The Indian real estate market has undergone palpable transformation in the last few years. This change has been led by rapidly rising demand for residential, office, retail, hotels and now warehousing space. Also, India offers higher average rental yields – 8.5 – 10.5% as compared to 3.5% in Japan, 5.2% in Singapore and 5.7% in Hong Kong. Higher yields and a relatively better spread between ten-year government bonds along with strong economic growth, increasing income levels, growing middle class and widespread urbanization has helped the Indian real estate market attract large investments.
However, despite the growing attractiveness, the Indian markets have been constrained by certain limiting conditions like absence of transparency and lack of institutionalization and liquidity. The issue of transparency is being taken care by way of reforms being undertaken by the state governments. The most effective way to tackle the other two is by allowing Real Estate Investment Trusts (REITs) to be active in the Indian markets.
REITs are investment vehicles that allow institutional as well as retail investors to partake in real estate ownership, management and development. REITs are already present in a number of mature real estate markets across the world like US, UK, Japan, Australia, Singapore, etc. and are now making inroads in emerging markets like India.
In India, REITs will help fill the financing gap as they would provide access to capital, both debt and equity capital from public and private sources at reduced costs. They will also offer an exit route for the developers to revolve funds and improve their margins. Success of REITs in other markets like USA, Australia, Singapore, etc. is a major case in point for their introduction in India.
For example, in Australia REITs play a major part in the commercial property market, with over 50% of the value of institutional quality commercial properties being held by REITs, supported by an active unsecured debt and commercial and mortgage backed securities market. According to CRISIL, REITs in India have the potential to hold atleast a 5% share (more than US$ 70 billion) of the total realty market by 2010.
This coupled with higher realty returns that the country offers (average development yields in India vary between 20-25 % while it is lower in the US and the UK) spell a great opportunity for the success of REITs in India. Draft guidelines for REITs in India were issued by the Securities and Exchange Board of India (SEBI) in December 2007 and are likely to be approved and enacted in the near future. However, much ground needs to covered and several issues need to be addressed before REITs can find a footing in the country.
The current regulations in India involve high transaction costs, present problems in ensuring clear land titles and prolonged delays in obtaining clearances and approvals. Moreover, at present, there is an absence of a credible database on real estate markets as well as standardized, accepted practices for property valuations. In such a scenario, it is very essential that certain regulatory reforms as well as an enabling framework is brought in so as to facilitate REITs to become an effective tool for institutionalizing real estate in India.
In the absence of a liquid market for income-yielding assets and the credit squeeze which has constrained development plans, many Indian developers have been exploring overseas listings through REIT structures in markets like Singapore. However with the recent fall in the global equities market (S-REIT index has fallen nearly 30% since its June ‘07 peak) and the significant drop in risk appetite for Asian assets together with the under-performance of the India Bulls Properties Investment Trust at the Singapore Stock Exchange has led to the postponement of the REITs plans by other major developers like Unitech and DLF. There is no doubt that it is time that the Indian realty markets start to develop on the back of a research-driven , structured investment approach, which has a long-term perspective and REITs would offer the ideal solution.