SEBI (REIT) Regulations
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This article is written by Kumar Rajiv Ranjan, pursuing Diploma in General Corporate Practice: Transactions, Governance and Disputes from Lawsikho. The article has been edited by Tanmaya Sharma (Associate, LawSikho), Ruchika Mohapatra (Associate, LawSikho) and Indrasish Majumder (Intern at LawSikho).

This article has been published by Abanti Bose.

Introduction

InvITs and REITs, new asset class investments available for the public at large, was recently in news as on July 30 2021, as the market regulator- Securities and Exchange Board of India( SEBI) reduced the minimum applicable values of REITs and InvITs and a revised trading lot to one unit for these new emerging instrumentalities for investments with a view to making them more attractive for the retail investors. The minimum application value for retail investors of REITs and InvITs was reduced by SEBI to the range of Rs 10000-15000, from the existing Rs 50000 for REITs and Rs 1.0 Lakh for InvITs, at the time of listing with a revised minimum trading lot of one unit. The move was aimed at enhancing the liquidity of the asset class as well as providing more depth to the market. The move, as was expected, met with a positive response from the retail investors.

Defining InvITs

InvITs [Infrastructure Investment Trusts], as stated above,  are new investment instrumentalities for retail investors and are more like mutual funds. It enables direct investment of small amounts of money from possible individual/institutional investors in the infrastructure sector to earn some small income as a return which is more attractive than Fixed Deposits (FDs) in Banks or Term Deposits (TDs) in Post Office. An almost identical instrumentality for investment in Real Estate Investment Trusts [REITs] which is for investment by retail investors in the real estate sector exclusively while InvITs may be considered as a slightly modified version of REITs that are designed to suit the specific requirements and circumstances of the infrastructure sector. The two instrumentalities are almost identical with the mutual funds in structure.

Functioning of InvITs

In order to form an InvIT, an infrastructural development company has to jump into the shoes of sponsors and shall be required to appoint trustees. Once the trustees are appointed and trust is formed, the assets are now taken over by the trust and directly controlled by the trustees. Another option is also available if InvIT decides to control the infrastructure assets indirectly through a Special Purpose Vehicle (SPV). In such cases, the SPV directly controls the infrastructure assets on behalf of the trust but the InvIT is required to essentially maintain at least a 50% stake in such an SPV.

For a more clear understanding of the functioning of InvITs, let us presume that we have an infrastructure company by the name M/s ABC Limited. Its core competence lies in erecting Washeries and coal evacuation Projects on a BOT [build-operate-transfer] basis in the primary energy sector based on coal combustion technologies. This signifies that M/s ABC Limited shall construct Washeries and coal evacuation projects like SILO, operate it for a fixed term on a lease agreement [ normally thirty years] and upon completion of its tenure, the infrastructure created shall be finally handed over to the Public Sector giant in Coal mining, Coal India Limited i.e. CIL.

Now, let us further presume that our company has received fresh orders for constructing 7 Washeries, 4 CHPs [Coal Handling Plants] and 2 SILOs for mechanized coal evacuation for which it needs money. Now this money will have to be raised for which the Company may go for selling shares (equity), taking a loan from the bank (debt) or borrowing by issuing fixed income instruments like debentures and fixed deposits. At the same time, under the new InvIT Regulation 2014, the company can go for another option i.e. InvITs [for coal mining and evacuation Projects].

Let us further presume that presently our company i.e. M/s ABC Limited is operating 6 washeries, 3 SILOS and 2 CHPs on a lease basis out of which 5 Washeries and 3 SILOs are having cash flow. By combining 3 Washeries and 2 SILOS operating in Orissa and Chhattisgarh, it can form its first InvIT [CG/Orissa]. For the remaining 2 Washeries and 1 (One) SILO operating in Jharkhand, it can form another InvIT [Jharkhand].

Once the trusts are constituted, the next stage is the appointment of Managers. For regulating InvITs, two types of Managers are required- one being Investment Manager and the other being Project Manager. While the Investment Manager is primarily responsible for ensuring that optimal returns are generated by existing investments of the trust, the day to day administration has to be monitored by the Project Manager and he shall also be responsible for under-construction infrastructure projects.

Once the managers are appointed, InvITs shall be required to be registered. The trusts so constituted can thereafter go for their initial public offers (IPO) or may also come up with non-convertible debentures [NCD] as is happening with most of the InvITs.

With the money so generated, it can thereafter buy more operational assets from the Company or other infrastructure companies and can also go for constructing new washeries, SILOs and CHPs as per the orders received for its operations on a BOT basis which would also comply with the mandatory requirement of 80% investment in revenue-generating infrastructure assets as Washeries, SILOs and CHPs are accepted infrastructure assets by Central Government authorities as high revenue-generating infrastructure assets.

Difference between InvIT and REIT

Real Estate Investment Trusts [REITs] is an investment vehicle that owns and manages investment grade and income-producing real estates properties such as investments in offices, malls, industrial parks, warehouses, hospitality sector, health care centres and almost any assets that can produce an annuity revenue stream. On the other hand, InvITs are designed to pool small sums of money from a number of investors to invest in assets that give cash flow over a period of time and here the investment is made in infrastructure projects such as roads or highways, energy sectors etc which take some time to generate cash flow.

Both are hybrid between equity and debt investment and have features of both equity and debt. While the operating business model helps provide stable, predictable and relatively low-risk cash flow like debt, there is growth potential like equity as well as the returns are not fixed with a scope of change of unit price.

In the eyes of financial experts, however, REITs are considered as a better investment option as compared to InvITs for the following reasons:

  • More stable return in REITs as they provide more stable income and certain yields as most of the REITs assets are invested in income-generating properties that have long term rental contracts. On the other hand, InvITs cash flows are less certain as they are dependent on a number of factors that affect their daily capacity utilization and scalability of tariffs.
  • Superior insulation from Regulatory/Political Risks in REITS as they hold land and buildings on a freehold basis or on lease from a government authority. On the other hand, concessions to InvITs on infrastructure projects are more prone to regulatory changes and political interference.
  • Greater visibility and growth in the case of REITs can be seen and also achieved through the redevelopment of existing assets, new instructions and acquisition of completed/leased assets while in the case of InvITs, growth depends on the successful acquisition of concession assets through a bidding process which is less visible.
  • Higher terminal value and property ownership in the case of REITS as its underlying assets see growth in value over a period of time. REITs also own the property leased out whose value grows over a period of time like all real estate properties. On the other hand, InvITs comprise concessions where the projects are returned to the authority or are rebid post the concession period.
  • Better liquidity and superior accessibility for REITs as it is more accessible to small investors and it has higher liquidity due to lower unit price and trading lot. InvITs had bigger trading lot sizes and, therefore, relatively weaker liquidity. This deficiency of InvIT has been attempted to be addressed by July 30 2021 notification. Earlier also in 2019, SEBI had reduced the minimum subscription limit for REITs to Rs 50000 from Rs 2.0 Lakh while for InvITs, it was reduced to Rs 1 Lakh from the earlier cap of Rs 10 Lakh.

Regulating InvIT

SEBI (Infrastructure Investment Trusts) Regulation  2014 or, in short, InvIT Regulation 2014 was notified by SEBI on September 26 2014 thereby prescribing the modalities for registration and regulation of InvITs in India. As per the aforesaid provisions, regulating InvITs consists of four constituents:

  1. Trustees,
  2. Sponsors,
  3. Investment Managers,
  4. Project Managers.

The role of trustees is to inspect the performance of an InvIT and they are certified by SEBI with a rider that they cannot be an associate of the Sponsors or Managers.

Sponsors are the Promoters of InvITs and they refer to any organization or a corporate entity having a capital of Rs 100 Crores that establishes the InvIT and are designated as such at the time of the application made to SEBI but for PPP projects, they are designated as the base developers.

Promoters/sponsors are also jointly required to hold a minimum of 25% of the holding in InvITs for a minimum period of three years excluding the situations wherein the administrative requirements or concession agreements mandate the sponsors to hold some minimum percentage in the special purpose vehicle (SPV). In such cases, the total value of the sponsors holding in the primary SPV and the InvITs should not be less than twenty-five per cent (25%) of the value of the InvIT on a post-issue basis.

The third class of regulating authorities is the Investment Managers and they are normally a corporate entity or Limited Liability Partnership (LLP) or organization that supervises assets and the investments of the InvIT and guarantees activities of the InvIT.

The fourth class is that of the Project Managers which refers to the person or persons who are responsible for attaining execution of the Project and PPP Projects. They are responsible for such execution and accomplishment of project landmarks with respect to the agreement and/or other relevant project documents.

The advantage of REITs and InvITs is that they are now innovating financial investment tools as they allow, on one hand, the developers to monetize revenue-generating real estate and infrastructure assets and at the same time, it allows investors and unitholders to safely invest in these assets without actually owning them with prospects for having a better return on investment than a normal fixed deposit or term deposit.

Such monetization also benefits the developers by allowing them to release capital for funding new infrastructure/real estate projects and at the same time, it allows liquidity to investors and unitholders as the units of the trust are listed on the exchange. Apart from these, REITs and InvITs also enjoy favourable tax benefits including exemptions from dividend distribution tax and relaxation of capital gains tax.

Salient features of InvIT Regulations, 2014

1. A tiered structure with sponsors setting up the InvIT which in turn invests into the eligible infrastructure projects either directly or via SPVs.

2. Low Risks: It has been designed to mitigate the under construction risks in the infrastructure sector with a  prescribed requirement that 80% of the investment must be made in the completed and revenue-generating projects. InvITs cannot invest more than 10% of their assets in under-construction projects which greatly reduces the biggest risks associated with an investment in the infrastructure sector, that of delay in completion of the Projects due to factors like delay in regulatory approval, financial closure etc.

3. InvITs aim at ensuring steady and predictable cash flows with a mandatory distribution of 90% of net distributable cash flow to the unit investors.

4. Regulated leverage limits by SEBI: Leverage cap of 70% on the net asset value and a cap on exposure to assets under construction( for publicly placed InvITs)

5. A requirement for the sponsors to hold a minimum of 15% of the units issued by the InvITs with a locking period of three years from the date of issuance which enhances security further.

6. Assets under InvITs have long term contracts that aim at providing a steady cash flow over the long term like 15 to 20 years depending on the underlying assets.

7. InvITs also provide an opportunity to grow by adding more operating projects and increasing the yield.

8. Better liquidity. Public InvIT units can be listed and traded on stock exchanges like other equity stocks. The most recent SEBI move to reduce market trading to one unit shall further enhance the liquidity for listed InvITs and is expected to result in efficient price discovery.

9. Robust corporate governance: Regulatory requirements like management of InvITs by independent trustees, investment managers and project managers, half-yearly valuation by independent valuers, strong minority investor rights, mandatory rating requirements, stringent disclosure policies, tighter caps on leverage etc are all aimed at robust corporate governance in InvITs. Efficient corporate governance further requires that 50% of the Board members of InvITs must be independent directors.

10. Efficient tax structure: InvITs enjoy a concessional long term capital gains tax rate like in equity if the units are held for over three years and sold via the stock exchange which is one of the attractive features of InvITs.

Some associated risks with InvITs

Being new investment instrumentality, there are always some associated risks and a few of them are enlisted below:

  • Operational risks: Certain degrees of uncertainties like delay in completion due to delayed clearance by Regulatory Authorities etc are always associated with infrastructural projects and so force majeure risks are always associated with InvITs which affects the availability of underlying infrastructure projects and a resultant adverse impact on revenues. Other risks include delays in collection, ad hoc expenses, tariff risks etc.

Operational risks, however, can be mitigated to some extent through reliable payment security mechanisms, insurance covers etc and investors should seek stable underlying assets with a good quality management team to circumvent the risks.

  • Refinancing risks: The predominant constituent of finances for infrastructure projects is debt. This envisages large bullet repayments and fluctuating interest rates which create refinancing risks even for AAA-rated infrastructure projects. So investors are required to tread with caution while going for long term infrastructure assets even with a superior credit rating as a situation of low demand and price-related risks may emerge in future.
  • Regulatory risks: In our country, infrastructure is a highly regulated sector and now InvITs have been introduced which is in a nascent stage still today and the regulations are also evolving. Hence, many unforeseen regulatory risks are involved with InvITs.
  • Return risks: Under the new module, public invITs are traded on a stock exchange like equity stock and, therefore, the unit price may vary and fluctuate resulting in capital gains at times but also capital loss sometimes. At the same time, the cash flow of the trusts is dependent on the underlying business. Hence, the income from the underlying assets and, therefore, InvITS is variable and may be lower than expected in some years.

Investment in InvITs still an attractive proposition : the reasons behind

Despite being a new instrumentality of investment, from the stakeholders’ point of view also, InvITs are still highly attractive  investment prepositions because of following reasons:

  • For developers, it provides an opportunity to monetize operational assets to free up capital and develop new assets.
  • For lenders, it provides an opportunity to diversify their operational lending funds to better quality infrastructure assets with higher ratings.
  • For investors, it is an attractive proposition to earn stable and predictable safe returns from a portfolio of operational assets. It is an attractive investment option for anyone and everyone investing in the capital market and looking for combining stable distribution and wealth.
  • For the government, such monetization allows creating room for further infrastructure development.

In fact, in just about three years since its introduction in 2018, infrastructure built up through InvITs and REITs have now crossed a whopping Rs 2 Lakh Crores today which can be considered as a stupendous success.

Conclusion

InvITs today are considered as a significant development tool as they help developers to recycle capital locked in long term infrastructure projects like roads, transmission lines on renewable assets etc and at the same time, it ensures a fair return on investments for the small investors who are increasingly getting worried due to constantly falling rates of FDs or TDs with taxation liabilities as well. It also enables the developers to raise long term debts through refinancing and by tapping a whole new set of investor classes like pension funds, insurance companies etc. A CRISIL rating analysis had shown that InvITs and REITs combined together do have the potential to raise around Rs 8 lakh crores of capital for India’s infrastructure build-up of over Rs 2 lakh crores now.

Today, 15 SEBI-registered InvITs and REITs are operating in India and credit ratings on ten of these have shown the highest credit ratings of AAA. First, two publicly listed InvITs were India Grid Trust and IRB InvIT Fund. Even the Insurance Regulatory and Development Authority of India(IRDAI) has allowed insurers to invest in debt securities issued by InvITs and REITs which is expected to improve the overall yield of the portfolios held by the firms which, in turn, is expected to provide more long term funding to the real sector. To further safeguard the investment, IRDAI has prescribed that insurers cannot invest in debt instruments of InvITs and REITs which are rated below AA as part of the approved investments. According to IRDAI, 75% of the insurers’ investments have to be made in AAA-rated assets and only 25% of the assets can go to instruments rated AA or even A. Thus, a conscious attempt has been made by the Regulatory Authority to safeguard the investment.

In a growing economy like India, mega-investment is required in developing infrastructure projects like roads, highways, transportation sector, electricity generation and distribution. Traditionally, these sectors were dependent on funding by government projects or by large corporations with no direct investments from the general public. Now, through InvITs and REITs, a new vista for people at large has been opened for investment.

So a new beginning has dawned in the infrastructure development and investment sector but we all have miles to go. In the current scenario where the interest rates for secured investments like Fixed Deposits(FDs), Term Deposits(TDs) are very low, conservative investors like common Indians are always looking to explore the alternative investment options for better returns and capital appreciation without compromising on fund securities and embracing high risks and for such mindsets, both InvITs and REITs are much better and safer investment options. But as they are very new investment options, it shall require some time for investors to embrace them with open arms until the market matures.

References

  1. The Economics Times- Prime Issue
  2. CRISIL on REITs and InvITs
  3. Blog on chittorgarh.com on “What is the difference between REITs and InvITs”.
  4. (Infrastructure Investment Trusts) Regulation 2014[amended up to July’21].
  5. “What are InvITs?”-An article by Swaraj Singh Dhanjal in Livemint.
  6. “What are InvITs….”- An article by Harsh Shah in Forbes Advisor.
  7. “What is an InvIT?” –by Larissa Fernando in Morningstar.
  8. “All you need to know about invIT…”Money Management in etmoney.com

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