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REDEFINING YOUR NET WORTH MENTES CAPITAL

REIT as an Investment Alternative

Redefining your net worth

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EXECUTIVE SUMMARY

BUYING A house is not easy. Anybody who has been through it will tell you how

difficult it is. The legwork to find the right flat in the right location, the piles of legal documents

to wade through, tying up the loan and finally getting the registration process through. Doing all

this may be worth the while when you are acquiring that dream house of yours. But is it worth

undergoing all this when you buy property for the sake of investment? Is there a better way to

invest in property? An option by which you will not have to undergo the painful process all

over again and at the end of it all discover that the property you acquired has slumped in value?

HDFC Bank’s India focused Real Estate Private Equity Fund comprising of only domestic

investors that began investing its corpus of Rs1000 crs since 2005 has given opportunity to PE

funds to get an exposure into this space..

For four decades now, Real Estate Investment Trusts or REITs, as they are called in the

U.S., have helped American investors buy into the property market without many of its

accompanying hassles. Here is how they work.

REITs are companies that buy, sell, manage and develop real estate assets. Much like

mutual funds do, REITs put together the investments of many individuals and institutions; and

then deploy this money in real estate. So if you want a piece of the action in the real estate

market, all you have to do is buy shares of a REIT. This entitles you to a share of the income

generated by the REIT from its property investments.

A REIT employs a horde of real estate professionals and legal eagles, who will make sure

that every piece of property acquired has a clear title and is not embroiled in a legal morass.

These experts will be on hand to fight any legal battles arising out of the property; which you, as

an individual, may not have the resources to do. The growing popularity of REITs with investors

has prompted 19 countries to flag off REITs on their shores. We, in India, do not as yet have

access to real estate investment vehicles such as REITs. But if you are hooked by the concept,

you may not have to wait too long before you can actually put it into practice.

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The Association of Mutual Funds of India, along with the stock market regulator is

already working on a proposal to flag off Real Estate Mutual Funds in India, which will work

much like the REITs. Once REITs do sweep into the Indian markets, investing in property will

surely become less daunting for millions of investors in the property market.

AIMS AND OBJECTIVES OF THIS RESEARCH PAPER

To understand what is REIT

Contribution of REIT towards real estate industry

REITs developments in India

Benefits of REIT

Mortgage market and its characteristics

RESEARCH METHODOLOGYPrimary data: Information that is collected directly or first-hand.. This data has been collected

by personal observation & personal interview with the operator sitting on the terminal in the

organization.

Secondary data: Information that is not collected first-hand, for example, data from a

government document or a database. It is also called as second-hand data or secondary-source

data.

This data has been collected from print outs, publications, and relevant websites

LimitationsREIT is one of the new concepts in Indian industry. There is no much development in the REIT

in India. And it is more popular in the other countries. The data is mostly towards the secondary

information.

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RECOMMANDATION AND SUGGESTIONS

REITs boost and help to stabilize capital access, and reduce capital costs. REITs have

proved successful in helping the commercial property business efficiently access the four

quadrants of capital: debt and equity, public and private. Capital, especially long-term

capital, is a vital resource for the property business, and REITs have proved effective in

attracting it. This is in part a reflection of their public status and partly of their tax

efficiency. Unsecured debt — the most flexible debt type — has been a hallmark of

REITs, and has aided them in boosting both their strategic and financial flexibility.

REITs can help develop the broader economy. With the introduction of REITs usually

there will be better transparency and efficiency, and access to stable, global and more

competitively priced capital, as well as stronger and more professional property

businesses. As such, the commercial property sector can become better positioned to help

develop the Indian economy.

REITs create conditions for building integrated property businesses. Most REITs in the

leading national markets are internally managed, and have diverse skill bases in property

development, redevelopment, acquisitions, divestitures, leasing and management. As

such, they can create long-term, value-added ongoing enterprises, and not just

assemblages of assets or "deals".

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INTRODUCTION

Real estate investing involves the purchase of real estate for profit. Profits are

accumulated slowly by renting out properties in a cash flow method, or are generally improved

and resold for a capital gain. In addition, real estate investors may wholesale properties as a

means to make profits.

Real Estate Investment Trusts, or REITs, have established themselves as the "Brand

Name" investment vehicle of choice for institutional and retail investors looking to participate in

real estate ownership, management and development. And while REITs are already common

players in developed markets, they are now also making their presence felt in emerging markets.

The attractions of REITs for investors are clear: they provide a similar structure for

investors buying into real estate as mutual funds provide for investment in stocks. Another key

design feature is the elimination or reduction of the taxation differential between directly-owned

property and property owned through a corporation – though whether this will be the case for

Indian REITs remains to be seen. Nevertheless, as India's real estate market grows and opens up,

REITs could play a major part in its development.

Although there are no REITs in India now — some India-referencing REITs are

reportedly considering listing offshore in established REIT jurisdictions — the Securities

Exchange Board of India (SEBI) is currently finalizing guidelines for the introduction of Real

Estate Mutual Funds (REMFs), and it will consider framing guidelines for REITs going forward.

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http://en.wikipedia.org/wiki/Capital_gain

http://en.wikipedia.org/wiki/Renting

http://en.wikipedia.org/wiki/Profit

http://en.wikipedia.org/wiki/Real_estate



SEBI's guidelines should also make it easier to invest in the sector through listed real estate

operating companies (REOCs) and increasingly through foreign direct investment (FDI).

More broadly, the introduction of REITs could also provide many benefits to India's

economic development, just as they have to other countries such as Australia, Singapore, Japan,

the UK and France. For instance, REITs can boost capital access and reduce capital costs for

property owners, managers and developers.

Moreover, in many markets REITs have successfully helped the commercial property

business better access the four quadrants of capital: debt and equity, public and private. REITs

also help create conditions for building integrated property businesses, and are well positioned to

appeal to foreign capital, thereby helping develop the Indian economy.

However, the road to establishing an Indian REIT sector could be challenging. Not least,

the authorities will need to change parts of India's legal and tax frameworks. Furthermore, the

real estate transaction process is cumbersome, and the property industry's transparency and

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disclosure levels could be improved. Already P/E funds are flowing into various sectors as

indicated by the pie chart below.

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FORMS OF REIT INVESTMENT

Equity REIT: The enterprise concerned fully owns the revenue generating property. One

distinct difference between Equity REITs and real estate entity is that the former should

purchase and develop its properties principally to drive income but the latter can sell it

and is not liable for continual engagement with the owners.

Mortgage REIT: These enterprises extend loans to real estate firms or property

management group, directly or indirectly. The returns churned out from the same are

passed onto its individual shareholders.

Hybrid REIT: As the nomenclature goes, it is a combination of both – Equity and

Mortgage. The percentage in each category depends on the risk appetite of the enterprise.

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EVOLUTION OF REIT IN THE WORLD

REITs started in the US in 1960. Over the past 50 years, the US REITs has attracted a market

capitilizationof over US$600 Billion and has been adopted in several parts of the world. As of

30-June-2014, there were 456 stock exchange – listed in the FTSE EPRA / NAREIT Global Real

Estate Index in 47 countries around the globe . Of the US$ 1.2 Trillion in equity market

capitilization represented in the Developed Markets Index, 78% came from the REITs.

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EVOLUTION OF REIT IN INDIA

In 2007 SEBI formally introduced the draft REITs regulations for public comments.

Because of downturn in the market during that period , no further developments took place in the

REITs regulation, Until October 2013 when a second draft of the regulations was issued for

public comments by SEBI. After taking industry inputs, amendments to regulations were made

and the draft was approved by allowing setting up and listing of REITs. Post the clarifications

provided in the 2014 budget, a final draft was introduced by SEBI in August 2014.

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OVERVIEW OF SEBI REGULATIONS TO REIT

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KEY ACTION POINTS FOR INVESTORS

REIT is of medium risk and thus the returns from Investment in these funds will not match tax

breaks you get while investing directly in a property. The attraction is because of the small ticket

size and quick exit you get enhanced liquidity which involves the trade off of tax breaks. To gain

something we have to lose something.

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FACTS OF INDIAN REAL ESTATE

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REIT FUNDS IN INDIA

DLF

DLF Ltd, the country’s largest realty company by market capitalisation, is readying plans

to float India’s first Real Estate Investment Trust (REIT) to raise an estimated Rs 6,000 crore

over the next two years.

While the company will use the funds to finance projects, it will offer individuals and

institutions an alternative investment vehicle to earn returns from realty projects in a model

similar to mutual funds (MFs).

DLF’s executive director Rajeev Talwar told HT that the company has engaged JP

Morgan and Morgan Stanley as investment bankers for the launch of two REITs. “We will have

the first REIT of the country, that is for sure and this would be over the next one year,” Talwar

said.

Talwar did not specify the size of the proposed floats, but sources said that two funds will

likely raise an estimated Rs 3,000 crore each. The first of these will hit the market this fiscal

year, followed by another one next year.

On Thursday, Finance Minister Arun Jaitley exempted units of business trusts in REITs

and SPVs (special purpose vehicles) from minimum alternate tax (MAT).

Talwar said that the earlier pre-requisite of MAT being applicable on exchange of equity

shares of a SPV for REIT units had restrained the company from taking its plans forward.

DLF’s two REITs will be used to fund office and retail projects. The company is

examining to put to use about 25 million square feet of land, which is currently leased out,

sources said.

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MAIN FEATURES OF REITS IN INDIA

Structure of REITs

REITs are set up as trust under the provisions of the Indian Trusts Act, 1882 and are

registered with SEBI. Like a mutual fund, it has three parties - Trustee, Sponsor(s) and

Manager - to avoid any conflict of interest issues.

The Trustee generally has an overseeing role on the activities of the REIT.

Sponsor(s), collectively hold at least 25% in the REIT for at least 3 years and 15%

thereafter. This is to ensure skin in the game. Sponsor’s responsibilities are to set up the

REIT and appointment of the Trustee.

Manager means a company or LLP or body corporate incorporated in India which

manages assets and investments of the REIT and undertakes operational activities of the

REIT. In short, the manager assumes the operational responsibilities pertaining to the

REIT. A manager needs to have at least 5 years of related experience coupled with other

requirements such as minimum net worth, manpower with sufficient relevant experience,

etc.

The trustee of a REIT is a SEBI registered debenture trustee who is not an associate of

the Sponsor.

OFFER OF UNITS, LISTING, INVESTMENTS AND DISTRIBUTION

Value of the assets owned/proposed to be owned by REIT should be atleast Rs 500 crore.

The REIT can raise funds initially through an initial offer and once listed, may

subsequently raise funds through follow-on offers.

Minimum issue size for initial offer is Rs 250 crore with a minimum public float of 25%.

Listing of units in a stock exchange is mandatory in India.

The minimum subscription size for units of REIT is Rs 2 lakhs and the trading lot is

specified at Rs 1 lakh so as to allow only reasonably informed investors into this market.

Permitted Investments by REIT are:

Atleast 80% in completed and revenue generating properties.

Not more than 20% in developmental properties and other eligible investments. Provided,

investment in developmental assets is not more than 10% of the value of REIT assets.

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REIT to invest in at least 2 projects with not more than 60% of value of assets invested in

one project. Related party transactions are subject to strict scrutiny.

REIT to distribute not less than 90% of the net distributable cash flows, subject to

applicable laws, to its investors.

Maximum borrowing permitted is 49% of the value of the REIT assets. Further, credit

rating and post 25% unit holders approval are mandatory to raise debt.

Full valuation to be carried out atleast once a year and half yearly updating of the same

has to be carried out.

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TAX TREATMENTS OF REITs IN INDIA

REITs are given "pass through status" from the perspective of income tax. Pass through

transactions are those transactions where the ultimate beneficiary, namely, the investor

receives the income (as dividends or interests payments) arising out of the

loans/bonds/transactions done by a Trust. Since income is ultimately going to the

investor, the Trust is exempted from paying the tax while the ultimate beneficiary is

taxed. Thus, rental income from real estate assets directly held by REITs are allowed to

pass through and are taxed in the hands of the unit holders of the REIT. This was

announced in July 2014 in the Union Budget 2014-15.

Further, Union Budget 2015-16 proposed to rationalise the capital gains regime for the

sponsors exiting at the time of listing of the units of REITs and InvITs, subject to

payment of Securities Transaction Tax (STT). The rental income of REITs from their

own assets will have pass through facility.

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IMPACT OF REITs

The introduction of REITs in India is expected to significantly benefit the investors as

well as the developers in the real estate industry. REIT are expected to provide an exit

route to Indian developers who are struggling to reduce debt, while on the other hand it

gives investors the ability to buy into the country’s property market which otherwise may

be out of their reach due to the sheer size of the amount to be spent for acquiring such

properties.

Thus, from the perspective of investors, holding units of REITs is a substitute for

investing directly in real estate. This is similar to investing in Gold Exchange Traded

Funds (Gold-ETFs).

REITs would also enable diversification of the portfolio of the investors and provide the

investors a new product that is regular income generating.

The freeing up of developer's capital is expected to bring in more investments in real

estate, thereby stimulating growth. Funds locked up in various completed projects can be

released to facilitate new infrastructure projects to take off.

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Assets that may qualify to be included in REITs may reach $20 billion by 2020

(according to an estimate by property broker Cushman & Wakefield). In the first three to

five years, as much as $12 billion could be raised.

REITs will force much needed transparency at least in the commercial sector, and lower

the reliance on financing from banks and incentivize developers to own and manage

assets with a long-term view. In a market where price data is almost impossible to come

by, this will be a revolution. It will help the investors in making more informed

investment decisions as returns can actually be analyzed rather than be based upon

anecdotes.

Opening up of REITs for foreign investors with support from the budget on such inflows

is expected to generate substantial foreign interest for investment in REITs.

In time, it will help develop a more mature and liquid market with broad participation

from investors.

ADVANTAGES OF REITS TO INVESTORS

Low Entry Barrier

MINIMUM SUBSCRIPTION: Rs 2 lakh (primary market)

TRADING LOT SIZE: Rs 1 lakh (secondary market)

Regular Income

Dividend income: At least 90% of the distributable cash flow must be distributed and at

least twice a year.

Transparency

REIT, through a valuer, will undertake full valuation on a yearly basis and update the

same on a half-yearly basis and declare NAV within 15 days from the date of such

valuation/updation.

Diversification

REITs will have to invest in at least two projects. Not more than 60% value of assets will

be in one project.

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Low risk

Not less than 80% of the assets should be invested in completed and revenue-

generating properties. The rest 20% can be invested in under-construction

properties, mortgage-backed securities, and listed/unlisted debt of companies in the

real estate sector, equity shares of listed companies which derive not less than 75%

of their operating income from real estate activity, G-secs and money market

instruments and cash equivalents.

Sponsor, trustee and manager cannot be an associate. This will ensure there is no

conflict of interest.

Sponsors must hold 25% of the units for first three years and 15% thereafter to

ensure their commitment

Liquidity: Investment in REIT also ensures liquidity as it is a traded security.

Tax Advantages: Incomes received from REIT will receive a pass through status.

Quality Real Estates: The fund will only invest in quality real estates.

Expert Management: The fund is managed by a Expert who will be well aware of the

Real Estate Market.

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WORK STRUCTURE OF REIT

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GLOBAL COMPARISON OF REITs IN KEY ECONOMIES

Globally, framework for REIT exists in several countries including United States of

America, Australia, Singapore, Japan, France, United Kingdom, etc.

The regulations governing a REIT framework plays an important role in determining its

success in any country. A comparison of REIT regulations across major countries is presented

below:

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A detailed comparison of Indian REITs with Singapore REITs is given below.

Type India Singapore

Legal Structure Trust, with Trustee, sponsor (s) and manager Trust with Trustee, sponsor (s) and manager

Manager Manager has to be an external company Manager has to be an external company

Identification of

Assets

A REIT has to identify assets prior to making

offer to public of units.

A REIT has to identify assets prior to making

offer to public of units.

% of under

construction assets

allowed

Investments in developmental assets not

more than 10% of gross asset value of the

REIT which have to be held at least 2 years

after completion.

The total contract value of property

development activities undertaken and

investments in uncompleted property

developments should not exceed 10% of the

property funds deposited property.

Further, such investment in permitted only if

the REIT intends to hold the developed

property upon completion.

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Such funds are

allowed to be listed?

Yes, Mandatory Yes, but not mandatory

Activities permitted At least 75% of value of the REIT assets

proportionately on a consolidated basis shall

be rent generating.

At least 75% of the deposited property

should be invested in income-producing real

estate

Not more than 10% of revenue from sources

other than rental and other specified sources.

Income

Distribution

At least 90% of its net distributable

income after tax to be distributed.

If capital gains from sale of

property proposed to be re-invested

in another property, no distribution

required. If not proposed to be re-

invested, 90% of the capital gains to

be distributed.

At least 90% of its taxable ordinary

income to be distributed in the same

financial year as it is received to

qualify for tax transparency.

Not required to distribute capital

gains.

Permissible

investments

Real estate assets (freehold or

leasehold) includes assets incidental

to ownership and operation of such

real estate assets (Only Indian

assets). Investment may be directly

in the properties or through an SPV

controlled by the REIT having at

least 80% of their assets in real

estate. A REIT is not allowed to

invest in units of another REIT.

Listed or unlisted debt of investee

companies/mortgage backed

securities. Investment also allowed

in equity shares of companies listed

on a recognized stock exchange in

India which derive not less than

75% of their operating income from

Real Estate activity

Government Securities and Money

Real estate, whether freehold or

leasehold, in or outside Singapore.

An investment in real estate may be

by way of direct ownership or a

shareholding in an unlisted special

purpose vehicle (“SPV”) constituted

to hold or own real estate. An

investment in another property fund

that is authorized will be considered

as an investment in real estate;

Real estate-related assets (listed or

unlisted debt securities and listed

shares of or issued by property

corporations, mortgage-backed

securities, other property funds, and

assets incidental to the ownership of

real estate (e.g. furniture) wherever

the issuers/assets/securities are

incorporated/located/issued/traded;

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market instruments/Cash

equivalents

Investments in developmental assets

not more than 10% of gross asset

value of the REIT which have to be

held at least 2 years after

completion.

Investment also allowed in listed or

unlisted debt securities and listed

shares of, or issued, by local or

foreign non-property corporations;

Government Securities (issued on

behalf of the Singapore Government

or governments of other countries)

and securities issued by a

supranational agency or a Singapore

statutory board and cash and cash

equivalent items.

Investments in uncompleted

property developments not

exceeding 10% of the property

funds deposited property subject to

holding of the developed property

upon completion.

Concentration of

investments

Minimum 2 projects with not more than 60%

of the value of the assets, proportionately on

a consolidated basis, in one project.

No minimum limit on no. of

projects.

except for non-real estate

investments (5% in any one issuer's

securities or any one manager's

funds)

For Listing – Not more than 30% of

gross assets invested in unlisted

securities

Restrictions on

Shareholding

At least 25% of the REIT's

outstanding units must be held by

public at all times post-listing with

at least 200 public unit holders.

Minimum Investment of Rs. 2 lakh

per investor

Trading lot size of Rs. 1 lakh in the

If listed, at least 25% of the REIT's

share capital or units is held by at

least 500 public shareholders

No minimum investment limit per

investor.

No minimum trading lot size.

No restriction on maximum

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secondary market

No restriction on maximum

shareholding

Approval of unit holders required if

shareholding of a non-sponsor

crosses 50%.

shareholding

Takeover code applies.

Maximum

Gearing Ratio

Maximum 50% of the aggregate

gross asset value on a consolidated

basis, with requirement of credit

rating and unit holder approval post

25%

60% (with credit rating) 35%

without credit rating

Regular Disclosure

requirements

Annual and Half yearly disclosures

Disclosures in initial offer

document/follow-on offer

document/other offer document

Regular disclosures in terms of the

listing agreement with the

exchanges

Event-based disclosures

Disclosures for related party

transactions.

Yearly disclosure (apart from

financials)

Disclosures in offer documents

Listed REITS must announce net

tangible assets per share or per unit

on a quarterly basis via SGXNET

and must comply with other regular

disclosure requirements in listing

rules.

Event-based disclosures

Disclosures for related party

transactions

Valuation of assets Assets to be valued fully (including

site inspection) by an independent

external valuer on a yearly basis.

Updating required on half-yearly

basis. Full Valuation including site

inspection required for every

purchase of asset and issue of new

units.

Valuer to be registered valuer under

Companies Act, 2013 and valuation

in accordance with International

Full valuation of real estate assets at

least once a financial year and may

be required in case of issue of new

units/redemption of units.

The Valuer must be independent,

reputed, be authorized under any

law of the state or country where

the valuation takes place to practice

as a valuer.

For related party transactions, two

independent valuations required

with one of the valuers

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Valuation Standards/ICAI standards

In case of a sale/ purchase of assets

from a related party, two

independent valuations of those

assets to be conducted.

commissioned independently by the

trustee.

Sponsor Holding Multiple sponsors allowed, subject

to maximum 3, where each holds

minimum of 5%.

Sponsor(s) to hold, collectively,

minimum 25% of the units of the

REIT for a period of atleast 3 years.

Minimum 15% of the units to be

held by sponsor(s) always.

Sponsor may sell stake to another

person post 3 years subject to

minimum holding of 5% and

maximum number of sponsors at 3.

Approval required from 75% unit

holders for any new sponsor/change

in control of the sponsor.

Sponsor units greater than 25% and

non-sponsor holding prior to initial

offer locked-in for a period of 1

year.

No restrictions

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DISCLAIMER*****************************************************************************This information/email sent by Mentes capital may express financial guidance but these recommendation, advice, or guidance does not account for specific and particular financial goal and any suggestions, opinions conclusions stated in this information/email endorsed by us unless it is assigned. Mentes capital does not warrant the accuracy of any such information or appropriateness of any transaction. The information through this electronic communication and any attachments are for informational purposes only and no circumstance should they be affirmed as an offer to sell or a solicitation to buy any of Mentes products or any such reports. Risk of loss can be of any amount on this investment. You should take all the precaution while trading and investing is suitable for you in light of your experience, goal and other relevant circumstances. Mentes capital and its associate, employees, partners, subsidiary branch shall not be liable for any losses incurred by you. Trading and investments in financial markets are subjected to market risks therefore advised to seek professional support. There is no guarantee/assurance as to returns, capital protection and appreciation. It’s the sole responsibilities of the investors and traders for any decision taken by them. Any information in the email attachment is for recipient personal and confidential use. It is affirmed that dissemination, distribution or copying this information is strictly prohibited. There is a risk of modification in the information due to electronic nature of email. It’s not guaranteed that messages are virus free, malicious code. We are not liable for virus free. Please contact your relationship manager for more information on these risks. Past performance of actual trades or strategies cited herein is not necessarily indicative of future performance.For detail disclaimer go to our website www.mentescapital.com.

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