Real estate: Getting REIT right, says Kotak Institutional Equities

Jul 21 2014, 13:23 IST
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Finance Minister Arun Jaitley made a progressive announcement on REITs (Real Estate Investment Trust) in his budget speech. (Reuters) Finance Minister Arun Jaitley made a progressive announcement on REITs (Real Estate Investment Trust) in his budget speech. (Reuters)
SummaryBudget proposals on investment trust fall short of industry expectations.

REIT, a reality? Not yet! Although the finance minister made a progressive announcement on REITs (Real Estate Investment Trust) in his budget speech, we believe work still needs to be done on the fine print and state-level issues need to be sorted for REITs to become a reality. Our discussions with accounting professionals, law firms and sponsors indicate hurdles that need to be overcome with respect to the current structure of a REIT. Also, even if some stakeholders take a hit on tax, high interest rates and a negative spread are still hurdles.

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Key announcement and on REITs—does it really change anything? The finance minister made two major announcements in the recent Union budget, which directly affect the tax structure for setting up a REIT.

o Capital gains tax on transfer of interest in an SPV to a REIT will be deferred until the sponsor monetises the investment.

Wish list. Most sponsors were seeking a one-time exemption in capital gains tax on transfer

of assets (in line with the practise in most successful global

REIT markets).

View. Globally, capital gains tax is exempt on transfer of shareholding. Change in the preferential tax regime in the finance bill makes its non-viable for the sponsor, we believe.

o The REIT’s dividend distribution tax is a pass-through if the income of the REIT is in the form of dividend from a subsidiary/SPV. Further, a 10% withholding tax for resident and 5% for non-resident unit-holders is applicable if interest earned by the REIT is distributed as dividend.

Wish list: Exemption in dividend distribution tax at the SPV level as 90% of the income would be distributed to investors.

View. This is not different from the existing structure for a developer with multiple subsidiaries/ SPVs holding such assets. In case a subsidiary is dividend paying, the tax is set off at the parent level, which is also paying dividend.

Assuming the current tax structure remains, is it viable for stakeholders?

o We believe India’s property market is at a nascent stage compared with developed markets. Excluding a few deals in the trough of 2010-11, most pre-let commercial property acquisitions took place at negative spreads and at high single-digit/low double-digit yields, while the cost of borrowing is about 11.5%. In most developed markets the yield spread is positive. In India buyers and owners look for capital appreciation and cap-rate compression as rents are near all-time lows in

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