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Context

• NSE Indices Ltd - a subsidiary of the National Stock Exchange (NSE), has launched India’s first-ever Real Estate Investment Trusts (Reits) and Infrastructure Investment Trusts (InvITs) Index.

NSE: https://www.iasgyan.in/daily-current-affairs/national-stock-exchange

About the Index

• Nifty REITs and InvITs index aim to track the performance of REITs and InvITs that are publicly listed and traded on the NSE.
• The weights of securities within the index are based on their free-float market capitalization subject to a security cap of 33% each. The average weight of top 3 securities is capped at 72%.
• The Nifty REITs and InvITs Index has a base date of July 1, 2019, and a base value of 1,000. The index will be reviewed and rebalanced on a quarterly basis.
• The launch of the Nifty REITs and InvITs Index aligns with NSE’s vision to provide market representative benchmarks for different asset classes.
• It will track the performance of publicly listed REITs and InvITs and act as a benchmark for active funds. 

What is Free-Float Market Capitalisation? Market capitalisation is the measure of a company’s outstanding shares multiplied by the price of each share. For instance, a company with 25000 outstanding shares at Rs. 40 each will have a market cap of Rs. 10 lakh. The size of market capitalisation for a company enables its categorisation into small-cap, mid-cap and large-cap classes. However, free-float market capitalisation is a different concept altogether. In standard market capitalisation, the calculation involves determining the total number of outstanding shares, including both public and privately owned ones. However, in free-float market cap method, the valuation of a company relies only on the outstanding shares held publicly. This share number is then multiplied with the price for each share. In this entire calculation, privately-owned shares are excluded. Therefore, shares owned by trusts, government bodies and promoters are ignored. This also indicates that the value of a free-float market capitalisation would always be lower than the company’s actual market capitalisation value. Free-float market capitalisation is also known as float-adjusted capitalisation. Example: The National Thermal Power Corporation has 120000 outstanding shares, out of which 30000 are publicly owned. The remaining 90000 shares are held by different government entities. The price of each share is Rs. 90. From this information, one can derive the market cap and the free-float market cap of the company. Market capitalisation – 120000 x 90 = Rs. 10800000 Free-float market capitalisation – 30000 x 90 = Rs. 2700000. Advantages of Using Free-Float Market Capitalisation Free-float market cap method of evaluating an index is preferred for the following reasons – Presents a practical picture Total market capitalisation method considers both the shares currently available, as well as those presently locked-in. Nonetheless, the free-float system only considers the number of shares that are currently available in the market for trading. Thus, this process is a more useful metric when it comes to judging the true picture of an enterprise. No distortion of valuation Market capitalisation of large-cap companies can fool investors into thinking that its shares are readily available for trading when the reality is different. Some of the businesses achieve large-cap, but most of their shares remain locked in since they are owned privately. With the free-float market cap, broad-based indexing is possible. This minimises the concentration of such companies with large market cap values. Market-driven methodology This calculation process eliminates companies that only have a minimal amount of shares available for trading in the market. Therefore, investors can locate businesses where they can park their excess funds by buying public shares using this valuation technique easily.

What is REIT?

• A Real Estate Investment Trust (REIT) is an investment instrument that offers proportionate ownership of an income-generating real estate asset to retail investors.
• A REIT is a company that owns and typically operates income-producing real estate or related assets.
• In simple language, it is a company that allows individuals to invest in large-scale, income-producing real estate. These may include office buildings, shopping malls, apartments, hotels, resorts, self-storage facilities, warehouses, and mortgages or loans.

Why would somebody invest in REITs?

• REITs provide a way for individual investors to earn a share of the income produced through commercial real estate ownership – without actually having to go out and buy commercial real estate.

REITs- the genesis

• REITs are more than 50-years-old and were originally devised in the United States in 1960 under the Cigar Excise Tax Extension Act. The first REIT was listed on the New York Stock Exchange in 1965.
• In the coming decades, similar instruments debuted on European, Japanese, and Australian stock exchanges.

Evolution of REITs in India

• Historically in India, investors have been investing in real estate by purchasing a property or land via real estate developers and property brokers.
• In such investments, investors had to rely on long-term market value appreciation of the property to generate a return on investment. This, however, was only possible when real estate markets would be on an upswing.
• Developers also had to fund projects by sourcing money through loans from banks, Private Equity firms, etc and this usually meant high-interest rates.
• In 2008, the Security and Exchange Board of India (SEBI) came up with draft guidelines that allowed investors to establish REITs as an asset class. The intent was to make it easier for foreign investors to invest in the Indian real estate market and make funding easily available for local developers.

How do REITs work?

The flowchart below shows the basic process of a REIT transaction:

Unitholders

Investment in REIT ————-> <————- Distributions

REIT

Ownership of assets ————> <————- Net property income

Properties

Buy/sell property ———-> <———-

Sponsor

How Does a Company Qualify as a REIT?

To qualify as a REIT, a company has to meet specific requirements as mentioned below.

• • The entity needs to be structured as a business trust or a corporation.
  • Extends fully transferable shares.
  • Is managed by a team of trustees or a board of directors.
  • Must have a minimum of 100 shareholders.
  • Less than 5 individuals should not have held 50% of its share during each taxable year.
  • Is required to pay at least 90% of the taxable income as a dividend.
  • Accrue a minimum 75% of gross income from mortgage interest or rents.
  • A maximum of 20% of the corporation’s assets comprises stock under taxable REIT subsidiaries.
  • A minimum of 75% of investment assets must be in real estate.
  • A minimum of 95% of REITs total income should be invested.

Taxation on REITs

Investors must consider the below points about taxation on REITs before investing in them:

Income from sale of REIT units

1. Capital gains from sale of Indian REIT units are subject to short-term capital gains tax at 15% if held for less than one year. 
2. Units held for more than three years (36 months) are subject to (Long Term Capital gains Tax) LTCG tax at 10% if they result in an income over Rs.1 lakh. 

LTCG: https://www.iasgyan.in/daily-current-affairs/ltcg

Additional points on taxation:

1. Interest income from REITs is taxable. 
2. Dividend income from REITs is taxable depending on the REIT’s special tax concession status. 
1. If a special tax concession has been obtained, dividend income is taxable in the hands of the investor. 
2. If not, dividend income is not taxable. 
3. Income from the amortization of Special Purpose Vehicle (SPV) debt is not taxable in the hands of the investor.

Pros and Cons of Investing in REITs

Performance of REITs in India

Windmill Capital Report

• India recorded 6.85 percent year-on-year (YoY) growth in the total leasable area of listed Real Estate Investment Trust (REITs), an increase from 87.6 million square feet (msf) to 93.6 msf between September 30, 2021, and September 30, 2022.
• Bengaluru continues to dominate the REITs market with 27.8 msf of the total leased area under REITs as of September 30, 2022.
• Noida witnessed exponential growth in the total leasable area under REITs from 7.4 msf to 11.9 msf registering 60.81 percent YoY growth.
• REIT as an asset class has performed better than BSE Sensex, the Realty Index and most of the small, mid and large-cap mutual funds.

Scope

• There is ample potential for more space being added to the existing REITs or the listing of new REITs.
• The asset class presents itself with tremendous opportunity and growth to all class of investors.
• Despite pandemic, REITs have delivered promising performance and are on growth path.
• Recent performances of REITs have shown that they have the potential to deliver value for all the stakeholders including investors, sponsors, trustees etc. Therefore, this relatively new asset class presents tremendous opportunity to investors.

Decoding Infrastructure Investment Trusts (InvITs)

• Infrastructure Investment Trusts (InvITs) are investment instruments that work like mutual funds and are regulated by SEBI.
• Typically, such a vehicle is designed to pool money (small sums) from several investors to be invested in income-generating assets.
• InvITs are mostly structured as trusts, and an independent trustee holds assets on behalf of unitholders.
• InvITs could be set up for sectors defined under the infrastructure as per RBI guidelines. So far, developers engaged in the road, power transmission, gas pipelines and tower transmission have formed InvIT.

REITs Vs. InvITs

• Infrastructure Investment Trusts or InvITs are structurally similar to REITs but the difference lies in the fact that while REITs own and operate office space, InvITs operate infrastructure.
• Infrastructure in this case includes but is not limited to roads, bridges, dams, power grids etc.
• While InvITs can be publicly listed, private listed or private unlisted, REITs must be publicly listed.

How do REITs and InvITs operate?

• A REIT/InvIT is established as a trust settled by the sponsor under the Indian Trusts Act, 1882 and the trust deed registered in India under the Registration Act, 1908. Also, a Certificate of Registration as REITs and InvITs needs to be obtained from SEBI. 
• There are various parties involved in REITs and InvITs, such as a sponsor, trustee, and investment manager.
• Distributions by REITs and InvITs are based on Net distributable cash flows (NDCF), unlike companies where dividends are based on profits.
• NDFCs are declared and made at least once every six months for publicly offered REITs and InvITs and once a year for privately placed InvITs.
• Investors receive periodic pay-outs of a minimum of 90 per cent of NDCF.
• However, unlike mutual funds, both InvITs and REITs also have characteristics of a business enterprise.
• While REITs and InvITs raise debt through a trustee and an investment manager, they are also actively involved in projects to maximize returns to shareholders.

Role of REITs and InvITs in driving the future of Indian infrastructure

• The Government of India launched InvITs and REITs to bring in long-term yield capital into the country and to increase private participation in infrastructure and real estate.
• The Government’s National Infrastructure Pipeline estimates a funding requirement of over US$1.4 trillion by 2025. REITs and InvITs have raised capital of over US$4 billion in India and the combined market-cap of the three listed REITs in India is over US$7 billion and over US$10 billion for InvITs. Thus, the early trends of performance of REITs and InvITs are encouraging.
• Investment of private sector of US$325 billion in infrastructure would be necessary to meet the National Infrastructure Pipeline’s estimate. In order to allow for capital recycling and further investments under PPP modes, InvITs play a key role in monetization of existing projects in some of these sectors (with conducive regulatory frameworks, cash flow profile, taxation advantage).
• The real estate sector in India is expected to reach a market size of US$1 trillion by 2030. Despite the near to medium term headwinds from COVID-19, long-term drivers for real estate demand are strong and likely to withstand current adversities. The REIT/InvIT route could potentially mitigate several investment challenges in the infrastructure sector. For example, when REIT/InvIT help developers release their invested equity and deployed capital in new projects they could enable the challenge of projects with high CapEx demands.

Note: Capital-intensive industries include automotive, airline, oil and gas, mining, manufacturing, and real estate. These companies all have to spend money on assets that are expensive. Examples of CapEx include the purchase of land, vehicles, buildings, or heavy machinery.

• Similarly, the self-amortizing nature of units provide convenient exit options to investors, thereby overcoming challenges that investors typically face with limited options.

Note: A self-amortizing loan is one for which the periodic payments, consisting of both principal and interest, are made on a predetermined schedule, ensuring that the loan will be paid off by the end of an agreed-upon term. Payments of this kind are known as fully amortizing payments. This type of mortgage is the default structure of mortgage loans unless otherwise specified. A self-amortizing loan is also known as an amortization loan.

• Besides the obvious advantages, REITs and InvITs enable efficient upstreaming of cash owing to certain regulations and the Government’s beneficial tax regime. In India, REITs and InvITs have also successfully tapped into global capital and infrastructure assets.
• InvITS and REITs will play a significant role in funding the Government’s infrastructure plans as well assist in meeting its asset monetization plans and at the same time enable deleveraging existing balance sheets which would in turn help meet the capitalization requirements of banks.
• By adopting consistency in financial reporting and by providing better transparency (benchmarking) and understandability for overseas investors REITs and InvITs could build the base for long-term success. We look forward to a new era of growth fueled by capital investment in REITs and InvITs.

PRACTICE QUESTION Q. REITs and InvITs can play a critical role in driving the future of Indian infrastructure. Discuss.

https://economictimes.indiatimes.com/markets/stocks/news/nse-indices-launches-indias-first-ever-reits-and-invits-index/articleshow/99405674.cms?from=mdr