Draft REIT Regulations: Top 3 Concerns?

About a month ago, this show discussed need for Real Estate Investment Trusts in India and what the architecture of a REIT regime should look like. Soon thereafter SEBI issued draft guidelines. The draft framework is broadly in line with industry expectations but there are some niggling concerns. Payaswini Upadhyay lists the top 3 changes industry would like to see

India is one step closer to becoming a part of the 205 billion dollar REIT market in the Asia Pac region. Recognizing REITs as an important asset class for industry and investors, SEBI has now proposed draft guidelines for REITs; the chosen structure is a Trust under the Indian Trusts Act.
The regulator has laid down specific eligibility criteria and responsibilities for the parties involved- the Sponsor, the Trustee, the Manager and the principal valuer.
The Sponsor sets up the REIT and is required to hold at least 25% stake for the first three years after listing and thereafter a minimum 15% for the life of the REIT; a Trustee, who is independent of the Sponsor, holds the REIT assets in a Trust and appoints a Manager. The Manager is responsible for the day to day affairs of the REIT and has to appoint the principal valuer who is tasked with the job of valuing the assets in a true and fair manner.
But a Trustee related requirement in the draft guidelines has experts worried. The Trustee has to ensure that the REIT’s assets have a marketable title and material contracts entered into by the REIT are legal and enforceable. SEBI places a similar requirement for mutual fund Trustees who have the responsibility to ensure that a Scheme’s objectives are met. While the MF regulations permit associate entities to act as Trustees; for REITs, SEBI has proposed an ‘independent’ Trustee – that implies an associate of the Sponsor, Manager or Principal Valuer cannot act as a Trustee.   Nishchal Joshipura
Partner, Nishith Desai Associates
"This, to me, is a very big burden that the Trustee has to take primarily because land title in India has been a big issue. And ideally this should be the responsibility of the Sponsor because on one hand the regulations say that the Trustee needs to be independent of the Sponsor and on the other hand the Trustee has to take on the obligation of the title of the property. That’s one area that SEBI should look at to change the obligation from the Trustee to the Sponsor."
REITs typically hold real estate assets such as fully built properties. Rental income from them is, in turn, distributed to REIT investors as dividend. SEBI has proposed that the funds to buy those real estate assets can only be raised via the IPO or FPO route. Experts say this can get very limiting especially in tough markets. Nishchal Joshipura
Partner, Nishith Desai Associates
"Unless flexibility is provided to do a preferential allotment to a single unit holder who is willing to put in millions of dollars- and of course, the approval requirements should be there which is there for listed companies i.e. to have approval of 75% shareholders by value. I think that is one thing that should be permitted for REITs. And second, Rights Issue which is a common way of raising funds for companies where all the shareholders can participate and put in funds in the company- I think a similar concept should be there for REITs especially because there is also an obligation on the Sponsor that he cannot be diluted below 15% of the holding of the REIT throughout the life of the REIT. If the Sponsor is not allowed to participate in the fund raising, how will he ensure that he is not diluted below 15% which is where the pref allotment and rights issue route would be important." Siddhartha Shah
Partner, Khaitan & Co.
"I think, like a public company, where the principle of pre-emptive rights for existing unitholders- where do I do a follow-on offer, it should not lead to a further dilution of the interest of my existing unitholders; the price should be at least equal to the fair value. Today the regulations are silent on the pricing norms which should be applicable to follow on offering- whether it should be the NAV or whether a price flexibility of anything above NAV should be allowed; so its not specified there."
The third important concern is regarding the lack of clarity on transfer of assets. In the draft regulations SEBI has proposed listing requirements that cover minimum asset size of the REIT, offer size, lot size, minimum subscription amount and public float. But the draft regulations do not make it clear whether the assets are required to be transferred pre or post listing. Experts say ideally the transfer should be allowed post listing. Pre0listing transfers would be difficult to unwind. Nishchal Joshipura
Partner, Nishith Desai Associates
"What might happen is if that is made mandatory, the issue that could occur is that the Sponsor would have already incurred the Stamp Duty cost and the tax cost for transfer of the property to the REIT. And on the other hand, for some reason, if the listing is not successful or minimum subscription amount is not received by the REIT, then they will have to unwind the entire structure where REIT will have to again transfer the property back to the Sponsor which will again entail Stamp Duty and tax cost. So that is something that needs to be clearly specified that SEBI would be comfortable if the REIT property is transferred to the REIT after listing." Siddhartha Shah
Partner, Khaitan & Co.
"Most market globally do allow REITs to go out and raise public money on the basis of an underlying binding contract from a Sponsor to transfer the asset. So this at least mitigates the risk in the event where the REIT is unable to raise a public offer. So I think somewhere- the regulations though silent- will need to enable this mechanism. For follow on contributions, again, as an operating REIT – if I am looking to acquire an asset- the pre-condition of the asset being contributed into the REIT before I do a follow-on offer will have the same challenge."
Market participants are hopeful that SEBI will address most of these concerns in its final framework. But what’s worrying them lies outside of these draft regulations and that’s the clarity on the tax front. Currently, there is no express provision for taxation of REITs and so, they are likely to be taxed as a Business Trust at the rate of 33.99%. Experts say unless a tax pass through status is given to REITs, the idea may not take off. In Mumbai, Payaswini Upadhyay