5 minute read 21 Sep 2021
REITs/InvITs in India

REITs and InvITs could drive the future of Indian infrastructure

Authors
Gaurav Karnik

EY India Real Estate National Leader and Tax Partner

Advising real estate private equity funds and developers on acquisitions and asset monetization.

Sandip Khetan

EY India Financial Accounting Advisory Services Leader

Keynote speaker. Seasoned accountant. Experienced GAAP consultant.

5 minute read 21 Sep 2021

EY report on the rising emergence of REITs/InvITs and the tremendous growth opportunity.

The role of REITs and InvITs in driving the future of Indian infrastructure

The current Indian economy has a sizeable dependence on infrastructure as a vehicle of growth. Infrastructure-based sectors such as roads, highways, and ports, along with the power and real estate sectors have witnessed growing demand for capital in recent times. As a result, Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs) have attained importance in furthering the economy’s infrastructure needs.

REITs and InvITs are conceptually like mutual funds, where a sponsor raises capital and invests them in infrastructure or real estate projects. Investors receive periodic pay-outs of a minimum of 90% of net distributable cash flows (NDCF). However, unlike mutual funds, they also have characteristics of a business enterprise. While REITs and InvITs raise debt through a trustee and an investment manager, they are also actively involved in projects to maximize returns to shareholders.

REIT/InvIT present attractive investment opportunities

The Government of India (the Government or GoI) launched InvITs and REITs to bring in long term yield capital into the country and to increase private participation in infrastructure and real estate.

The Government’s National Infrastructure Pipeline estimates funding requirement of over US$1.4 trillion by 2025. REITs and InvITs have raised capital of over US$4 billion in India and the combined market-cap of the three listed REITs in India is over US$7 billion and over US$10 billion for InvITs. Thus, the early trends of performance of REITs and InvITs are encouraging.

Investment of private sector of US$325 billion in infrastructure would be necessary to meet the National Infrastructure Pipeline’s estimate. In order to allow for capital recycling and further investments under PPP modes, InvITs play a key role in monetization of existing projects in some of these sectors (with conducive regulatory frameworks, cash flow profile, taxation advantage).

The real estate sector in India is expected to reach a market size of US$1 trillion by 2030[1]. Despite the near to medium term headwinds from COVID-19, long term drivers for real estate demand are strong and likely to withstand current adversities. The REIT/InvIT route could potentially mitigate several investment challenges in the infrastructure sector. For example, when REIT/InvIT help developers release their invested equity and deployed capital in new projects they could enable the challenge of projects with high CapEx demands. Similarly, the self-amortizing nature of units provide convenient exit options to investors, thereby overcoming challenges which investors typically face with limited options.

Besides the obvious advantages, REITs and InvITs enable efficient upstreaming of cash owing certain regulations and the Government’s beneficial tax regime. In India, REITs and InvITs have also successfully tapped into global capital and infrastructure assets.

REITs have become an attractive investment opportunity overseas, delivering high yields through steady distributions and long-term capital appreciation, while offering liquidity and an alternate funding mechanism. Additionally, real estate, having low correlation with other asset classes, qualifies as a meritorious portfolio diversifier. FY2020 saw public listing of 16 REITs having total market capitalization of US$7.6 billion, marking India’s debut REIT (currently trading at over US$4.5 billion)[2].

InvITS and REITs will play a significant role in funding the Government’s infrastructure plans as well assist in meeting its asset monetization plans and at the same time enable deleveraging existing balance sheets which would in turn help meet the capitalization requirements of banks.
Gaurav Karnik
EY India Real Estate National Leader and Tax Partner

Infrastructure Investment Trusts could be set up for sectors defined under Infrastructure definition as per RBI guidelines. Till date, developers engaged in road, power transmission (including gas pipelines) and tower transmission have formed InvIT. Sectors with favorable outlook in the following is likely to witness more participation from InvITs in ensuing years.

REITs and InvITs are subject to mandatory regulations

REITs and InvITs are primarily governed by SEBI regulations. While InvITs can be public listed, private listed or private unlisted, REITs are required to be publicly listed. There are various parties involved in a REITs and InvITs such as a sponsor, trustee, and investment manager. Distributions by REITs and InvITs are based on NDCF, unlike companies where dividends are based on profits. These distributions are declared and made at least once every six months for publicly offered REITs and InvITs and once a year for privately placed InvITs.

A REIT/InvIT is established as a trust settled by the sponsor under the Indian Trusts Act, 1882 and the trust deed registered in India under the provisions of the Registration Act, 1908. Further, a Certificate of Registration as REITs and InvITs needs to be obtained from SEBI. 

Accounting for REIT/InvITs can be complex with multiple legal entities being involved and the interplay of various regulations. Having the relevant structure in place early and evaluating the relevant tax, accounting and other implications would allow sponsor(s) to make the most of this increasingly popular route to funding.
Sandip K. Khetan
EY India Financial Accounting Advisory Services Leader

Under SEBI regulations, REITs and InvITs should present three years of audited combined financial information under Ind AS.  REITs and InvITs face many practical challenges that arise during acquisitions including consolidating auditors, GAAP conversion (from Indian GAAP to Ind AS) and uniform accounting policies. In addition, there are other complex areas related to asset acquisitions, business combinations, classification of unit capital and appropriate accounting for distributions. Distributions by REIT/ InvIT are based on the Net Distributable Cash Flows (NDCF) unlike companies where the dividends are paid based on profits. REITs and InvITs have to follow several guidelines related to meetings of unitholders, related party transactions, valuations and audits.

REITs and InvITs can raise funds by way of Initial Public Offering (IPO), Private Placement (PP), preferential allotment, qualified institutional placement, rights issue, bonus issue, offer for sale. All types of fundraising are subject to various mandatory regulations.

Tax implications for REITs and InvITs

From a tax perspective, REITs and InvITs are pass-through vehicles under income tax rules and income (in the form of dividends and interest from underlying assets) is fully exempt. The distributions made by investment trusts are taxed directly in the hands of investors depending on the nature of such distributions (dividend, interest or capital repayment). REITs and InvITs have different income tax implications for sponsor, unitholders and the REIT or InvIT, at various stages.

Fueling the future of infrastructure with REITs and InvITs

The Government, SEBI and other regulators have played a proactive role in popularizing and promoting REITs and InvITs in India. Sponsors/management have an important role in establishing high standards of corporate governance which is a pre-requisite for any investment. By adopting consistency in financial reporting and by providing better transparency (benchmarking) and understandability for overseas investors REITs and InvITs could build the base for long-term success. We look forward to a new era of growth fueled by capital investment in REITs and InvITs.

Summary

REITs and InvITs are conceptually like mutual funds, where a sponsor raises capital and invests them in infrastructure or real estate projects. With the Indian economy’s sizeable dependence on infrastructure, they have attained importance in furthering its infrastructure needs. The Government, SEBI and other regulators have played a proactive role in popularizing and promoting REITs and InvITs in India. We look forward to a new era of growth fueled by capital investment in REITs and InvITs.

About this article

Authors
Gaurav Karnik

EY India Real Estate National Leader and Tax Partner

Advising real estate private equity funds and developers on acquisitions and asset monetization.

Sandip Khetan

EY India Financial Accounting Advisory Services Leader

Keynote speaker. Seasoned accountant. Experienced GAAP consultant.