Evolution of REIT in India: From Inception to Current Trends

In India, the real estate industry not only ranks as the second-largest source of employment but is also expected to account for 13% of GDP by 2025, as per CBRE estimates. Despite its importance, the shortage of public funding and ongoing need for fresh capital investment are serious concerns. Consequently, exploring alternative sources of funding for these critical sectors has become essential.

What is REIT?

A real estate investment trust (REIT) is a company that owns, operates, or finances income-generating properties. Similar to mutual funds, REITs pool capital from multiple investors. It enables the investors to receive dividends from real estate investments without directly purchasing, managing, or financing properties themselves.

An REIT is established by a sponsor that initially owns real estate assets. These assets are transferred from a special-purpose vehicle (SPV) to the REIT in exchange for units of the trust. The sponsor is required to retain a certain number of these units. The rest of the REIT units are offered to the public through an initial public offering (IPO); the proceeds from this offering go to the sponsor in exchange for their units in the REIT.

The tenants of the properties owned by the REIT pay rent to the SPV that manage these assets. After deducting statutory dues and taxes, the rental income is passed to the REIT. The REIT then distributes the net distributable cash flows as dividends to its unit holders. This structure provides investors with means to invest in commercial real estate markets, offering a steady stream of rental income.

Types of Real Estate Investment Trusts

REITs come in several forms but primarily fall into three categories, each with its unique focus and investment strategy.

Each type of REIT offers a different risk return profile, catering to the diverse preferences of investors looking to get exposure to the real estate sector.

Evolution

REITs started in the US in 1960, letting small investors join real estate investments for income. This innovative approach to real estate investment flourished since and has been adopted globally, inspiring similar frameworks in approximately 40 countries worldwide. Over the last three decades, the number of listed REITs grew from 120 across two countries in 1992 to 893 across more than 40 countries and regions in 2022. This growth underscores the increasing recognition and adoption of REITs as a viable investment vehicle on the international stage.

Asia increasingly embraced the REIT model. From having 31 REITs across six countries and regions in 2005, it rose to 223 REITs in 11 countries and regions by 2022. This frantic growth demonstrates the increasing demand for real estate investment structures that combine simplicity and liquidity for investors. India joined the REIT model when the first-ever REIT in the nation, Embassy Office Parks, was launched in March 2019. Since then, the country has had another three live REITs: Embassy Office Parks REIT, Mindspace Business Parks REIT, Brookfield India Real Estate Trust, and Nexus Select Trust. However, the movement in the nation’s REIT market is just getting started. Although the REIT market has grown robustly over the past year, the REIT model still represents only 13.7 per cent (Rs29,272 crore) of the total listed real estate in India – in comparison with 98.9 per cent in the US and 94.8 per cent in Australia. The potential of the Indian REIT model market remains vastly untapped.

Source: Indian REIT Association

Together, these entities have a considerable gross asset under management (AUM) of US$ 15.6 billion (Rs. 1.3 lakh crore), a combined market capitalisation of over US$ 9.6 billion (Rs. 80,000 crore) and a portfolio surpassing 112 million square feet (msf) of Grade A commercial and retail spaces across the nation, as of September 30, 2023.

Source: Indian REIT Association

The gross asset value (GAV) of REITs have increased threefold since the inception of REIT, expanding at a CAGR of ~36%. The impact of REITs in India has been noticeable, with cumulative distributions exceeding Rs. 14,300 crore (US$ 1.7 billion) since 2019. This amount has surpassed the combined dividends distributed by real estate companies that make up the entire Nifty Realty Index, as of September 2023.

Source: Indian REIT Association

Impact of REITs on India's Real Estate Sector

REITs have the potential to impact the real estate sector in India in several ways:

Source: Indian REIT Association

Overall, REITs have the potential to transform the Indian real estate sector by providing liquidity, improving transparency, and stimulating development activity. However, its success depends on factors such as regulatory support, investor awareness and the overall performance of the real estate market.

Micro, Small and Medium REITs

SEBI introduced a new category of REITs, termed small and medium REITs (SM REITs). These are characterised by a minimum asset value requirement of US$ 6 million (Rs. 50 crore), a substantial reduction from the previous threshold of US$ 59.9 million (Rs. 500 crore) for traditional REITs. This move will make real estate investment available to more people, levelling the playing field.

Under the revised regulations, SM REITs are granted the flexibility to establish separate schemes for holding real estate assets through SPVs, a structure that is anticipated to streamline operations and enhance the security and attractiveness of these investments. This regulatory adjustment is a strategic effort to solidify the sector's foundation, boost investor confidence and resolve the complexities associated with SPV securities.

The introduction of SM REITs is anticipated to have a transformative impact on the prop-tech platform domain, enabling entities, such as hBits, Strata, PropertyShare and Altgraf, to transition into the SM REIT structure, provided they satisfy SEBI’s 'fit and proper' criterion. This regulatory shift is designed to promote investor participation in real estate as an asset class, thereby increasing market liquidity and opening new avenues for growth and investment in the sector.

By lowering the minimum asset value for REITs, SEBI is effectively widening the real estate investment field, allowing small scale projects and investors to reap the benefits of REITs. This strategy not only addresses the changing demands of the market but also corresponds to the worldwide trend of fostering greater inclusivity and diversity in real estate investment.

Path Forward

The outlook for REITs in India appears highly promising. According to ICRA, a leading rating agency, the market for REIT-ready office supply is poised for exponential growth, with the potential to expand the office REIT market size by a remarkable 6.0–6.5 times. This forecast is based on the significant increase observed over the past five years, where the REIT office supply in the top seven cities of India surged 3.3 times, reaching approximately 82 msf.

Source: Indian REIT Association

According to ICRA, as of September 30, 2023, the total office space ready for REITs is estimated to be approximately 510 msf, representing 53% of the total Grade A office supply. This substantial portion of the market is valued at US$ 69.5–74.3 billion (Rs. 5.8–6.2 lakh crore), considering a capitalisation rate (cap rate) of 8.0–8.5%. This valuation underlines the vast potential that the Indian REIT market holds for growth and investment.

Geographically, Bengaluru emerges as a dominant player, contributing 31% to the REIT-ready office supply, followed closely by the Mumbai Metropolitan Region (MMR) and Hyderabad, which account for 16% and 15% of the supply, respectively. This distribution emphasises the strategic importance of these cities as central hubs for the development and expansion of the REIT market in India.

Source: Indian REIT Association

In conclusion, the expansion of the REIT market represents a great opportunity for investors, developers and property managers. More than anything, it represents a move to more organized and available real estate investing and a well-arranged mechanism for income generation and asset appreciation. Furthermore, such a path is expected to attract even more attention from international investors, further increasing liquidity and driving the development of the real estate market. The role of the further evolution of the REIT structure, through changes in law and market requirements, is extremely important in the way of realising this potential.