MC EXCLUSIVE Finance Ministry backs equity status for REITs, InvITs; Decision likely in SEBI's next board meet

REITs and InvITs are blend characteristics of both equity and debt investments.

SEBI may consider classifying Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs) as "equity" in its next board meeting, likely in the next two months. This would enhance the visibility and acceptability of these two instruments, giving mutual funds the option to include them into their equity-oriented schemes, thereby enabling retail investors to tap them for more stable returns, Moneycontrol has learnt.

According to two government officials, the Finance Ministry is in favour of classifying these two instruments as equity,  and has conveyed the same to SEBI. "We certainly hope, in the next board meeting, the reclassification (to equity from hybrid at present) is approved," an official told Moneycontrol.

REITs are companies that own, operate, or finance income-producing real estate. Instead of buying individual properties, an investor buys units (shares) in a REIT, which then invests in a portfolio of real estate assets. InvITs, meanwhile, are similar to REITs but focus on infrastructure projects. They pool money from investors to invest in a portfolio of operational infrastructure assets

A hybrid fund, in the context of mutual funds, is an investment scheme that combines different asset classes in a single portfolio. The most common combination is equity (stocks) and debt (bonds/fixed-income securities), but they can also include other assets like gold or real estate.

Why REITs, InvITs are hybrid funds

REITs and InvITs are categorised as hybrid funds because they blend characteristics of both equity and debt investments,  and offer a unique combination of income generation and potential capital appreciation, say experts.

These two instruments are listed and traded on stock exchanges, similar to equity shares; but also have a key characteristic--to distribute a significant portion (typically 90 percent) of their net distributable cash flow to unitholders in the form of dividends or distributions. This provides a steady and predictable income stream, similar to interest payments from debt instruments, they say.

Officials, however, say the exposure of MFs in these schemes is below 1 percent, which should ideally go up given the nature of these instruments to provide stable returns (for investors), as well as to drive investments in the real estate and infrastructure sectors.

"The classification into equity shall directly help in attracting more investments into these two instruments," another official said.

SEBI has also suggested increasing the investment limits for MFs in REITs and InvITs, from 10 percent of the (equity and hybrid) scheme’s net value (NAV), to 20 percent. At present, a mutual fund scheme cannot invest more than 10 percent of its NAV in units of REIT and InvIT, subject to maximum of 5 percent of its NAV in units issued by a single issuer.

Officials say there’s a possibility that a decision to raise the limits to 20 percent overall, and 10 percent by a single issuer can be taken in the next meeting as well. They say foreign mutual funds are specifically seeking  raising the NAV limits

The current caps have restricted mutual fund exposure to these instruments to less than 1 percent — no small thing, especially in an industry built to fund the income that will be generated by these assets over the long term, said Siddharth Maurya, Founder, Vibhavangal Anukulakara – a financial services company based in Delhi.

Maurya says that the current limits don’t give fund managers much room to work with, even if the assets are strong. "These instruments are also classified as hybrid instead of equity, which keeps them out of most popular equity schemes. Add to that the lower liquidity, fewer listings, limited track record, and the fact that many investors still don’t fully understand how they work and it is clear why participation remains limited," he added.

Vivek Iyer, Partner, Grant Thornton Bharat said that enhancing the limits for Mutual Funds will help deepen the market for the REITS and InvITs. "However, it would be worthwhile to classify these products as hybrid rather than equity, so that Mutual Funds can design schemes that capture the right risk and return profile of products for their investors," Iyer said.

The Association of Mutual Funds in India (AMFI) and the Mutual Fund Advisory Committee (MFAC), are of the view that the REITs and InvITs should be classified as hybrid securities rather than as equity or debt securities. This is mainly because of the dissimilarity in the structure related to their cash flows, dividends, half-yearly Net Asset Value (NAV) calculation based on valuation, voting rights limited to certain operational decisions, and so on.

REITs and InvITs provide ownership rights to their investors. The units issued to investors (by REITs and InvITs) represent shares in the underlying asset, which is real estate for REITS and infrastructure assets for InvITs. REITs receive rental income and InvITs receive infrastructure revenue, and these are often performance-linked, similar to dividends paid on equity instruments. Also, the cash flows from REITs and InvITs are relatively stable, like that of fixed-income securities.

“Hence, they shouldn’t be classified as equity,” noted Vinod Joseph, Partner, Economic Laws Practice. “REITs and InvITs have features of both equity and debt and under SEBI’s regulations for mutual funds, they are, quite rightly, treated as a distinct class,” he added.