This article is written by Anumeha Agrawal pursuing BA.LLB (Hons.) from Symbiosis Law School, Pune. On June 16, 2020, the Securities Exchange Board of India issued SEBI (Real Estate Investment Trusts) (Second Amendment) Regulations, 2020 significantly amending the original regulations. This article explains the concept of REIT, its major stakeholders and the key legal provisions governing it. It further provides a detailed analysis of how the regulations changed the erstwhile position of REITs, its sponsors, its unitholders and other related parties.

Introduction

Real Estate Investment Trusts (“REITs”) is a trust registered under the regulations which are incorporated to provide an opportunity to invest in real estate equity options with eliminating the elaborate investment procedure involved in the real estate industry. 

These are governed by SEBI (Real Estate Investment Trusts) Regulations, 2014 (“the Regulations”). Recently SEBI issued the SEBI (Real Estate Investment Trusts) (Second Amendment) Regulations, 2020 (“the Amendment”) which significantly altered the position of the sponsor of REITs, and relaxed compliances required to be adhered by them.

Key provisions

REIT

REITs are an investment option similar to mutual funds, but instead of the fund/trust investing in equity, they invest in real estate. The source of their income is from renting or mortgaging their real estate properties. 

Eligibility criteria

Eligibility criteria for REIT

The eligibility criteria for setting up of REIT is given u/s 4 of the Regulations as the following:

1. The instrument of trust is registered as a deed under the Registration Act, 1908.
2. The main objective of the trust is to carry on the REIT activities.
3. The sponsor, manager and trustee are all separate entities.
4. There are no multiple classes of REITs.
5. The parties to REIT are fit and proper persons as defined under Schedule II of SEBI (Intermediaries) Regulations, 2008.
6. Whether any previous application for grant of the certificate has been rejected.
7. Whether there has been any regulatory action taken against parties to REIT.

Eligibility criteria for sponsor

Section 4 (2)(d) of the Regulations provides the eligibility criteria of the manager of REITS as the following:

1. Post initial offer every sponsor must hold a minimum of 5% units of REIT.
2. Each sponsor/ group of sponsors (with one person identified as a representative sponsor) identified under registration application, offer document, placement memorandum. 
3. In the case of group sponsors, only one of the following entities may be considered:

• The person/entity holding interest/ shareholding in assets of SPV/ Holdco to be transferred to REIT.
• The person holding units of REIT on a post-issue basis.
• A person/entity whose experience is being utilised to meet the eligibility criteria.

1. The collective net worth of sponsor(s) is a minimum of 100 crores and the individual net worth is a minimum of 20 crores.
2. Minimum experience of 5 years in real estate development or fund management and where the sponsor is a developer minimum 2 of his projects should have been completed.

Eligibility criteria for a manager

Section 4 (2)(e) of the Regulations provides the eligibility criteria of the manager of REITS as the following:

1. Minimum net worth (in case of a body corporate) and minimum net tangible assets (in case of an LLP) is to be 10 crores.
2. Minimum experience of 5 years in fund management/ advisory services/ property management/ development in the real estate industry.
3. Must have a minimum of 3 key personnel with a minimum experience of 5 years in fund management/ advisory services/ property management/ development in the real estate industry.
4. Must have a minimum 50% of directors (in case of a body corporate) and members of governing board (in case of an LLP) as independent directors.
5. Must have entered into an investment management agreement with the trustee providing for responsibilities as provided under the Regulations.

Eligibility criteria for trustee

Section 4 (2)(f) of the Regulations provides the eligibility criteria of the trustees of REITS, they are to be registered under SEBI (Debenture Trustees) Regulations, 1993 as a trustee not an associate of a sponsor or manager and satisfies the criteria specified by the Board.

Issue and listing of units

1. As per Section 16 of the Regulations, the units of REITs must be listed on recognised stock exchanges within 12 days of the date of closure of the initial offer.
2. In case the listing permission is not provided or withdrawn, the REITs must return the units.
3. All trading activities of REITs shall be as per the by-laws of the stock exchange and listing agreements.
4. The minimum trading lot of REIT is 100 units.
5. The redemption of the units is only allowed under buyback or delisting.

Rights and responsibilities of REIT parties

The rights and responsibilities of REIT parties are given under Chapter III of the Regulations:

Sponsors or sponsor groups

The rights and responsibilities of the trustees are given u/s 11 of the Regulations:

1. The sponsors shall set up REIT and appoint its trustee.
2. The sponsors shall transfer/ undertake to transfer the entire shareholding and interests of the SPV, Holdco, SPV or assets to the REIT before the allotment of units of REIT.
3. The sponsors and sponsor groups shall hold collectively a minimum of 25% of total units after the initial/post-issue basis for at least 3 years of listing of such units.
4. And any holding exceeding 25% shall be held for a minimum of 1 year of listing of such units.

Manager 

The rights and responsibilities of the manager are given u/s 10 of the Regulations:

1. The manager shall make any investment and disinvestment of the REIT.
2. The manager shall also ensure compliance, legality, validity and enforceability with the laws of both real estate and investment. 
3. The manager shall in consultation with the trustee, make appointments of key positions like valuer, auditor, bankers, insurance, other intermediaries, agents and service providers.
4. The manager shall appoint an auditor only for 5 consecutive years, and if an auditor is not an individual, then the reappointment for another 5 consecutive years may be made subject to the approval of unitholders.
5. The manager shall oversee the development of under-construction activities if the REIT has invested in the same.
6. The manager shall submit quarterly reports to the trustees w.r.t the position, compliance and status of under-construction properties.
7. Ensure the computation of NAV based on valuation and declaration of the same within 15 days of such valuation.
8. Provide information to the board and stock exchange as required.
9. The manager shall ensure all activities of REITs and its intermediaries, agents and service providers are according to the regulations and maintain coordination with the trustee.

Trustees

The rights and responsibilities of the trustees are given u/s 9 of the Regulations:

1. The trustee shall hold REIT assets for the benefit of the unitholders.
2. The trustee shall enter into an investment management agreement with the manager on behalf of REIT.
3. The trustee shall oversee activities of the manger, its associates and require compliance certificate every quarter.
4. The trustees shall ensure compliances, disclosures, distributions and periodical review of the status of unitholders.
5. The trustees shall also ensure that the subscription amount is kept in a separate account.
6. The trustee shall also ensure that the remuneration of valuers is not linked to the value of the asset.
7. The trustee shall ensure that the manager fulfils all his duties.
8. The trustee shall obtain approval from unitholders u/r 22 for bringing in any change of in control of the manager.
9. The trustee shall also ensure that all compliance, particularly in case of a change in manager due to removal or otherwise.

Valuers

The rights and responsibilities of the valuers are given u/s 12 of the Regulations:

1. The valuers shall ensure the valuation of REIT units to be impartial, true and fair. 
2. The valuers shall ensure the integrity of the valuation reports.
3. The valuers shall ensure the financial resources and availability of key personnel with adequate experience to perform valuations.
4. To maintain the independence of the valuers and its employees shall not invest in units of REITs and shall not sell the units during its tenure as valuers and six months after that.
5. The valuer shall accept the remuneration for the service only from the REIT and its representative.
6. The valuer shall be acquainted with all laws and regulations and act in adherence to those w.r.t such valuations.
7. The valuer shall disclose any pending business transactions with any party contracting with REIT.

Auditors

The rights and responsibilities of the valuers are given u/r 13 of the Regulations:

1. The auditor is under the responsibility to follow the relevant accounting standards, maintain audit reports and show the true and fair position of the REITs.
2. The auditor has the right to access the books of accounts, information and vouchers w.r.t the activities of the REIT which is necessary for him/her to perform his/her duties.

Unitholders

The rights of unitholders of REIT are given u/r 22 of the Regulations which are as follows:

1. Right to receive income/distributions as provided in the offer document.
2. Right to vote (either by postal ballot or electronically) on matters requiring unitholders approval (except when the related party is involved in transactions).
3. Right to receive a written/ electronic notice of at least 21 days of the meeting.
4. Right to attend an annual meeting within 120 days from the end of FY and the gap between two meetings is not to be more than 15 months.
5. Right to give or abstain approval on the following matters, and the right that the REIT shall only undertake the following on obtaining the majority approval of unitholders:

• Under regulation 18, 19 and 21.
• Any transaction (except borrowing) which is equal to or more than 25% of total REIT assets.
• Borrowing over the specified time limit.
• Issue of units post the initial offer.
• Increasing period of compliance with investment conditions.
• Any issue in the ordinary course of business which according to sponsors/ trustee/ manager is material and requires unitholders approval.

6. Request an issue to be taken up and the approval shall be required with a 3/4th majority on the issues including:

• Removal and reappointment of another manager.
• Removal and reappointment of another auditor.
• Removal and reappointment of another valuer.
• Change in trustees if trustees’ acts are detrimental to the interests of unitholders.
• Delisting of the REIT if in the interest of unitholders.
• Any other issue which they have reason to believe acts in detriment to unitholders’ interest.

7. Any person or PAC (not being sponsors, associates or related party) can acquire units which result in their total holding becoming 25% or more of the value of outstanding units of REIT without the approval of 75% of unitholders by the value of REIT (excluding the value of sponsors and related parties’ holding). In case such an approval is not secured, the dissenting unitholders have a right to be offered an exit option by the acquirer.

8. Right to vote in cases of a change in sponsor or change in control of sponsor, and the mandatory requirement of securing a 75% approval of the unitholders (excluding the unitholders of related parties). In case such approval is not secured the dissenting unitholders are given an exit option by the proposed sponsor.

9. Regulation 23 also provides it with the right to receive a half-yearly (with 45 days of the half-year ending on September 30) as well as annual report (within 3 months of the end of the financial year) of the REIT and its activities.

Previous position of the regulations

Redesignated sponsor

Regulation 2(zl) defined a re-designated sponsor as a person who assumed the responsibility of the sponsor from either a sponsor or another re-designated sponsor.

All the provisions of eligibility, rights and responsibilities of the sponsor mentioned above also apply to re-designated sponsors.

Strategic investor

The Regulation 2(ztb) defined strategic investor as the following holding a minimum 5% of total offer size of REIT either jointly or severally:

• An infrastructure company (non-NBFC registered with RBI)
• A scheduled commercial bank
• A multilateral/ bilateral development financial institution
• An NBFC registered with RBI
• A foreign portfolio investor

Holdings of the Sponsor

Before the amendment, u/r 11 (3)(b) and (c), in addition to the responsibilities mentioned above, the sponsors and sponsor groups were also required to:

• Maintain a collective minimum holding of 15% of the total outstanding units of REIT.
• Maintain an individual minimum holding of 5% of the total outstanding units of REIT.

Lock-in Periods

Regulation 11(4)(a) provided that such minimum holding was to be maintained for at least 3 years from the date of listing of units of the REIT.

Change in Sponsor

Regulation 11(4)(b) and (c) stated that even after the 3 years when the sponsor was to sell these units, it must arrange another person to act as re-designated sponsor fulfilling the eligibility norms of the sponsor with the approval of the unitholders.

Regulation 11(5) stated any sale of units by the re-designated sponsor was also subject to the same procedure.

Amended position

Inducted Sponsor

The “inducted sponsor” has been inserted u/s 2 (qaa) of the Regulations means a person who has been inducted under the Regulations after the approval of the unitholder u/s 22(8) of the Regulation.

Strategic Investor

The definition of strategic investor u/s (ztb) of the Regulations has been amended to include an insurance company registered with IRDA and a mutual fund.

Declassification of the Sponsor

Regulation 7A was inserted to introduce the provision of de-classification of the status of sponsor whose units have been listed on stock exchanges for a minimum of three years, and if it meets the following criteria:

1. The total unit holding of such sponsors and its associates is not more than 10% of the outstanding units of REIT. 
2. The manager of REIT is not controlled by the sponsor or its associates.
3. The sponsor or its associates are not fugitive offenders.
4. The unitholders have approved the declassification.

Minimum holding by Sponsor

The Regulations were amended to remove the requirement of sponsors to hold collectively a minimum 15% and individually a minimum of 5% of outstanding units of REIT.

Lock-in period for Sponsor

The initial lock-in period of 15% unitholding for three years from the date of listing of the units was removed.

Approval by unitholders

The requirement to obtain a unitholder approval before a transfer of units by a sponsor to another person is done away with.

Any change in the Sponsors of the REIT units by either replacement of an existing sponsor or mere addition of a new sponsor shall only be done after obtaining the approval of the unitholders of REIT, and the dissenting unitholders were to be provided with an option to exit.

Change in Sponsor 

However, the requirement of approval of 75% unitholders for any change in sponsor or change in control of sponsor is still in force and in absence of such approval, the dissenting unitholders must be provided with an exit option.

Exit option

With respect to the exit option provided to the dissenting unitholders in case of change of sponsor or change in control of the sponsor(s), the amendment replaced the clause “who proposes to buy the units” with “in the manner, as may be specified by the Board”. 

Implications of the amended regulations

Clearly, the changes brought about by the amendment reduce the compliance for the sponsors. Subsequent to the amendment there are only two requirements for the sponsor:

• To collectively hold a minimum 25% of total units of REIT for 3 years from the date of listing of units.
• To hold any units exceeding the 25% threshold for one year from the date of listing of units.

Under regulation 4, there is still a requirement of minimum 5% holding on the post-initial-offer basis for each sponsor which was amended under Regulation 11.

The provision of declassification of a sponsor allows sponsors to exit a REIT after 3 years of its listing. Although Regulation 6A states that a simple majority of unitholders but a conflicting provision requires any change in sponsor or control of sponsor requires a 75 % approval of the unitholders by value, this is an ambiguity in the current scenario of declassification.

And subsequent to three years of the listing of units, the sponsors can sell all their units and cease and even if the unitholders don’t agree with the same, the only remedy they have is they will be provided with an exit option.

The exit option itself was to be provided by the proposed sponsor or incited sponsor buying the units but the same was also amended and to be made according to the Board’s procedure.

Are the amended regulations in the interest of investors

The amended regulations are focusing on making REIT as an option more sponsor (the initial and major investors) friendly which is understandable due to the current scenario of the real estate industry and the juvenile nature of the investment option itself. These initial measures may attract large developers or investors of real estate to set up their REITs. 

However, these measures have led to a dilution of safeguards provided to the general investors- the unitholders of the REITs which is not going to have a positive impact in the market in the long run. The rights and protection mechanism established for the unitholders are the vital incentives and assurances needed by the common small investors to invest in REIT.

By eliminating the permanent requirement of the sponsors to maintain a minimum unit holding percentage, the regulation has ceased the mandatory nature of the direct commercial interests the sponsors were to automatically have in a REIT which may result in sponsors having less engagement and involvement in REITs. The liberty to declassify a sponsor subsequent to 3 years of listing of the units (and other criteria) enables the sponsors to exit REIT in case of non-profitability in its operations.

The cumulative minimum unit holding of the sponsors is 25% the rest 75% will be held by the public and on the instance of such losses, the unitholders will be suffering. Particularly when the exit option provided to the unitholders in case of declassification is not given.

This may lead to a trend in the market that the sponsors can establish a REIT and exit after only 3 years leading to adverse effects on the investors. This will not only diminish the people in REIT as an investment but also impact on the value of real estate properties further damaging the chances of revival of the industry. 

Critical analysis

The REIT as an instrument has not been very successful due to several factors like low rents for the commercial real estate and the performance rates of commercial real estates vary with the geographical locations.

The regulations came in the year 2014 and till now only two REIT issues have been initiated, the Embassy Office Parks REIT was the first Indian REIT to file its final draft prospectus with SEBI on March 27, 2019, followed by Mindspace Business Parks REIT on August 3, 2020. The Embassy Office Parks REIT had a face value of Rs. 300 and on August 7, 2020, the market value has increased to Rs. 378. It has also announced a cumulative distribution of Rs. 24.39 per unit for the financial year 2020, approximately 8.13% distributed profit pa.

The time-consuming nature of the process of land acquisition, legal compliances and other construction activities also leads to the slow take-off of the instrument. The real estate market needs a new revival mechanism and the REITs has the potential to provide it. 

The new changes brought by the Amendment has left many dichotomies in the Regulations leading to inconsistencies and complications, this needs to be rectified by the Board.

The REIT is a new instrument of investment that is not trusted yet, either by the investors or by the sponsors, thus there is a need to create a balance between their rights. Prior to the amendment, the sponsors were required to maintain a perpetual minimum unit holding, it was not fair for them and made many sponsors reluctant to invest in the said option due to non-availability of an exit option. 

By virtue of the amendment, the situation is improved by the introduction of the provision of de-classification after 3 years. However, the said period of 3 years is too short for any real estate investment to start yielding substantial profits. 

Furthermore, the exit of initial sponsors may detriment the interests and faith of unitholders in REIT. Thus for the smooth functioning of REIT, the minimum lock-in period for the sponsors should be 5 years.

Suggestions

The foremost suggestion to the board is that removing the sections having contrary provisions so as to bring the clarity in the Regulations and legal compliances that the REIT has to follow.

Another suggestion to be implemented is that the exit option provided under the Regulations, which earlier was stated to be bought by the proposed sponsor or inducted sponsor but now it is to be done in the manner provided by the Board, which has not been clarified and ought to be provided in a more explicit manner.

The protection level the unitholders were extended earlier by providing the minimum unit holding thresholds for the sponsors for perpetuity, made sure the interests of the sponsor and the unitholders were also aligned and the sponsors could not exit the REIT.

Enabling declassification of sponsors after three years seems like a relatively short period and a longer period should be provided by the Board. Five years seems like a reasonable period of time before a sponsor can declassify according to the real estate sector position, functioning and nuances involved in a real estate project becoming profitable.

The percentage of votes of the unitholders required for the approval of declassification should be consistent throughout the Regulations and the exit option available to the unitholders in case of not obtaining such approval shall also be stated in a clear and precise manner. In particular who will buy these units needs to be stated, considering the impugned change is ‘leaving of a sponsor’, so as to prevent any violation of rights of both investors and sponsors.

The exit option in terms of other instances of change in sponsor or change in control of sponsors shall also be provided in the same manner.

The price at which the units are to be bought by the sponsors to provide the exit option to the dissenting unitholders is also not provided under the Regulations which is a major criterion in dictating whether such an exit option is effective or merely ornamental in nature.

Conclusion 

In the end, it can be said that the amendment is in favour of the existing and prospective sponsors of the REIT and maybe an encouraging step in order to bring more sponsors in the REITs. The instrument has the potential to revive the real estate market if implemented correctly.

But it has also diluted the protective provisions of the unitholders in case of exit options due to admission of a new sponsor, replacement of an existing one or declassification as newly introduced. The effect of enabling this declassification and a significant reduction in the minimum unit holding may or may not be in favour of the interests of the investor, the outcome can be ascertained only by witnessing the future market trends.

References

• https://www.sebi.gov.in/legal/regulations/jun-2020/securities-and-exchange-board-of-india-real-estate-investment-trusts-second-amendment-regulations-2020_46887.html

• https://www.sebi.gov.in/legal/regulations/mar-2020/securities-and-exchange-board-of-india-real-estate-investment-trusts-regulations-2014-last-amended-on-april-17-2020-_38449.html

• https://www.mondaq.com/india/fund-management-reits/960408/reits-and-invits-sebi-introduces-norms-for-de-classifying-sponsors-induction-of-a-sponsor-and-relaxes-sponsor-lock-in-requirements#:~:text=Given%20that%20declassification%20of%20a,not%20be%20fugitive%20economic%20offenders.

• https://bloncampus.thehindubusinessline.com/b-learn/insight/why-reits-have-not-taken-off/article24697376.ece
• https://www.sebi.gov.in/sebi_data/DRG_Study/IRC2015/4.2PrashantDas.pdf

---

LawSikho has created a telegram group for exchanging legal knowledge, referrals and various opportunities. You can click on this link and join: