Internationally, all mature real estate markets have successfully implemented a REIT regime.
REITs as an investment vehicle have enabled public and institutional participation in the real estate asset class through exchange-traded units while also enabling greater liquidity and funding by accessing public markets.
Internationally many institutional investors, sovereign and pension funds, financial institutions and multifamily offices are subscribers to REITs allowing them to successfully diversify their investment portfolio while also providing access to a stable income stream.
Globally, US, Australia, France, Japan and the UK are the top five markets for REITs. There are now 37 REIT markets Japan and Singapore being significant markets in the Asia region.
A key consideration for investment into REIT instruments is the returns and the yield spread with the risk-free rate of return, in most cases the bond yields on long-term government securities for that particular country.
In Singapore the yield spread average over the past 5 years has been over 400 bps, which tells the story of how the S-REITs (how Singapore REITs are referred to) with the average returns over this period from REITs being 8.4 percent (dividend yield + capital value appreciation), clearly riding clear of the global economy tantrums and major political events.
Even in 2016, S-REITs gave dividend returns of 7 percent which were higher than those in Australia and Japan.
While we may be a little far away from an actual REIT listing in India, the revisions in regulations clearly indicate that institutional as well foreign investors are being courted most aggressively for the product when it is finally listed and offered for subscription.
Currently, the Indian government’s 10-year bond yields are at north of 7.0%. Stable, income generating assets are currently trading in the 8-9% yield range. With an average capital value appreciation of 4 to 5%, REIT returns should be around 11 to 12%, a similar spread of 400 to 450 bps as seen in Singapore.
With currency hedging costs, these yields will drop by around 5 to 6%, bringing REIT yields to around 6 to 8%, which would be similar to established REIT markets and interestingly lower than Fixed Deposit rates in India.
Only investors who entered the market in 2011 and 2012 when the rental recovery was still underway and capital values had bottomed out hold enough play to ensure their REIT listings find a good market response.
It is this conundrum that will affect global investors. Also, many investors are entering the market now; with more money chasing a lesser number of core assets, property yields have dropped to 8 to 8.5% levels.
These entry levels with slower capital value appreciation and associated lease tenancy risks and relatively higher risk weight of India is likely to find difficulty in attracting foreign investors for REIT issues.
A healthy capital value appreciation amid rising rents for quality assets may still allow for REIT yields to be favourably benchmarked for some.
The current strategy being adopted by a few large institutional and pension funds of undertaking development risk by getting into brownfield development allows them this leeway that creating core assets going forward will provide them with enough headroom to offer REIT yields that will be attractive to foreign investors.
A future environment of falling interest rates and lower government bond yields will also offer enough spread for foreign investors to sink their teeth into the Indian REIT pie.
An improving regulatory environment with better investor protection as evidenced by India’s improving rank in World Bank’s Ease of Doing Business rankings in 2017 is a precursor will also give higher confidence to investors.
Shobhit Agarwal is MD & CEO – ANAROCK Capital.