Capstone Project on REITS- Dhara Badiani KHR2009PGDMF012

8/2/2019 Capstone Project on REITS- Dhara Badiani KHR2009PGDMF012

1/67

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


2/67

REITS- Right for INDIA? 2011

2 | P a g e

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


3/67


3 | P a g e

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.
http://www.blurtit.com/q9320140.htmlhttp://www.blurtit.com/q9320140.htmlhttp://www.blurtit.com/q9320140.htmlhttp://www.blurtit.com/q9320140.htmlhttp://www.blurtit.com/q9320140.htmlhttp://www.blurtit.com/q9320140.htmlhttp://www.blurtit.com/q9320140.htmlhttp://www.blurtit.com/q9320140.html


4/67


4 | P a g e

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.


5/67


5 | P a g e

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:


6/67


6 | P a g e

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.


7/67


7 | P a g e

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:


8/67


8 | P a g e

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,


9/67


9 | P a g e

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.


10/67


10 | P a g e

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.


11/67


12/67


12 | P a g e

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


13/67


13 | P a g e

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.


14/67


14 | P a g e

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:


15/67


15 | P a g e

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


16/67


16 | P a g e

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


17/67


17 | P a g e

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


18/67


18 | P a g e

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.


19/67


19 | P a g e

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


20/67


20 | P a g e

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


21/67


21 | P a g e

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


22/67


22 | P a g e

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


23/67


23 | P a g e

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


24/67


24 | P a g e

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


25/67


25 | P a g e

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


26/67


26 | P a g e

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


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


27/67


27 | P a g e

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


0

0.2

0.4

0.6

0.8

1

1.2

1.4

Beta as of 31 December 2009

Beta


28/67


28 | P a g e

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


29/67


29 | P a g e


Chart E


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


30/67


30 | P a g e

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.


31/67


31 | P a g e

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


32/67


32 | P a g e

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


33/67


33 | P a g e

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.


34/67


34 | P a g e

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.


35/67


35 | P a g e

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.


36/67


36 | P a g e

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


37/67


37 | P a g e

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


38/67


38 | P a g e

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.


39/67


39 | P a g e

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.


40/67


40 | P a g e

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


41/67


41 | P a g e

= 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



-0.96 0.22 -4.44 0.00

nareit 0.51 0.05 10.94 0.00



0.14 0.24 0.56 0.58

nareit 0.42 0.07 6.17 0.00



-0.46 0.95 -0.49 0.63

nareit 1.43 0.16 9.03 0.00


42/67


42 | P a g e

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


43/67


43 | P a g e

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

1

1.2

1.4

1.6

1.8

Ascendas India Trust

Price


44/67


44 | P a g e

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.


45/67


45 | P a g e

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

1

11/06/

2008

11/07/

2008

11/08/

2008

11/09/

2008

11/10/

2008

11/11/

2008

11/12/

2008

11/01/

2009

11/02/

2009

11/03/

2009

11/04/

2009

11/05/

2009

11/06/

2009

11/07/

2009

11/08/

2009

11/09/

2009

11/10/

2009

11/11/

2009

11/12/

2009

11/01/

2010

11/02/

2010

11/03/

2010

11/04/

2010

Indiabulls

Price


46/67


46 | P a g e

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


47/67


47 | P a g e

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)


48/67


48 | P a g e

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.


49/67


49 | P a g e

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

Documents

Capstone Project on REITS- Dhara Badiani KHR2009PGDMF012