Departure from debt to equity model: REIT to the rescue of real estate

Real estate is property which is made up of land and the buildings on it. It is also the natural resources of the land which include farmed crops and livestock, uncultivated flora and fauna, immovable properties and, water and mineral deposits.

Real estate finance is the cornerstone of loan books for many banks and NBFCs which are involved in this particular lending whereas for the borrowers this type of finance plays a significant factor within their overall finance package.

Real Estate Markets in India

Real Estate is one of the most dynamic sectors globally. In India; it is the second largest employers after the Agricultural sector. According to the JLL’s projection, housing sectors contribution to Indian GDP is expected to be 11% which is almost double from the current contribution of 5-6%. According to the report from CREDAI and JLL, India’s real estate sector is projected to reach US$180 billion by 2020 from US$126 billion in 2015. In 2017, private equity and debt investment in this sector increased by 12% year-on-year basis across 79 transactions.

 Source: Credai-JLL Report, EY- India’s Growth Paradigm

In the year 2017, this sector saw some consequential ups and downs with some implementation in government policies including RERA and GST. Demonetization with Benami transaction law also had a major impact in this sector. Demonetization proved beneficiary for this sector and by the beginning of 2017 buyers sentiment improved with emboldening budgetary reforms.

Crisis building up in India’s real estate sector

The real estate sector is of considerable interest for different investors because the post-liberalization uptrend of this sector divulges quite outstandingly the characteristics and contradictions of post-reform growth. It is one of the sectors which is most benefited from the credit splurge. The surge of housing loans ameliorates at the end of the 1990s and remained high up-to 2006-2007, before the global financial crisis. The share of housing finance in total credit rose from 5% in 200-01 to 12% in 2006-07. But, the most important fact is despite the 2008 subprime crisis the proliferation of credit to both housing and the overall construction sector in India remained very high till very recently.

At the end of UPA2, due to certain political downturn like DMK and TMC government pull-out from the collation and also deterioration of different macroeconomic parameters starting from crude oil price hike to rising in inflation which thereby decreasing the purchasing power of parity of end user which had a great hit on this sector.

The recent slowdown in India’s real estate sector reflects the challenges which they are facing post-reform growth, and fixing them is going to be a major challenge. As real estate is cash driven sector and most cash-based revenue in India are also generated from this sector so Demonetization also had a great impact on the slowdown. Most of the daily operations in this sector are funded by operational and financial creditors so the cash pull-out lead to the major decline in this sector.

The RBI’s decision to impel banks to immaculate their balance sheets by identifying non-performing assets, resolving bad debts of large defaulters and, failing that, taking them to the bankruptcy court as per Insolvency and Bankruptcy Code Bill for liquidation, has focused attention on the crisis in a few sectors. Besides the power, steel and textiles sectors, the sector which is of primary concern is real estate, consisting of housing, commercial real estate and hospitality assets. India’s large Real Estate firms like Jaypee Infratech, Amrapalli and Unitech are being impeached by several Public Sectors and Private Sectors Banks and home buyers who had paid them advances but didn’t receive their home or residential property yet have turned to the courts.

REIT

Real Estate Investment Trusts are an investment vehicle that own, operate and manage a portfolio of income-generating property to provide returns at regular intervals. They are mostly commercial properties such as offices, shopping malls, multiplexes, hotels, etc. that generate rental income. It works like a mutual fund which pools fund from a number of investors and invests in rent-generating properties.

REIT has a 3-tier structure:

1.     The sponsor who is responsible for setting up the REIT.

2.     The fund management company which is responsible for selecting and operating the properties.

3.     The trustee who ensures that the money is managed in the interest of unit-holders.  

The REIT was approved by the SEBI and like other mutual funds. It will pool the money from all investors across the country and will subsequently be invested in commercial properties to generate income. The REIT fund will need to be registered to SEBI via an IPO. The minimum asset sizes to be invested as per SEBI guidelines is Rs 500 crore and the minimum issue sizes need to be less than Rs 250 crore. The investors would be able to buy the units from either primary and/or the secondary markets as in case of other public issues. The main objective of REIT is to provide investors with the dividend that are generated from the capital gains accruing from the sale of the real estate properties.

Why is REIT important?

The Indian real estate sector for the last few years have been facing a liquidity crunch on account of low demand and unsold inventory. So, REITs can help cash-strapped developers to monetise their existing property and also help the real estate developers to switch from debt-based fund to equity-based fund. As per SEBI guidelines, REITs need to distribute a minimum of 90% of their income earned to investors on a half-yearly basis. Thus, 90% of sale proceeds to are to be paid out to the unit holding investors until and unless the amount is reinvested in another property. So, the investors will receive regular income and at the same time will also get to benefit from price appreciation which in terms will boost their returns. In real estate, both capital and rent appreciations from properties depend on the locations, industrial development and infrastructure of the surrounding area. So, with a diversified portfolio of REITs will help to juggle these risks.

Embassy Group, an Indian partner of Blackstone Group LP and a commercial real estate developer, is going to lay the spadework for India’s first REIT.

Conclusion

The recent slowdown in second largest employer sector of India and also different NCLT cases against the major real estate developers are one of the prime issues in Indian Economy. Thus, to bring more investment through REIT might act as an aid and bring more capital infusion in this sector which might ameliorate the present condition of the big bang real estate developers.