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.

be charged at a maximum marginal tax rate with the benefit of setting off the 10% TDS cut. This structure is marginally better than the previous one with some saving at the SPV level.

Trusts are now taxed at a maximum marginal rate if they are discretionary trusts, or those engaged in business. Beneficiaries of these trusts are not taxed. This assumes that these taxes are all domestic trusts. This basic principle is sought to be retained, where the constitution of business trusts is concerned. Further, a new section is proposed to be inserted, which taxes income of the business trust at the maximum marginal rate. Various industry bodies and sponsors made the following representations to the government, which largely remain unaddressed.

o As 90% of the net income will be distributed to unit-holders/investors, DDT should be completely exempt. This practice is also followed in successful REIT markets.

o Complete tax exemption of capital gains to the sponsor and the REIT on disposal of assets as the net proceeds of the disposal of asset in a REIT is distributed to unit-holders.

o Stamp duty exemptions on transfer/purchase of properties directly by REITs: In India land is a state subject and stamp duty is levied by states. The five states which hold the majority of the assets which could potentially be listed in the form of REITs are Maharashtra, Karnataka, Haryana, UP and Tamil Nadu. The stamp duty on asset transfer varies from 6-9% in these states. Direct holding of a property by the REIT (going away with the step down SPV structure) will save some tax leakage (DDT). Separate representations will have to be made to the states for this.

Assuming current tax proposals are agreeable, it’s viable for whom?

Should a Grade A developer with a strong balance sheet monetise through REIT? Most banks, financial institutions are keen to lend to Grade A developers. Hence as evident, the cost of borrowing for a Grade A developer is already low and falling further. Besides, the introduction of Commercial Mortgage-Backed Securities (CMBS) like structures has improved the cost and structure of borrowing for the developer. The recent (maiden) fund raising, initiated by DLF, was at 10.9%, which makes the effective post-tax rate 7.3%. We believe a developer would be more comfortable raising debt and keeping the property appreciation for himself if debt is available at the current rate (11-12%).

Additionally, as the commercial property market is emerging from

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