The budget presented by finance minister Arun Jaitley on 29 February allows a true, full pass-through for real estate investment trusts (REITs) and infrastructure investment trusts.
It does so by removing the dividend distribution tax (DDT) at the special purpose vehicle (SPV) level under a business trust (100% owned with exceptions). Assets being held in an SPV is a fact and a regulatory necessity in Indian circumstances. Hence, the proposal to remove DDT could substantially help the establishment of business trusts in India as vehicles where infrastructure and real estate developers can partially exit their revenue-generating assets such as commercial buildings, special economic zones, information technology parks, roads, renewable and other power projects, transmission lines, and list the business trusts so created on Indian stock exchanges to raise perpetual capital from a very new set of investors who want steady, regular yields backed by stable assets and some growth.
There is a great need for such instruments in the Indian marketplace and could be used by domestic and foreign pension funds, high-net-worth individuals, insurance companies, long-only funds, etc.
The ability of infra and real estate developers to exit their assets partially and raise much-needed resources for repayment of debt as well as recycling of capital would hopefully lead to a reduction in bank bad loans and revive the investment cycle, for which there is a crying need.
But there is another benefit of these trusts as well.
A major concern in India is that of public sector bank recapitalization. The Reserve Bank of India has allowed banks to revalue their real estate assets and allowed the revaluation reserve to be treated as tier-1 capital. The finance minister, in his budget speech, has also talked about disinvesting assets held by public sector enterprises and reinvestment of the proceeds in new projects.
Taking a cue from this, and piggy-backing on REITs, I see possibilities in the use of the REIT structure to help state-owned banks not only add to tier-1 capital, but also raise cash and liquidity.
State-owned banks own vast commercial real estate for their offices and branches. These assets can be revalued and swapped into a REIT (sponsored and controlled by the bank) and the asset leased back to the bank—the bank REIT can be listed and the money so raised flow back to the bank for further lending.
A bank REIT would be a very sought-after product in view of the quality of both assets and the quality of a well-regulated tenant (i.e. a state-owned bank).
Further, the holding of units of a listed bank REIT instead of real estate in the balance sheet of a bank could also help for capital adequacy as the risk weightage of the units of a REIT, having a ready market, may be lower than the real estate assets held on a bank balance sheet.
The income-tax law currently does not provide for any capital gains exemption for a swap of assets by the bank with either an SPV under a REIT or to the REIT directly. Further, stamp duty would also be levied in many states. These could both be a deterrent and hence the finance minister should consider exempting the swap of assets into a REIT or its SPV from capital gains tax.
To sum up, bank REITs could provide a virtuous circle, help in recapitalization of public sector banks, provide cash and liquidity to banks for lending, create an alternative yield-based equity instrument in the market and offer an investment opportunity to foreign and Indian pension funds, insurance companies and rich individuals.
Vivek Mehra is a partner at PricewaterhouseCoopers Pvt. Ltd. The views expressed by the author are personal.