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Recently, the Securities and Exchange Board of India introduced regulations with respect to small and medium-sized Real Estate Investment Trusts, hence drawing the attention of investors who strive and work towards exploring new avenues of investment in real estate. Real estate has always been one of the favorite asset classes for Indians, and SM REITs introduce a whole new avenue for investment in this sector.
By definition, an SM REIT stands for Small and Medium Real Estate Investment Trusts. As such, it is really a more flexible and more available version of the classic REITs. Whereas classic REITs had been in the market for quite some time, the SM REIT is targeted to reach more investment opportunities, as well as be able to answer more investors’ needs.
What is a REIT and How Does a REIT Work?
In order to understand what an SM REIT is, one must first understand what the classic version, the REIT, is. A REIT is an investment vehicle that holds a portfolio of income-producing real estate properties.
The properties generate rental income that is distributed to the investors in the form of dividends. As such property increases in value over time-a process known as capital appreciation-the price of the REIT units also goes up, further rewarding the investor. The setup, therefore, allows diversification into real estate without the need to buy or handle it.
Key differences between SM REITs and traditional REITs
While traditional REITs are mainly set up for big projects like office buildings and shopping malls, SM REITs are more flexible. They may invest both in commercial and residential real estate, opening wider investment opportunities.
Typically, SM REITs have fewer numbers and value of properties than the original REITs. This focus allows for more concentrated investment strategies that may be associated with potentially higher returns but also higher risks.
Investment in Residential Properties
One peculiar thing in the case of the SM REITs is the opportunity to invest even in residential properties. In India, the yield is around 2-3% per annum on average at present against residential property, which is relatively low compared to commercial properties.
Now, it is yet to be seen whether the SM REITs will gain momentum in investing in low-yield residential properties among investors. At the same time, demand due to SM REITs could affect housing prices, which is an area for observation.
Since these types of investments are much riskier, the minimum investment amount, as per SEBI, is INR 10 lakh for SM REITs
Multiple Investment Schemes
Whereas traditional REITs provide just one single value across all the units, SM REIT allows for multiple schemes to be carved out under one portfolio. Each scheme could invest in property of different types; for instance, one scheme could be allocated for commercial property, while another would target residential property.
Further, this leads to the fact that units of various schemes of the same SM REIT may stand for completely different assets, thus offering a diversified choice for investors under one single REIT roof.
Fractional Ownership Platforms
SEBI’s regulations also catch up with the increasing trend of fractional ownership platforms. These are normally designed to allow investors to purchase a portion of real estate, which lowers the barrier to entry to real estate investment. However, most of such platforms have been unregulated and hence pose risks to investors.
In bringing such platforms under SM REIT regulations, SEBI seeks to ensure investors that such investments also fall within the regulatory ambit. Fractional ownership platforms have been asked to declare their listing within six months from the introduction of these new regulations.
How Do SM REITs Work?
Let’s break it down into a structure to understand how the SM REITs work:
- Registration: An SM REIT should basically first register with SEBI.
- Pooling Resources: Investors pool their money into the SM REIT in return for units. The SM REIT may borrow funds with a limit of not more than 49% of the value of the scheme.
- Transfer to SPV: Pooled money is transferred to an SPV that, in reality, holds the property.
- Purchase of Properties: The SPV will invest at least 95% of its assets in completed and revenue-generating real estate projects. The investment in under-construction properties shall not be made.
- Rent Income: The SPV gets rent from the tenants or the proceeds of sale of the property.
- Distribution of Income: The SPV distributes at least 95% of its cash flows back to the SM REIT.
- Distribution to Unitholders: The SM REIT will distribute 100% of the net cash flow, after deducting operating expenses to the unitholders quarterly.
Major Disclosure Requirements
To ensure transparency and safeguard the interest of investors, SEBI has prescribed various disclosure-related requirements for SM REITs. These include the particulars of properties that would be acquired, estimated lease rental income for each property, along with comparison with lease rental income of similar properties. Further, the NAV of the scheme shall be disclosed in terms of the latest valuation report as at the end of March 31st of each year.
SEBI also regulates that the SM REITs shall not have less than the prescribed level of investment by them in their units so as to align the interest of the manager with that of the unitholders. The term used is “skin in the game.” A SM REIT has to retain 5% of the units for five years, which is extended to 15% if debt is involved. There is a gradual reduction after five years.
Conclusion
SM REITs have opened up a new class of investment for Indian investors, emerging from the bouquet of benefits accruing from the conventional version with more flexible investment alternatives. However, like any other new class of assets, investors should exercise caution.
To the prospective investors in SM REITs, it is very important that you review your risk appetite and carefully study the statutory disclosures on property particulars, expected returns, and revision of NAV from time to time. As the market matures, SM REITs may be an important component in the portfolio of a diversified investor in search of new avenues to participate in the most happening real estate market in India.
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