[By Arnav Laroia & Shashank Pandey]
The authors are students of West Bengal National University of Juridical Sciences, Kolkata.
Introduction
The Securities and Exchange Board of India (‘SEBI’) recently made significant changes to the Securities and Exchange Board of India (Real Estate Investment Trusts) Regulations, 2014 (‘Regulations’) by an amendment, signalling a watershed moment in the evolution of the Indian real estate investment landscape. The SEBI (Real Estate Investment Trusts) (Amendment) Regulations, 2024 (‘Amendment’) seek to improve accountability, reliability, and operational efficiency in the Real Estate Investment Trusts (‘REITs’) sector, reflecting SEBI’s commitment to creating a strong and dynamic investment environment. Furthermore, the Amendment aims to make real estate investments more accessible to retail investors, especially through Small and Medium REITs (‘SM REITs’), thereby boosting confidence in investment in commercial real estate. REITs are companies that own, operate, or finance income-generating real estate properties, allowing investors to earn dividends from real estate investments without directly owning property.
It is worth noting that these changes come at a critical time as the Indian real estate market matures and attracts a wide range of domestic and international investors. The updated Regulations, which address key areas such as regulatory compliance, disclosure requirements, and investor rights, are expected to boost the credibility and appeal of REITs in India.
This article delves into the specific changes resulting from the Amendment, their implications for stakeholders, and the overall impact on the Indian real estate investment ecosystem.
Regulatory Initiatives: Enhancing Accessibility
The Regulations prior to the amendment simply defined a REIT under Regulation 2(1)(zm) as a trust registered under the Regulations. The Amendment has expanded the definition of REIT under Explanation 1 of Regulation 2(1)(zm) to include SM REITs, as added under Chapter VIB of the regulations. An SM REIT under Regulation 26H(c) is defined as a REIT that pools investor funds into one or more schemes in accordance with sub-regulation (2) of Regulation 26P. Regulation 26P(2) allows an SM REIT scheme to make an offer of units if the proposed asset size is between Rs. 50 crores and Rs. 500 crores, and the minimum number of unitholders, excluding the investment manager, its related parties, and associates, is at least 200 investors.
The Amendment’s recognition and regulation of Small and Medium Real Estate Investments is a critical step towards protecting investments and increasing investor trust in this specialised investment industry. Furthermore, by establishing asset size requirements and a minimum number of unitholders, this regulatory measure will also stabilise the Small and Medium Real Estate Investment market, which is a high-risk market. The following will encourage investment in smaller and emerging real estate projects that might not meet the thresholds for traditional REITs, which are set at a minimum value of Rs. 500 crores under Regulation 14. This is a significant step towards increasing investment in smaller projects and cities, making it easier to invest in REITs for relatively smaller investors.
Notably, India’s small cities and towns are becoming significant regional job markets due to economic expansion and infrastructure improvements. According to reports, Tier-II and Tier-III locations offer talent and real estate costs at least 30% lower than Tier-I cities. Therefore, enterprises are increasing their presence in regional cities to meet rising consumer demand, contributing to the growth of the real estate market. Additionally, the requirement for a minimum number of 200 unitholders helps spread investment risk across a large group of investors, potentially lowering individual risk and increasing market stability. This could also possibly lead to increased diversity and inclusion of willing investors who were otherwise excluded from such REITs because of a lack of opportunity to invest.
Protection of Assets: Ensuring Accountability
The Amendment under Regulation 26R mandates that the investment manager identify and provide information in a draft scheme offer document on the real estate assets or properties it intends to purchase. The document must be filed with SEBI and with the designated stock exchange. The minimum price for each unit of the SM REIT scheme is Rs. 10 lakhs, with each scheme identified by a separate name. As previously mentioned, each scheme’s real estate assets must be worth at least fifty crore rupees.
In addition, the books of accounts, bank accounts, investment or demat accounts, and assets are all required to be ring-fenced and separated by the trustee and investment manager. The trustee must ensure the property papers proving the title to the real estate assets or properties once a year and keep them in safe deposit boxes at a designated commercial bank. Furthermore, the draft scheme offer document shall be hosted on the websites of the SEBI, approved stock exchanges, and merchant bankers involved in the matter for a period of 21 days, therefore becoming publicly accessible.
These are some significant steps towards achieving the goals of the Amendment, as the inclusion of real estate assets in the draft scheme offer document and its 21-day public disclosure period increase confidence and transparency, enabling prospective investors to make well-informed decisions. In addition, including SEBI in the evaluation of the draft scheme offer document and providing feedback guarantees that the schemes comply with regulatory requirements and that any prospective issues are resolved before the scheme’s disclosure to the public. This regulatory monitoring has some resemblance to securities market norms, such as businesses’ publishing of the Draft Red Herring Prospectus, which is essential to maintaining investor confidence and the integrity of the SM REIT market.
Additionally, the minimum unit price of Rs. 10 lakhs ensures that the investments are significant and that the investors are financially capable of understanding and accepting the associated risks, given the high-risk nature of this market. Moreover, asset segregation and safekeeping safeguard investors’ funds and ensure accountable management. The explicit requirement to keep property documents secure, as well as the trustee’s annual inspection, ensures accountability and proper management of real estate assets.
Provision for Distributions: Streamlining Interests
The amendment further stipulates under Regulation 26ZK that, in accordance with the Companies Act, 2013, the investment manager must transfer 95% of the Special Purpose Vehicle’s net distributable cash flows (‘NDCF’) to the SM REIT scheme. Regulation 2(zs) defines a Special Purpose Vehicle (‘SPV’) as a company or Limited Liability Partnership where a REIT owns at least 50% of equity, holds 80% of its assets in direct properties and is solely involved in holding and developing properties without investing in other SPVs. SEBI will utilise the remaining funds as required. At least once per quarter, the distributions must be announced and paid to unitholders within fifteen working days after the end of the quarter. The management will provide the unitholders with 15% annual interest for the duration that the payment is delayed if they are unable to meet these deadlines. The SM REIT is not liable for any kind of recovery of the excess interest.
The requirement to distribute 95% of the NDCF, combined with the quarterly distribution schedule, provides investors with a high degree of income predictability. The strict deadlines and penalties for late payments reinforce the importance of timely payments, which can boost investor confidence and attract more investment in SM REITs. Notably, research for the security market indicates some level of correlation between the payment of dividends and the consequent attraction of investors. Therefore, it can be expected that payment of distributions in SM REIT investments will attract investors as well.
Furthermore, the inability to recover excess interest from the SM REIT ensures that the investment manager maintains stringent financial discipline and employs effective management methods to avoid delays and penalties. This provision helps to align the investment manager’s interests with those of the unitholders.
Concluding Reflections & The Way Forward
SEBI’s initiative to lay down clear and comprehensive guidelines to make real estate investment accessible to a group that is much more diverse and larger than the existing one and to ensure the security of investments and assets bolsters the confidence of investors in the Real Estate Investment market. A sense of security is crucial for the growth of any investment sector. With the rising economy, it is crucial that we include investors from every class and part of the country.
The Amendment accomplishes this goal in two ways. First, it permits investors with fewer resources to invest in REITs with a minimum investment of Rs. 10 lakhs, which strikes the ideal balance between an investor’s necessary risk commitment and the targeted flexibility to attract investors. Second, by establishing the minimum valuation of eligible units at Rs. Fifty crores., the Amendment brings into its fold a significant number of real estate holdings located in small cities and towns that are experiencing constant development and are feasible for profitable investments. However, there are a few uncertainties that need to be addressed. The legality of investments in units under Rs. Fifty crores is the most pressing challenge, as it may restrict engagement from smaller investors who fail to meet the minimum asset size criteria. Furthermore, the actual implementation of firm governance and compliance requirements has yet to be determined.
Nevertheless, the Amendment is projected to influence the whole investment sector considerably. These measures, which enhance transparency, decrease risks, and extend access, are projected to attract more investors and boost trust in India’s real estate market, resulting in considerable development and stability.