ranging between 6-10%. HNIs and real estate equity funds have been envisaging interest in these kind of income yielding and office properties.
The Commercial Stock in India
Cities like Mumbai, Delhi NCR and Bangalore house majority of Grade A commercial buildings in the country. However, cities like Chennai and Pune are also significant contributors in this space with huge stock of Grade A IT buildings, IT sector being the major driver here. Have a look:
Investment in Real Estate – Current Scenario
Pre-leased properties form an important part of the HNI’s investment portfolio. Apart from HNIs, funds like Blackstone, Baring Capital, IDFC RE fund, Milestone and NV Advisory have also given a special focus on investment in income yielding properties.
The annual rental returns in these investments range from 8% -11% depending on the size of the investment, location, type of property and tenant.
Smaller ticket proposals typically yield a return of 6-9%. Within the smaller ticket band properties, those which are high street/ground floor properties (retail real estate) with good visibility and tenants like reputed banks, FIs and retailers tend to yield lower, between 5-7% annually. However, larger properties costing upwards of INR 50 crore can offer returns in the band of 10-11% annually. These are typically large floor plates or an entire building leased to big corporate houses.
What the Future Holds: REITs
REITs (Real Estate Investment Trusts) are all set to foray in the Indian market. These are expected to provide the retail investor an opportunity to indirectly invest in income yielding commercial assets.
So what exactly is an REIT? An REIT is a listed entity, and its shares are publicly traded on the stock markets. The inherent value of the listed entity is derived from the underlying income generating Real Estate assets that the entity owns (and in effect manages). The holdings could be sector focused or diversified across office, shopping (retail malls), industrial or even residential.
REITs are regulated vehicles that could allow a broader swathe of institutions and individuals – including smaller investors – to participate in the real estate sector. Due to their efficacy in channeling funds into real estate in a transparent and investor-friendly way, REITs are widely seen as a win-win for buyers, developers and the economy.
Indeed, the concept has been successful in dozens of developed and developing markets. North America is amongst the most developed REIT markets, and the first REITs are estimated to have come into the USA in 1960s. Emerging markets like Brazil, Russia, and Philippines also boast of REITs. Today, they are present in over 30 countries around the world. The global market capitalisation of REITs has grown from $300 billion in 2003 to just over $1 trillion in September 2013, according to Ernst & Young.
India’s market regulator SEBI (Securities and Exchange Board of India) recently released the norms for setting up REITs in India (certain clarity on structures and tax are expected soon), and the first REITs are expected to be launched sometime next year.
The developers benefit from REITs as it helps them unlock the value of the leased buildings by selling these to the REITs rather that selling these strata / floor by floor / unit by unit.
In order to ensure that REITs are not misused, SEBI has drawn up a detailed list of instructions for aspiring trusts and investors. Some of the most important rules are that each trust must have assets worth at least INR 500 crore ($81 million), and each investor must put in at least INR 2 lakh ($3258). 80% of the value of the assets must be invested in completed and rent-generating properties, with the rest being invested in non-completed properties or financial securities. And 90% of the net distributable cash flows must be paid to investors as dividend.
These norms are geared towards ensuring that fly-by-night operators don’t enter the REIT arena, and investors’ interests are protected at all times. However, while SEBI’s intent is laudable, there is some confusion prevailing over the taxation treatment for these trusts and the dividends they pay out. The industry has asked for capital gains and dividend distribution tax to be removed so as to make REITs more viable for promoters and investors.
While we await REITs in India, some of the Indian developers have listed their properties on the Singapore exchange:
REIT # 1: Office properties in South India
Performance of the REIT (Indexed):
• Listing at 100 per unit in mid 2007
• Peak at 107 per unit in late 2007
• Trough at 29 per unit in end 2008
• Recovered to 68 per unit in early 2010
• Range bound since then
REIT # 2: Office properties in Mumbai
Performance of the REIT (Indexed):
• Listing at 100 per unit in mid-2008
• Peak at 103 per unit in mid-2008
• Trough at 18 per unit in end 2008
• Recovered to 42 per unit in early 2010
• Dropped to 30 per unit by end 2013
REITs surely offer benefits to the financial markets, assist developers exit/monetize their holdings and invest in development, and offer an alternate investment vehicle to the retail investors. However, like they say “please read the offer documents carefully before investing”, these are capital market instruments, and the market pricing et al is governed by market forces, and not just the underlying assets. They are here to stay.