What are Real Estate Investment Trusts and why do we need them badly in India?

Author: Sachin Gupta | Find me on Twitter Follow @sach_gupta

Recently, Securities and Exchange Board of India (SEBI) has put up Real Estate Investment Trusts (REIT) for public comments in order to draft the final set of guidelines.

So, what are REITs and what benefits can they provide to small investors with 2-3 Lacs of invest-able income? Can these investors invest small amounts in REITs? We explore here.

A real estate investment trust is basically a creation of the internal revenue code. It is a real estate company or trust that has elected to qualify under certain tax provisions to become a pass-through entity that distributes to its shareholders substantially all of its earnings in addition to any capital gains generated from the sale or disposition of its properties. Because the individual investor has the opportunity to pool his/her resources with those of persons of like interests, funds are assembled to permit purchase of buildings, shopping centers, and land in whatever proportion seems to offer the most attractive returns. Investments must be approved and management activities reviewed by a board of trustees who are accountable to shareholders and are ordinarily well qualified to make such decisions.


Following are the requirements to qualify as trust in countries where REITs are in existence for years:

Asset requirements:

1. At least 75% of the value of a REIT’s assets must consist of real estate assets, cash, and government securities.
2. Not more than 5% of the value of the assets may consist of the securities of any one issuer if the securities are not includable under the 75% test.
3. A REIT may not hold more than 10% of the outstanding voting securities of any one issuer if those securities are not includable under the 75% test.
4. Not more than 20% of its assets can consist of stocks in taxable REIT subsidiaries.

Income requirements:

1. At least 95% of the entity’s gross income must be derived from dividends, interest, rents, or gains from the sale of certain assets.
2. Minimum of 75% of gross income must be generated from rents, interest on obligations secured by mortgages, gains from the sale of certain assets, or income attributable to investments in other REITs.

Distribution requirements:

1. Minimum of 90% of REIT taxable income must be distributed to shareholders.

Stock and ownership requirements:

1. Be taxable as a corporation
2. Board of directors or trustees should manage the REIT
3. Fully transferable shares
4. REIT shares must be transferable and must be held by a minimum of 100 persons

REITs that are not listed on an exchange or traded over the counter are generally called private REITs.



Various types of REITs:

Industrial/Office: 
These REITs are further subdivided into those that own industrial, office, or a mix of office and industrial properties. Some analysts further segregate these REITs by property location (i.e., whether they are in CBD or suburban locations). For example, if REITs were to become reality in India, the REIT with focus on Office Space in Gurgaon can result in attractive returns for investors.

Retail:
These REITs are further subdivided into those that own strip centers, regional malls, outlet centers, and free standing retail properties.

Residential: 
These REITs are further subdivided into those that own multifamily apartments and manufactured home communities. Some analysts further segregate those REITs that own student and military housing.

Diversified: 
REITs that own a variety of property types.

Lodging/resorts: 
REITs that primarily own hotels, motels, and resorts.

Health care: 
These REITs specialize in owning hospitals and related health care facilities that are leased back to private health care providers who operate such facilities.

Self storage: 
These REITs specialize in ownership of self storage facilities.

Specialty: 
These REITs specialize in numerous types of properties, including prisons, theaters, golf courses, cellular towers, and timberland. Specialty REITs have been a rapidly evolving segment of the industry.

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