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This article is written by Utkarsh, pursuing a Certificate Course in Real Estate Laws from LawSikho.

Introduction

The real estate sector all over the world has generated a revenue of $31678B in 2021 and is ranked amongst the top 3 global industries by revenue according to an analysis of global industries based on their revenue by IBISWorld. In India, at present, the real estate sector contributes 6-7% to the country’s GDP and according to a report by IBEF on the real estate industry in India, this contribution is expected to increase to 13% by the year 2025. In 2017, the real estate sector in India had a market size of US$120B, and according to this report by IBEF, it is expected to further increase to US$1 trillion by 2030. This implies that there is prodigious growth potential in the Indian real estate sector and hence it becomes a notable opportunity for investment. 

Generally, there are two ways to invest in real estate, first one is the traditional way wherein a person directly purchases a property and then yields returns either in the form of rent or sells it at a higher price for profit. However, this form of investment could become cumbersome as it involves going through a lot of hassles like getting clearances, maintenance, unviable tenants, etc. The other way to invest in real estate is by investing in equity stocks of listed real estate companies like Godrej Properties, DLF, etc. But this form of investment is prone to market risk and is highly volatile. Besides these conventional ways, there is a new-fangled approach of investing in real estate known as Real Estate Investment Funds (REITs) labelled as real estate securities. In this article, we will be discussing these real estate securities with a focus on regulations governing them in India.

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What are real estate securities?

Real estate securities mean fungible and tradable financial instruments related to the real estate sector and include investments in the form of residential/commercial properties, mortgages, or interests from a real estate property, stocks, or real estate companies, etc. 

In India, real estate securities are available in the following forms –

1. Real Estate Funds or Real Estate Mutual Funds (REMFs)

These funds invest in actual property and payout returns to the investors in the form of profits earned from property rentals and from the sale of a property.  Apart from this, they may also invest in bonds/instruments secured by the property, and the annual interest earned on such investment is shared among the investors. Kotak Realty Fund, HDFC Property Fund, IL&FS Realty Fund were some of the initial real estate funds in India prior to SEBI’s involvement in real estate-related investments.

2. Real Estate Investment Trusts (REITs)

These are investment trusts that follow a model like that of mutual funds, but unlike real estate mutual funds that invest in real estate assets as well as real estate companies’ stocks, REITs are limited to investing in real estate assets only by owning and operating revenue-generating real estate properties. REITs are readily available to trade on major stock exchanges and at present, in India, there are only three REITs available – Brookfield India REIT, Mindspace Business Parks REIT, and Embassy Office Parks REIT.

Regulations for real estate mutual funds (REMFs) in India 

India’s securities market regulator Securities and Exchange Board of India (SEBI) governs the mutual funds in India via its regulations laid down under the ‘SEBI (Mutual Funds) Regulations, 1996’. On April 16th, 2008, SEBI notified amendments in these regulations via SEBI (Mutual Funds) (Amendment) Regulations 2008 and allowed mutual funds to establish real estate mutual funds. This amendment inserted a new chapter in the existing regulations, called “CHAPTER VIA REAL ESTATE MUTUAL FUND SCHEMES” that laid down guidelines regulating such schemes.

Based on these guidelines, mutual fund schemes focused specifically on the real estate sector could now be set up in India by allowing such schemes under Regulation 49E to invest in equity shares/bonds/debentures of companies involved in the real estate sector, securities backed by mortgages, and securities of similar investments and Indian real estate excluding real estate assets in the form of under-construction properties or vacant lands as it is believed that these are prone to higher risk and may take longer to generate any income compared to already completed properties. Moreover, these funds are not permitted to engage in housing or lending-based business activities.

Regulation 49E specifies that REMFs shall invest a minimum of 35% of its net assets in the real estate assets as listed under Regulation 49A and the balance assets may be in the form of mortgage-backed securities, equity shares, or debentures of real estate companies up to 75% and the remaining 25% in the form of other securities. Furthermore, REMFs are not allowed to transfer real estate assets amongst their schemes.

Prior to this amendment, real estate funds had an investor base limited to financial institutions, corporates, and high net worth individuals. The SEBI guidelines opened more channels of investment for real estate developers by allowing a major chunk of such funds to be invested in real estate companies.

Regulations for real estate investment trusts (REITs) in India

REITs were initially conceptualised by SEBI in 2008 by introducing draft regulations but never confirmed them. Later, after years of suggestions, public opinions, and consultation from stakeholders, on 26th September 2014, SEBI finally published SEBI (Real Estate Investment Trusts) Regulations, 2014, and laid down the guidelines governing REITs in India.

REIT as trust is established in accordance with the provisions of Indian Trusts Act 1882 and granted certificate to operate by SEBI based on the application submitted by the sponsor of REIT in the format specified under Schedule I of the Regulations and based on further compliances as mentioned therein. Regulation 4 specifies the eligibility criteria for grant of certificate to the REIT and describes the grounds for persons or companies to qualify as Sponsor, Manager, and Trustee of the REIT.

According to Regulation 18, REITs are supposed to hold a minimum 80% of assets in the form of completed income-generating properties including hotels, hospitals, industrial parks, etc. and the remaining 20% of assets are to be held in the form of securities or real estate companies as debt or mortgage-backed, government securities, money instruments, under-construction properties unlike REMFs which are prohibited to hold uncompleted or vacant land, etc.  The latest amendment to these regulations was made on June 16, 2020, via SEBI (REITS) (Second Amendment) Regulations, 2020 wherein certain provisions related to sponsors were amended. Certain key amendments are discussed in brief below –

  • A new regulation was inserted mentioning when the status of a sponsor would be declassified. Inserted as Regulation 7A, it says that the status of only those sponsors of a REIT shall qualify for declassification whose units have been listed on the stock exchange for a period of not less than three years, subject to further conditions and approvals as laid down under this Regulation. This regulation seems to give an edge to the sponsors as it enables them to exit a REIT after only three years of it being listed without considering the unfavourable effects on investors.
  • Another regulation laying down the guidelines applicable to situations wherein a new sponsor acquires units of the REIT was also inserted via Regulation 6A. It says that whenever there is a change in sponsor of a REIT, then such inducted sponsor shall receive the consent of not less than 75% of the unit holders, and in case consent is not received then the sponsor who is acquiring the units shall provide an exit option to the conflicting unit holders by buying their units in the manner as may be specified by SEBI.

Conclusion

The REMFs and REITs regulations were introduced by SEBI as its innovative steps to improve liquidity in this vital sector of real estate in India’s economy. These are benefiting the real estate developers as well as the investors because such schemes provide alternate sources of funding and liquidity to the developers while the investors get access to premium real estate and earn stable returns in the form of dividends. 

While REMFs primarily focus on investing in securities of publicly listed real estate companies, the REITs on the other hand are inclined towards owning and financing income-generating real estate. At one point in time, SEBI even thought of rolling back REITs regulations because it was afraid that the co-existence of REITs with REMFs would create confusion among the investors. However, after observing the mediocre response of investors towards REMFs, SEBI finally introduced the REITs regulations in 2014. 

REITs are speculated to have a lot of potentials to strengthen the real estate market and therefore SEBI is working towards improving these regulations by bringing in new changes as and when required. To date, SEBI (REITS) 2014 has been amended seven times making changes related to assets, sponsors, investors, public issues, etc. However, the recent amendments regarding a short-term declassification period and exit options for unit holders seem to be vague and create uncertainty among the sponsors as well as the investors. 

References

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