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REITs need to take concerns about India’s real estate sector into account

DeekshaSinghSome days ago, the Securities and Exchange Board of India (“SEBI”) issued a Consultation Paper on the Draft SEBI (Real Estate Investment Trusts) Regulations, 2013 (“Draft Regulations”). The SEBI had first issued draft regulations relating to setting up of REITs in 2008. Now with the current proposal, it is looking to provide impetus to the real estate sector.

REITs were created in 1960 in the United States to give investors the opportunity to invest in the real estate sector, which is a high-yield sector, using liquid securities. This allowed them to access this sector in the same way that they would invest in other asset classes. There are different types of REITs, classified on the basis of their investment strategy.

What_are_REITsThe Draft Regulations envisage trusts registered with the SEBI that invest in real estate assets, being operated by a manager, appointed by the trustee. They can invest in properties directly or through special purpose vehicles, but only in assets based in India. The Draft Regulations also specify the manner in which the units by the REITs can be issued and listed. You can read more about the proposed structure and guidelines for the kind of REITs that SEBI will permit in India, here.

A reading of the Draft Regulations indicates that the SEBI has given due importance to transparency to ensure that investors can invest through these vehicles with a complete picture of the risks and rewards involved. However, even if it enacts these Draft Regulations, both Real Estate Investment Trusts (“REITs”) and investors will need to take into account some of the concerns plaguing the Indian real estate sector.

Foremost amongst these is the lack of clear title in most real estate transactions in India. Before investors can be brought in to invest in these real estate assets, REITs will need to ensure that sound due diligence is conducted on each of these assets.

Grading system?

Securities-LawA possible solution lies in the implementation of a grading system. The assets that form part of a REIT’s corpus must be mandatorily graded before it can issue and list units. This system should not only take care of the valuation of assets, but also be used to establish a clear and marketable title. These assets should only be deemed investment-grade if these stringent requirements are satisfied. Thus, while there will be no reduction of the obligation on investors to go through the disclosures carefully before investing, a grading system will help ensure that issues specific to the real estate sector in India are taken into account.

The SEBI will need to revise the Draft Regulations to provide mechanisms to account for issues specific to the real estate sector in India. The Draft Regulations are open for comments from the public till October 31, 2013.

(Deeksha Singh is part of the faculty on myLaw.net.)