India’s first real estate investment trust has captured investor interest, but its success will take time, writes Indrajit Basu. Real estate investment trusts, or Reits, are poised to break new ground as India prepares to launch its first: the biggest in Asia by office square footage. The much-awaited float, which aims to raise an estimated $1 billion, is slated to debut four years after receiving the nod by the Indian regulators, the Securities and Exchange Board of India and the Reserve Bank of India. Considering the regulators’ efforts to match global standards, the trust is expected to be more attractive to foreign investors than similar domestic instruments. Yet, even as offshore investors celebrate the chance to participate in India’s fast-developing real estate market through a sophisticated alternative asset class option, experts say the associated risks and an inadequate risk premium mean the maiden Reit is not for the impatient. In September 2018, Embassy Office Parks, a joint venture between US private equity major Blackstone and Embassy Group, announced plans to float a Reit listing 33 million square feet of office space. Expected in early 2019, it will be the biggest office Reit listing in Asia in terms of square footage. It will also catapult India into the league of countries such as the US, UK, Singapore, Indonesia and Japan that have vibrant Reit markets. “This Reit is a significant development for the real estate sector in India because it provides an easy entry for offshore investors into a complicated market,” says Shobhit Agarwal, managing director of Anarock Capital, a real estate investment bank that advises on big-ticket funding, acquisition and consolidation in the real estate space. “This Reit would be an ‘investment for dummies’ opportunity for those who are keen on testing the water in India before dipping their toes in the complex real estate markets of the country,” he adds. Highly volatile
A Reit pulls together income-generating properties that are usually beyond lay investors’ reach. Like mutual funds, Reits enable dividend-based returns and are traded on stock exchanges. Over the years, Reits have caught the gaze of property-focused investors who look for easy liquidity of investments and stable returns, along with long-term capital growth, without tying those upsides to a traditional bricks-and-mortar investment. Commercial property, and particularly foreign interest in Indian commercial assets, has also earned a lot of attention over the past four years. Despite rules related to Reits being in place for almost five years, no Reit has ventured out until this one because of the complexities of the real estate sector. The sector is highly volatile, which makes it unpredictable in terms of returns. Confusing land laws, high upkeep efforts, and complex law enforcement and property rights rules are some of the other factors that make real estate investing in India daunting for inexperienced offshore investors. Consequently, “with the low availability of India’s top-grade commercial assets, any good asset that is listed and traded is a good opportunity for investors”, says Amit Goenka, chief executive officer of Nisus Finance Services, which specialises in real estate services. The forthcoming Reit claims that its portfolio includes “seven best-in-class office parks and four prime city-centre office buildings”. They are in the submarkets of India’s top office markets of Bengaluru (formerly Bangalore), Pune, Mumbai and Noida (near Delhi). Replication of these assets, according to the Reit’s offer document, would be difficult given the land acquisition complexities and long development timelines in India. More than 135 million square feet of office space was leased in these markets over the past five years. This exceeds the total absorption – a measure of the net change of the supply of commercial space over a specific period of time – for 11 cities, including New York, San Francisco, central London, Shanghai and Tokyo, over the same period. The Reit’s target areas are among the top-performing in India and account for 72.5% of total grade-A office stock and 76.9% of total absorption in three months, according to the offer document. These markets, the document claims, have exhibited strong market dynamics, with world-leading absorption and constrained forecast supply resulting in high rent growth and low vacancy on average. Over 81% of the gross rentals are generated from 160 marquee tenants, including Fortune 500 companies such as JP Morgan, Google, Rolls-Royce and Microsoft. Global investors are said to be making a beeline for the instrument, with large banks such as Nomura and JP Morgan Chase reportedly expressing significant appetite for this float. “For foreign investors, this Reit is a good opportunity because India is one of the fastest-growing economies in the world that also assures faster growth of all asset classes – including real estate,” says Goenka of Nisus. The Securities and Exchange Board of India, the regulator for the securities market, is keen on attracting offshore capital for Reits and has offered a couple of tax benefits to the Reit sector that are applicable to this float too. For instance, offshore investors would need to pay 5% tax (compared with 10% for domestic investors at maximum marginal rates) for the returns received as interest on the debt investment made by a Reit. This is creditable in the home jurisdictions of the offshore investors. Investors coming from jurisdictions, such as Singapore, with which India has double taxation avoidance treaties would also be exempt from the country’s 10% long-term capital gains tax, although that phases away over time. The flipside
But the Reit could face headwinds. While reports suggest that the sponsors, Blackstone and Embassy Group, expect to provide an annual return on investment of around 7%, some say that may not be attractive enough for investors. According to Ruchir Sinha, a real estate expert with law firm Nishith Desai Associates, at optimal occupancy (over 90%), the average return in prime commercial real estate in India can range between 7% and 9.5%, with an annual capital growth of about 5% per year. Together with capital growth, the gross annual return expectation can be in the region of 12% to 14% in rupee terms. However, according to Sinha, the total return is more like 6% for offshore investors looking at US dollar returns after adjusting for the approximate 6% hedging cost of the dollar. “I expect that offshore investors in Indian Reits would mainly be offshore insurance companies, pension funds, sovereigns and the likes, which would be comparing Reits in India with dollar-denominated returns in other markets. For such investors, 6% return is not very attractive compared to other developed markets like the US, which offer comparable returns without the typical regulatory, tax and litigation risk that India poses,” he says. Additionally, most Reits calculate returns based on 100% occupancy. This Reit claims it has already achieved a committed occupancy of 95% and has maintained occupancy at greater than 93% in the past three years. India is still an emerging market, however, and offshore investors should view the India Reit as an emerging market opportunity rather than that of a mature market, says Agarwal of Anarock Capital. “Compared to other Asian markets, particularly Singapore and Hong Kong, the Indian Reit could provide better returns, since Singapore is trading at 4.5% to 5%, while the credit rating of the assets in Hong Kong Reits is even lower,” he adds. This Reit is betting on India’s status as a leading services hub for global corporations, drawn to a cost structure that is significantly lower than anything found in an American tier II city. As owners of one of “India’s largest top-grade office portfolios”, its sponsors claim that this Reit is strongly positioned to continue capitalising on the growth story of the Indian commercial space. The demand for office space witnessed 23% year-on-year growth in 2018, according to data from Colliers International. And with an expected return of as much as 15% annually over a period of around ten years, “Indian Reits would be ideal for long-only investors but not for opportunistic or short-only ones,” adds Goenka. Experts are hoping a successful listing of the Reit could open the floodgate for offshore investors. The instrument will also provide another avenue for cash to flow into the country’s developing real estate sector. Whether it starts a trend of similar launches remains to be seen. ©2019 funds global asia