The Securities and Exchange Board of India (Sebi) has proposed a range of measures to overhaul regulatory frameworks for Real Estate Investment Trusts (REITs), Small and Medium REITs (SM REITs), and Infrastructure Investment Trusts (InvITs)—special investment vehicles that allow entities to invest in real estate and infrastructure assets without direct ownership.
According to the market regulator, the proposals intend to clarify existing rules, promote sustainability, expand the investment vehicles' asset base, and enhance their operational efficiency. Stakeholders, including industry professionals, investors, and market participants, have been asked to send their comments by 13 November.
Mint explores Sebi’s proposals and their potential impact on India’s evolving real estate investment landscape.
A REIT is a collective investment scheme that pools money from multiple sources to invest in a portfolio of real estate assets. These assets can include commercial properties, office buildings, shopping malls, retail centres, and industrial parks, which generate regular rental income.
SM REITs cater to smaller investors and smaller portfolios of real estate assets. The key difference between REITs and SM REITs is the size and scale of assets.
InvITs are similar to REITs except for their focus area. InvITs pool funds to invest in infrastructure projects that generate stable cash flows, such as roads, bridges, power plants, transmission lines, and other essential utilities.
Common infrastructure definition: The market regulator has proposed to amend the definition of “common infrastructure” under the Sebi (Real Estate Investment Trusts) Regulations, 2014. Traditionally, REITs have focused on urban commercial real estate, such as office parks, malls, and residential complexes. However, the growing emphasis on sustainability has created interest in integrating infrastructure assets like power plants, water treatment facilities, and waste management systems into REIT portfolios.
The new proposal clarifies that such infrastructure assets can be included under the "common infrastructure" category. It would allow REITs to invest in and benefit from projects with a broader sustainability focus, improving their ability to meet long-term environmental goals. The proposed change would also enable REITs to include such infrastructure assets even if spread across multiple projects.
The move could enhance REITs' attractiveness for investors looking to align their portfolios with environmental, social, and governance (ESG) standards.
It also opens new avenues for REITs to diversify into, making them more resilient to sector-specific downturns.
Interest rate derivatives: Sebi has proposed to allow REITs and InvITs to use interest rate derivatives (IRDs) such as forward rate contracts (FRCs) and interest rate swaps (IRS) to hedge against fluctuations in interest rates. This is especially important for infrastructure projects, which typically have long financing tenures and are susceptible to interest rate volatility.
By using these derivatives, REITs and InvITs can stabilize their cost of borrowing and improve cash flow predictability.
The proposal aligns with best practices followed by other asset management vehicles like mutual funds, where derivatives are primarily used for risk mitigation, not speculative purposes.
The regulator said in the consultation paper that introducing such hedging tools will give REITs and InvITs greater flexibility in managing financial risks, especially during periods of rising interest rates, enhancing investor returns stability.
Allowing REITs and InvITs to hedge with IRDs could offer protection against rate fluctuations, making them more appealing for risk-averse investors. However, the complexities of derivative management could impose operational challenges, particularly for smaller managers, said Vivek Rathi, national director of research at Knight Frank India.
Credit ratings for borrowings: REITs, SM REITs, and InvITs must obtain a credit rating when their borrowings exceed certain thresholds. However, there has been some confusion over whether the rating should apply to individual loans or the overall trust. Sebi has proposed that credit ratings should apply to the trust.
This means the credit rating will reflect the trust’s financial health and ability to meet debt obligations. This clarification will simplify the regulatory landscape and provide a clearer, more comprehensive picture of these trusts' financial stability. It will also ensure that investors can assess the overall risk associated with the trust’s borrowing capacity rather than focusing on individual loan terms.
REITs' asset base: One of the most notable Sebi proposals is to expand the range of assets that can be included in a REIT portfolio. Currently, REITs are restricted to investing in commercial real estate. However, the regulator has suggested that infrastructure assets like warehouses, hotels, hospitals, and data centres should also be eligible for inclusion in REITs, provided they generate rental income and have long-term leases.
The tweak would broaden the scope for REITs, making them more diverse and resilient. Allowing REITs to include operational assets like hotels and warehouses could significantly broaden the pool of assets REITs can invest in, giving them more flexibility in asset selection while maintaining focus on rental income generation, said Samantak Das, chief economist at global real estate services company JLL.
However, Rathi pointed to this pool of assets' cyclical nature and sensitivity to market fluctuations. “Sebi should allow for the optional inclusion of such assets, ensuring they are aligned with the REIT's risk profile, operational capabilities, and investor base. A balanced approach that prioritizes low-volatility, income-generating properties may be more prudent.”
SM REITs, which are aimed at smaller portfolios (with a minimum asset size of ₹50 crore, compared to ₹500 crore for larger REITs), will have to distribute at least 95% of their net cash flows to investors quarterly.
The lower asset value threshold of ₹50 crore will allow SM REITs to tap into smaller segments of the real estate market that are currently underserved, Das said. “The scheme-based structure enables more targeted investments in specific property types or locations which could appeal to investors seeking focused exposure.”
The Sebi has proposed updating key information documents (KIT and KIS) for SM REITs every six months and changing the public issue process. Units in SM REITs will be offered through a book-building process, and in case of oversubscription, units will be allotted proportionally. The scheme also mandates that at least 90% of the fresh issue must be subscribed, with the remaining 10% allocated for general purposes.
One of the key challenges for SM REITs, according to experts, is managing the complexity and higher operational costs that arise from handling smaller portfolios. The lower minimum asset value threshold could limit economies of scale. At the same time, the proposed six-month period for rectifying breaches of investment conditions might be difficult for smaller assets that experience greater volatility.
Das believed SM REITs are likely to occupy a niche in the market, appealing to investors looking for more focused real estate investments; however, they may face challenges in achieving the scale and liquidity of larger REITs.
Senthil Gunasekaran, chief business development officer of New Growth at KFin Technologies, saw this as a pivotal step for both large and small REITs, potentially accelerating sector growth and investor confidence. "Sebi’s phased implementation for complex changes could further ease the transition. Clearer tax and credit rating guidance would also provide greater clarity."
According to Rathi, SM REITs may successfully tap into smaller real estate segments by specializing in assets that larger REITs might overlook. However, they may struggle to compete with traditional REITs' established liquidity and scale.
Das said while maintaining regulatory consistency is important, some targeted modifications to the SM REIT framework could enhance their appeal to both investors and real estate developers looking to tap into this new market segment. Smaller portfolios could lead to higher relative operating costs, and the restrictions on investing in under-construction assets could limit growth potential. However, he noted that these vehicles would appeal to investors seeking more targeted exposure to specific property types or locations.
Sudarshan Lodha, co-founder of Strata, emphasized that expanding the asset base of REITs to include green energy and essential utilities is a forward-thinking move that aligns with global sustainability trends. This could also help SM REITs scale responsibly and attract environmentally conscious investors.
