REITs and InvITs could drive the future of Indian infrastructure

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].

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.