All About REITs and their Relevance
The Securities and Exchange Board of India (SEBI)
recently announced guidelines for the creation of real estate investment trusts
(REITs) in India.
Just as mutual funds do with equity and debt, REITs will
pool money from investors and invest them in income-generating (rental assets)
offering them a way to diversify their portfolios by investing in property.
After collecting money, REITs will issue units to
investors, which will then be listed on exchange for buying and selling.
This will help establish a new asset class, and being a
quasi debt-equity instrument, be attractive for risk-averse investors get the
twin benefits of yield as well as capital appreciation, an ICICI Securities
report says.
For developers, it would “improve property market
transparency, smoothen volatile property cycles, and potentially lower the cost
of capital.”
Here are excerpts from the report, which terms the
introduction of REITs as a “potential game-changer for real estate in India”.
Key benefits
- Portfolio diversification : For small investors and institutions, REITs provide an opportunity to invest in large scale commercial real estate, which would have otherwise been only possible for HNIs and wealthy individuals.
A compulsory dividend payout (typically >80% globally
and >90% in India) makes the underlying asset similar to a bond, with a
growth component built-in through price appreciation.
- Liquidity and cost of capital benefits: REITs are mandated to provide recurring dividends, and most REIT legislations globally also put a cap on gearing (debt-to-asset) ratios, which reduces the risk perception associated with the asset class.
Further, tax
concessions ensure that dividend payouts are healthy and less impacted by
changes in central tax laws.
- Improved transparency and less volatile markets: REITs improve transparency in the real estate markets as information is periodically disclosed on average rents, occupancy levels, tenant profile, renewal profile, etc. Availability of such information reduces information asymmetry, which is typically seen in real estate markets and is a key reason for volatility.
Nature
of instrument
Due to the underlying cash flow stability (recurring
annual rental income) of the asset, and predictability of dividends (compulsory
distribution), REITs are commonly viewed as an yield instrument. They typically
tend to have a high correlation to bond yields. Thus, in a softening interest
rate environment, cap rates will fall (assuming spreads remain same).
In most cases, REITs trade at a positive spread over bond
yields to account for market risks and individual property risks such as local
market demand-supply, vacancies, tenancy risk, gearing risk, etc.
A commonly used valuation metric in the commercial asset
class is cap rate or capitalization rate. It is defined as net operating income
(rent minus expenses) produced by an asset divided by the market value of the
asset.
Cap rates used in valuing properties are impacted by bond
yields (cost of capital), and the expectation of rent reversion defined as
growth or de-growth in rent due to changes in the physical property market.
How i-REITs compare
The key basic Indian REIT structure is broadly in line
with REIT legislations in Asia, especially on limits on gearing (currently set
at 50 percent), payouts (90 percent), and investment in real estate (80
percent).
Only developed REIT markets (US, Australia, etc.) have
significantly higher freedom in gearing requirements (no gearing limits). While
investments in foreign assets are not allowed, we believe it is largely
irrelevant as long as there is a ready availability of REIT’able domestic
assets.
The key aspect that remains to be resolved is tax
transparency, which is out of SEBI’s ambit and needs to be addressed by the
Union Finance Ministry.
Macros, micros
aligning for i-REITs
Consensus expectation is that bond yields in India are
expected to decline in the next 12 months, and unlikely to spike unless driven
by global market conditions.
The office sector
appears to be a silver lining for real estate developers given its declining
vacancy levels and improving rents. Softening yields and increasing exit
options (such as CMBS, potential REITs) are likely to positively impact cap
rates and improve asset valuations.
Large developers in India such as DLF continue to be
burdened with debt in their balance sheet and a weak cash flow generation
profile, which is likely to make them closely pursue equity options (including
REIT).
As residential markets remain sluggish due to inventory
overhang, and weak sales, REIT listings can offer a potentially attractive exit
option to such developers to improve their balance sheets.
Source: Moneycontrol.com
No comments:
Post a Comment