Legal Aspects Of Real Estate Investment Trusts
Author: LawSphereX
Category: Property & Real Estate
Published:
Updated:
LEGAL ASPECTS OF REAL ESTATE INVESTMENT
TRUSTS
Vaishnavi Sarraff & Suzanne Siddiqui, Symbiosis Law School, Nagpur
ABSTRACT
This article deals with the deep analysis of various subjects regarding Real estate. It gives a description of the definition of REITs and how they work. The evolution of REITs is being described as well as the pros that REITs provide towards the economy. The current study examines the various literature reviews and the risks pertaining to Real estate by studying the content. The study also covers the detailed meaning of the variables contained in the topic and respectively different chapters have been made. The article emphasizes the main research objectives which are to determine laws pertaining to REITs and whether investing in real state is a boon or bane for the society and for the investors.
The Securities and Exchange Board of India (SEBI), the regulatory authority overseeing the country's securities market, has actively pursued the development of innovative financing models in recent years. However, its initial attempt to introduce REITs in
2007 did not reach completion. Likewise, SEBI's second effort in 2008 to
establish a REIT regime in the form of REMFs also encountered challenges due to a lack of investor interest. This paper examines the proposed REIT regulations, identifies their limitations, and suggests strategies to attract more investors to this innovative financial instrument. The aim is to foster rapid and sustained growth in India's housing and real estate sector, thereby contributing to the overall economic development of the nation. Further, the topic covers the other research question regarding the growth of housing and real estate industries in India. The two main objective questions are being dwelled into and researched thoroughly. Various literature has been looked into and deciphered the problems pertaining to real estate, the problems are further been considered and studied and on the basis of problems the objective of the study is made.
After refereeing to various sources and tackling the problem in the literature review, a conclusion is derived from the overall study and on the basis of precedents and the research suggestions are made which can be considered as an essential element in the future research on REITs. Keywords: Real estate, REITs, SEBI, investment assets Chapter 1 Synopsis History Apart from all the ways to invest in the market real estate has proved to be the most efficient way in the global market. REITs provide a bigger picture and exposure by providing investment instruments with flexibility. Initially, the REITs emerged in the United States as an incomegenerating method for people but later with the passage of time it got evolved and continued to grow over the past sixty years. In fact, many countries have experienced a stable growth of REITs and have contributed to the country’s economy.
In the present as well. REITs continue to catch the attention of investors in different countries for various developments itself and have the enough potential to grow even further. Introduction REITs form a category within innovative as well as structured finance transactions which are differentiated by their personalized nature and thus there is an absence of specific definition. Before the coming of REITs in the United States before 1960, and trying to enter into the real estate market, they needed to acquire tangible property from the market. In India, REIT is defined as a major and important component of a business trust as per section 13A of the Income Tax Act, set up in the form of a trust. On the other hand, the corporate sector in India is witnessing fleet expansion, which is increasing demands in the market.
This growing corporate sector enhances the necessity for leased structures, shopping complexes, residential areas, and other communal spaces, eventually augmenting investments in real estate. Before 2014, India failed to make or perform a proper and systematic approach to real estate investment within the country. Initially, people used to either rent or purchase buildings whereas investors often relied on loans from banks and other financial institutions. Responding to this, the “Securities and Exchange Board of India” (SEBI) came up with the concept of Real Estate Investment Trusts (REITs) in 2014, with the purpose to revolutionize the fragmented trails of the real estate landscape in India.
India’s diversity resulted in difficulties characterized by obligations ranging from acquisitions to disposals, which posed challenges for making a planned framework for real estate markets in the country’s economy. Nevertheless, with the introduction of new regulations, investors now could enjoy the advantages of both stabilized returns and market value appreciation within a regulated and transparent environment by placing their funds in listed REIT units. As per the “National Association of Real Estate Investment Trusts”, real estate investment trusts, commonly referred to as REITs, are companies involved in the ownership or financing of income-generating real estate across various property sectors.
These entities undergo official registration with the Securities Regulator, compelling them to comply with specific eligibility criteria, capital adequacy standards, and the listing of their debt or equity securities on a recognized stock exchange. Additionally, REITs often provide people with a readily tradable interest in real estate, resulting in benefits from special tax considerations and commonly offer attractive and high dividend yields. Nevertheless, REITs persist as an effective avenue for capital raising and furnish investors with a practical exit strategy. Risks About REITs REITs vary from country to country and so do their regulations. There are many REITs across different countries that have seen serious downfalls and have resulted in a decreasing number of investors due to a lack of trust and fear from the investors.
For example, during the COVID-19 pandemic, there was a significant decline in the performances of REITs in 39 countries. Still, in many countries, REITs are still growing and are not fully mature which has a direct impact on the minds of the investors because the REITs are risky and nature investors may tend to invest their resources in the REITs which yield high profits. Literature review This part of the article lays down the emphasis on the sources that have been referred to for the topic “Legal aspects of real estate investment trust”. Many sources have been referred which consist of law journals, articles and law firm publications. The sources referred to are listed below:- • In the law journal Legal Analysis of Real Estate Investment Trust Regulation In India1 many detailed information regarding the REITs has been given.
It states the emergence of REITs in India and also the meaning, usage and the act involved. A business trust, association, or
1 Amit Kumar Kashyap and Vibhore Batwara; Brics Law Journal (2022)
corporation that was primarily formed to own or finance real estate is known as a REIT. Like most corporations, the REIT is managed by qualified managers or advisors on a day-to-day basis, with policy being set by a board of directors or trustees chosen by shareholders. Many REITs are organized by individuals with real estate experience, such as mortgage bankers or real estate brokers. • Research Trends and Directions on Real Estate Investment Trusts’ Performance Risks (MDPI)2 The article mainly focuses on the varied aspects of REITs in India as well as in different countries. It mentions the past, recent and future trends of the REITs across the globe. The article also provides the readers with statistical data relating to the growth as well as the downfall of the REITs.
The article lays down the emphasis on how REITs can be a disaster for one country and can affect the economic condition of that country. People broadly just view REITs as profit generating entities that can also help in the country’s overall development but on the contrary, the other side of REITs is unexplored. They can also emerge as magnanimous risks for people and can render the country’s development. The articles mentions the history and background of the REITs and how they emerged in today’s world. It has laid down the emphasis on the importance of REITs and how one should start to invest in the same. The article also has deeply analysed the mindset of the people at large relating to the willingness to invest in sectors like REITs.
• Real estate investment trust returns: Predictability and Determinants3 The journal mainly talks about the shareholders and it mentions the findings of the National Association of Real Estate Investment Trust (NAREIT). According to the report, a Genuine Bequest Speculation belief (REIT) is a substance that's created to channelise the stores that may contribute to operational working or possession of the genuine domain to assist in producing salary for the financial specialists A business trust, organisation, or corporation that was primarily formed to own or finance real estate is known as a REIT. Like most organisations, the REIT is managed by qualified managers or advisers on a day-to-day basis, with policy being defined by a board of directors or trustees chosen by shareholders.
2 Chioma Okoro and Marie Mangwi Ayaba; MDPI (2023)
3 Helen X.H. Bao, Pu Gong, Boli Yang; JSTOR (2015)
Statement of Problem In this particular article, there are references to various sources and the information which are already exists and discovered. A deep analysis of various sources has helped in the integration of facts in this article on REITs. However, there are some issues and areas which are not profoundly looked at or researched. Some findings from the previous sources suggest that there is still scope for advancement in the field of REITs. As the profits and benefits of REITs are already known and stated, yet there is no major discovery or investigation done about the risks and downfall of REITs, no precise data is framed for the above contention. The primary categories include Mortgage and Equity REITs and in spite of their advantages, REITs come with certain limitations as well including no assurance of asset distribution.
The theory of REITs is broad and so the its types, but there is no such clarification about the differences among the types especially for common people, there is no peculiar awareness about different kinds of REITs. Further, the limited data on REITs are still questionable as there are only three registered in India till now. The first was listed on the 1st of April, 2019, representing challenges with other structured financial existing entities. Objectives 1. To determine and analyse the laws relating to Real estate investment trusts. 2. To suggest recommendations on how to make REITs useful to assist the growth of housing and real estate industries in India and to determine various kinds of REITs. Research Questions 1. What are the laws existing in the context of REITs? And are there advantages or disadvantage for REITs in the Indian market? If yes, then how? 2.
What could be the desired recommendation in the purview of growth of the housing and real estate industries in India? Hypothesis This research deals with the various types of Real Estate Investment Trust. The articles deal with the problems which are an obstacle to the development of REITs. The study deeply analyses the problems and the preconceived notions about the topic that have been already in the public domain. Further, the articles suggest the different approaches that can be helpful to overcome the problems faced. Chapter – 2 Study of Variables • Real Estate Real estate, classified as physical assets, comprises land along with any permanent structures or installations on it, regardless of whether they are naturally occurring or human-made. It is typically categorized into five main types: residential, commercial, industrial, raw land, and special use.
Investment avenues in real estate span from purchasing residential properties, and rental units, to land parcels. Alternatively, individuals have the option to indirectly invest in real estate through Real Estate Investment Trusts (REITs) or by joining pooled real estate investment initiatives. • Types of Real Estate 1. Commercial: Property that is acquired to earn profit like hospitals, stores, theatres etc. 2. Industrial: Property that is acquired with an aim to produce or manufacture goods or for the purpose of research and development. 3. Land: Grounds, vacant property, houses etc. 4. For some special purpose: Public properties like temples. • Investment Investment is basically the method of generating money by using the money in some asset. There are various types of investments but the motive is the same to gain profit in future.
Investing involves committing capital now with the aim of increasing its value in the future.
Investing requires dedicating resources like time, money, and effort, anticipating a higher return in the future than the initial outlay. The Investments usually do not assure appreciation and may result in a lower sum than the initial investment. Diversifying investments is a prevalent tactic for risk reduction, although it may also reduce potential earnings. § How it works The objective of investing is to generate income and gradually increase value, utilizing various approaches such as acquiring “bonds”, “stocks”, or “real estate properties”, among others. In general terms, any endeavour pursued with the expectation of enhancing future revenue is categorized as an investment. For instance, pursuing further education to improve knowledge and skills falls within this realm.
The initial investment of time in attending classes and money for tuition fees is projected to result in higher earnings throughout one's career. Since investing is centred on the potential for future growth or income, it inherently carries risk. An investment may fail to generate income or even depreciate over time. For example, a company in which you invest could declare bankruptcy. Similarly, the field in which you invest time and money to obtain a degree may lack a robust job market. § Different types of investment • Stocks A share of stock symbolizes a stake in either a publicly traded or privately held company. Owning stock offers investors the opportunity to potentially receive dividend payments stemming from the company's profits.
Furthermore, as the company progresses and garners more interest from prospective investors seeking to acquire its shares, the stock's value may increase, providing the potential for capital gains upon sale. Conversely, the stocks that are preferred often take precedence in receiving dividend payouts and must be settled before dividends are distributed to holders of common stock.
§ Bonds A bond represents an investment requiring an initial upfront commitment, followed by periodic payments throughout its duration. Upon maturity, investors receive the principal amount initially invested in the bond. Comparable to debt instruments, bonds serve as a means for specific “entities” to raise capital. Various government bodies and corporations “issue bonds”, enabling “investors” to provide funds in exchange for earning a yield. § Real Estate Real estate investments usually involve investing in tangible, physical properties that fulfil diverse needs. Land can be developed, office buildings occupied, warehouses used for storage, and residential properties utilized for housing. Real estate investment strategies may include acquiring raw land, developing land for particular purposes, or buying fully operational properties.
In some instances, real estate investments can involve ventures that produce commodities. For example, investors might explore farmland investments where, apart from capitalizing on land value appreciation, they can also generate returns from crop yields and operational income. § Commodities Cryptocurrency, a form of blockchain-based currency, serves as a means to conduct digital transactions or store digital value. Companies involved in cryptocurrency can issue coins or tokens, which have the potential to increase in value over time. These tokens facilitate transactions within designated networks or cover transaction fees. This involves investors locking their tokens on a network to aid in transaction validation, leading to rewards in the form of additional tokens.
Additionally, the emergence of cryptocurrency has paved the way for decentralized finance, a digital aspect of finance enabling users to “lend”, “leverage”, or “utilize currency” in various alternative ways. § Collectables Engaging in collectables investment, which is considered less conventional, entails acquiring rare items with the anticipation of their demand appreciating over time. The fundamental principle behind collectables investment mirrors that of other forms of investment like equities. Both approaches foresee a surge in popularity for a specific asset in the future. For example, although a contemporary artist may presently lack widespread recognition, shifts in global trends, artistic preferences, and market dynamics could lead to heightened interest in their work over time, potentially elevating its worth.
• Risks At its core, there is a fundamental interplay between investment returns and risk. Generally, investments characterized by higher risk levels are anticipated to generate greater returns, whereas safer investments typically yield lower returns. When individuals deliberate on investment choices, they must evaluate their own risk tolerance, a factor that varies from one person to another. Some may be willing to embrace the possibility of losing their principal in pursuit of higher profits, while others prioritize safeguarding their capital and select safer options that promise steady albeit slower growth. The connection between investments and risk is frequently shaped by the unique circumstances of an individual's life. As individuals approach retirement, the stability of their income wanes, leading them to shift towards safer investment avenues.
Conversely, young professionals, who have a longer timeframe to recover potential losses, often lean towards riskier investment prospects. • Trusts A trust, functioning as a legal entity with its own rights, resembles the legal status of a person or corporation. Within a trust arrangement, the trustor grants authority to another party, the trustee, to hold title to and oversee property or assets on behalf of a third party, known as the beneficiary. Establishing trusts serves to provide legal protection for the trustor's assets, ensuring their distribution aligns with their intentions. Furthermore, trusts offer the potential to streamline administrative processes, reduce paperwork, and occasionally lessen inheritance or estate taxes. Moreover, trusts can be structured as closed-end funds operating as public limited companies.
Explore further insights into trusts and their utilization in safeguarding assets for beneficiaries. § Different categories 1. Living It is also known as an “inter-vivos” trust, which is a formalized arrangement in which people’s properties are kept aside in a trust for their own benefit during their lifetime. Upon creation of the trust, a trustee is designated to oversee its management and allocate the assets to the beneficiaries upon the grantor's passing. 2. Revocable and Irrevocable A revocable trust allows the trustor the freedom to make changes or terminate it during their lifetime. In contrast, once set up, an irrevocable trust remains unchanged. Testamentary trusts” are generally established as irrevocable, though they can become revocable through a will if the grantor is alive.
The permanence of these trusts, with assets permanently transferred from the trustor's ownership, aids in minimizing or avoiding estate taxes. 3. Funded A funded trust holds assets provided by the trustor while they are alive, whereas a trust that is not funded is only made up of the trust agreement without any assets. Unfunded trusts may receive assets after the trustor's death or may remain without funding. However, the trusts that are not funded are exposed assets to risks that trusts aim to mitigate, so ensuring proper funding is essential. Chapter - 3 Research Question 1: What are the laws existing in the context of REITs? And are there advantages or disadvantage for REITs in the Indian market? If yes, then how?
Real estate is the future of India as it serves as the one of the largest employment providing sectors after agriculture and will continue to grow by a significant percentage in the next 10 years. It has gained the interest of many Indians but still remains to be organised properly due to a lack of regulations and other major parameters. The regulations passed by the SEBI in 2008 were never enforced properly. During this period, REITs have spread globally, starting from the USA in the 1960s, Australia in the 1970s, and numerous other nations during the 2000s. Again, in 2013, there was a hope to establish REITs in India but the taxes were vague in nature. The amendment of 1961 in the Income Tax Act established regulations for the functioning of REITs in India. In India, REITS are governed by SEBI (Security and Exchange Board of India).
It has introduced regulations concerning small and medium real estate investment trusts (REITs), stipulating that investment managers for these REITs must maintain a minimum net worth of ₹20 crore. Furthermore, the regulations outline that REITs are authorized to raise a minimum of ₹50 crore from at least 200 unit holders. In May of last year, the market regulator published a consultation paper concerning small and medium REITs, aiming to integrate unregulated fractional ownership platforms under its oversight. In November, it greenlit the introduction of these REITs, although the detailed framework has just been issued. Fractional ownership entails several individuals pooling resources to jointly acquire and own predominantly commercial rental properties in India.
• Some essential requirements for registration – (a) Ensuring the trust deed is duly registered in India under the provisions of the Registration Act, 1908. (b) Mandating that the primary objective of the trust deed aligns with engaging in REIT activities in accordance with REIT Regulations. (c) Incorporating the responsibilities of the trustee, as outlined in REIT Regulations, into the trust deed. (d) Specifying that the Sponsor, Manager, and Trustee are distinct entities. (e) Guaranteeing equal rights among all unit holders without any preferential treatment, with only one class of units. (f) Confirming that all involved parties in the REIT are deemed fit and proper individuals or entities. • How can a person invest in a REIT? People interested in REIT can draft an application regarding subscription in the commencing REITs.
Afterwards, with the completion of the issuance of units, people can invest in REITs just like investing in the shares of different companies. • Advantages of REITs: § Returns Investors tend to invest in assets that are capable of higher returns. REITs are a good example of an investment approach that can provide great returns to investors in the long term. It helps people to grow their investments slowly without much disturbance. § Source of stable income According to the law, there is a mandate of distributing 90% taxable income to the people who possess shares as bonuses which offers a great and stable source of income to the investors. The consistent distribution of dividends is highly appealing to investors prioritizing income, particularly retirees in search of dependable streams of passive revenue.
§ Accessibility REITs provide various options to people with respect to vast varieties of real estate portfolios. Not like the earlier methods of investment in which investors were required to invest a lot of time but now, REITs make it possible for investors to look at a variety of options of real estate like residential and commercial and many others even without any prior submission of capital. This can be termed as a better version of single markets without risks pertaining to investments. • Disadvantages of REITs: § Market sensitivity While diversification provides benefits, REITs remain exposed to market fluctuations. Economic downturns or changes in interest rates can impact the value of real estate assets and consequently affect REIT performance.
Investors should expect potential volatility, which may require adopting a long-term investment strategy to manage through market fluctuations. § Returns to interest rates The Reserve Bank of India (RBI) periodically alters the repo rate, which in turn impacts interest rates. These changes directly impact the returns generated by REITs. Generally, as interest rates increase, the value of REIT stocks tends to decline, while REIT values often rise when rates decrease. § Implications of taxes While REITs provide tax efficiency for investors, it's important to take into account specific tax considerations. Typically, dividend income from REITs is taxed from the people’s income sources, which could be higher than the capital gains tax rate. Furthermore, not all dividends received from REITs qualify for preferential tax treatment.
It's recommended that investors consult with tax professionals to fully understand the exact tax implications of their REIT investment. Chapter - 4 Research Question 2: What could be the desired recommendation in the purview of the growth of housing and real estate industries with respect to different kinds of REITs in India? Housing scarcity poses a significant challenge in India, particularly due to the substantial investment required in the housing and real estate sectors, especially in the economic housing segment. The relatively low percentage of Mortgage to Gross Domestic Product (MGR) underscores the importance of recognizing the substantial potential for economic development inherent in housing and real estate investments. These sectors are intricately linked to over 269 other industries, highlighting their profound impact on economic growth.
The stability of the housing sector lies in its direct contribution to the economy through real estate investment, which not only generates revenue and employment opportunities but also stimulates increased business activity. Numerous studies have unequivocally demonstrated the positive impact of housing on the economic development of nations, with the housing and real estate sector playing a pivotal role in global economic progress. India, undergoing growth and development, is no exception, with studies revealing the significant economic and social ramifications of housing. A survey conducted by the National Building Organization (NBO) revealed that the construction of 2 million housing units annually could create an additional 10 million man-years of indirect employment.
Housing also boosts the real purchasing power of the economy, leading to progress in industries such as consumer durables and domestic appliances. Notably, rural housing should be prioritized as an additional engine for fostering rapid rural prosperity and income growth. Rural housing scarcity is particularly acute in India, with an estimated shortage of approximately
43.90 million units, compared to 18.78 million in urban areas. Regardless of geographical
location, there is a pressing need to prioritize housing for the poor, as the majority of housing shortages affect this demographic. Initiatives such as "affordable housing" and "low-income housing" need to be promoted to ensure inclusive and balanced development. Conclusion From the above study on the main topic, various issues regarding REITs have been unravelled. The initiation of the share-to-unit exchange in REITs does not constitute a trading transaction itself; instead, the financial aspect falls under VAT responsibility. The government may consider exempting this transaction from VAT. Alongside alteration costs, stamp duty and registration charges are obligatory. At the outset, transferring assets may also be exempt from stamp duty when surrendered to a REIT or an SPV owned by a REIT. Such exemptions have been granted.
Pass-through benefits for REITs are limited to interest and rental income, which are taxed at the investor's level. Income from capital gains and other sources is taxable at the REIT or trust level. REITs are investment vehicles that focus on real estate assets, governed by SEBI guidelines which include recommendations on listing, cash flow distribution, leverage, and investment strategies. The classification of a REIT depends on its ability to meet debt obligations timely. REITs function similarly to mutual funds, pooling investments from multiple investors into a single trust, managed by a designated manager. They invest primarily in income-generating assets such as rental properties. Registration of REITs is a necessary procedure, typically involving sponsors, trustees, and investment managers. The trustee holds REIT assets and ensures compliance with regulations.
Each entity—sponsor, trustee, and investment manager— plays a distinct role; for instance, sponsors establish REITs and appoint trustees. Suggestions There should be more detailed inquiry on the topic and deep analysis to be done as there are many profits discovered in the context of REITs but no such major information regarding the risks pertaining to REITs is present. Because REITs also have backdrops and challenges that should be administered and should be brought under the public domain. There shall also be certainty with respect to the distribution of the assets and profits from REITs as they are still unclear. Types of REITs are mentioned but still, there is vagueness among the public, so the government should come up with certain programs or workshops to inform people about the various aspects of REITs.
Further, there is not enough data available on REITs so, more research should be done to understand the real aspects of REITs with the help of statistical data.