REITs have been a part of the global financial landscape for over six decades, with the first one debuting in the U.S. in the 1960s. As per the Indian REIT Association (IRA), more than 1,000 listed REITs worldwide collectively hold a market value of ~$1.9 trillion, accounting for around 59 percent of the global real estate sector. As of FY25, cumulative distributions from Indian REITs exceeded Rs. 22,800 crore, surpassing the dividends distributed by real estate companies in the Nifty Realty Index.
Decoding the Progress and Pitfalls of India’s REIT Market
Over the past decade, India’s regulatory framework for REITs has undergone significant evolution under the oversight of SEBI to foster market development, enhance transparency, and protect investor interests.
Evolution of the regulatory framework over the past decade
Under the 2014 SEBI Regulations, REITs were mandated to have a minimum asset value of Rs. 500 crore. With the 2024 Amendments, SEBI introduced Small and Medium REITs (SM REITs) with a reduced minimum asset value of Rs. 50 crore, encouraging broader participation in real estate investments. SM REITs are required to have a minimum of 200 investors and maintain the same level of governance and operational standards as a standard REIT.
Increased window to meet public float requirements
Initially, SEBI mandated a minimum public float of 25 percent of total REIT units at the time of listing. The 2016 amendments introduced slabs for public float requirement, allowing REITs to gradually meet the 25 percent public holding within three years.
Relaxed sponsor holding and lock-in period
Originally, sponsors were required to hold at least 25 percent of the REIT units post-offer. Subsequent amendments reduced this requirement to 15 percent, with a mandatory lock-in period of three years from the listing date. The 2023 updates retained this lock-in duration but introduced a phased reduction mechanism, allowing sponsors to gradually lower their holdings over time.
Valuation
REITs are required to value assets based on fair value measurement, which is defined by international accounting standards. The discounted cash flow (DCF) method is often used for this purpose, particularly for properties with long-term lease agreements or rental incomes. SEBI introduced a provision for third-party auditors to review and verify the valuations carried out by independent valuers. This has helped streamline the valuation process, enhancing transparency and investor confidence in REIT valuations.
Taxation
Previously, distributions made by REITs that were categorized as repayment of debt were not subject to taxation in the hands of the unitholders. The Finance Act 2023 revised this treatment by stipulating that such repayment of debt distributions would now be taxable as 'income from other sources' in the hands of the unitholders. This change was implemented to address the issue of double non-taxation, where neither the trust nor the investors were taxed on these distributions.
The government revised the taxation approach in the Finance Act 2023 to lessen the impact on investors. The revised method takes into account the original purchase cost of the REIT units and prior amounts already taxed. If this calculation results in a negative value, it means that the investor does not owe any tax on those distributions for that year.
Key challenges faced by investors today
Short track record: The Indian REIT market is still in its developmental phase, characterized by a relatively limited track record compared to more established global markets, posing challenges in accurately assessing long-term performance and risk-adjusted returns, potentially raising investor caution. Limited awareness on the REIT concept amongst domestic retail and institutional investors restricts its growth pace.
To enhance transparency and investor confidence, SEBI, in collaboration with the IRA, has introduced data benchmarking institutions (DBIs) for REITs. These DBIs will provide detailed insights on REIT performance, operational metrics, valuation standards, and disclosures, enabling investors to make more informed decisions.
Sectoral concentration risk: A key risk in the Indian REIT market is its concentrated exposure to the office real estate sector. Presently, three of the four listed REITs predominantly hold office assets, with the fourth focused on retail. Upcoming REITs are also primarily oriented towards office assets. This concentration risk could lead to performance volatility should the office real estate market experience adverse conditions, potentially impacting returns besides discouraging/hampering market discovery for other eligible asset classes.
How New REIT Regulations Are Boosting Efficiency and Profitability in India
On the operational front, governance standards have been raised through provisions enabling unitholders holding material stake to nominate directors to the REIT manager’s board. This enhances accountability and promotes active investor participation. The new regulations have streamlined compliance requirements, reducing administrative burdens for REITs.
From a financial performance viewpoint, the introduction of investment options such as liquid mutual funds and interest rate derivatives has helped REITs to hedge risks associated with market fluctuations. The ability to invest in common infrastructure assets, such as power plants, water treatment facilities, waste treatment or processing plants, has diversified revenue streams, resulting in improved financial stability. Enhanced disclosure requirements, such as detailed financial statements and standardized offer documents for SM REITs, have enhanced transparency, enabling investors to make more informed decisions. Besides, stricter asset valuation standards and revised investment guidelines translate in better risk management and more accurate asset pricing.
Global REITs: Where Does India Stand?
Indian REITs currently represent less than 1 percent of the global listed real estate value and around 13 percent of the total Indian listed real estate sector, highlighting significant growth potential for Indian REITs as the market matures.
While the Indian REIT market is gradually evolving, it offers relatively limited investment options in comparison to more mature global markets. Indian REITs are predominantly concentrated in the office and retail segments, with minimal or no diversification across other real estate asset classes like healthcare, hospitality, or residential properties. This sectoral concentration limits diversification of risk and exploration of wider real estate market trends for investors. On the other hand, established markets like the United States, Singapore, and Europe offer investors exposure to a wide array of sectors and geographies. These markets benefit from a mature and liquid environment that support specialized investments in niche areas such as data centers and healthcare facilities, improving portfolio diversification and risk management.
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Impact of Rising Interest Rates
Cost of capital: Rising interest rates increase borrowing costs for REITs. This can reduce their ability to finance new acquisitions or developments, impacting growth and returns.
Preference for fixed-income securities: REITs typically offer stable income through dividends, so when interest rates rise, alternative fixed-income investments (like bonds) become more attractive. This can lead to drop in REIT prices, as investors shift to higher-yielding alternatives. Where market volatility and investor sentiment play a significant role, a rise in interest rates can depress REIT valuations.
Dividend yields: If debt costs rise significantly, a higher percentage of income may go toward servicing of debt, possibly reducing distributions to unit holders. If REITs are unable to offset the increased costs through higher rental income or asset appreciation, their dividend yields may be impacted, making the REITs less attractive to income-focused investors.
Valuation impact: Higher rates also increase the discount rate used in property valuations, resulting in a lower present value of future cash flows, which can reduce the overall market valuation of REITs.
Fluctuating Demand for Commercial Real Estate
Vacancy and rental income: Commercial REITs, especially in India, are heavily reliant on the demand for office space. Economic factors such as GDP growth, business expansion, and employment rates influence the demand for office real estate. High demand supports higher occupancy rates and rental yields, improving cash flows and investor returns. Conversely, during periods of economic slowdown or recession, businesses may downsize or delay expansion, leading to higher vacancy rates, lower rents, and a negative impact on the financial performance of office-focused REITs.
Sector-specific risks: Presently, three of the four listed REITs predominantly hold office assets, with the fourth focused on retail. Upcoming REITs are also primarily oriented towards office assets. As explained above, this lack of diversification poses a concentration risk, and may cause volatility and impact overall returns if the office market weakens.
Regional disparities in demand: In India, demand for commercial real estate varies significantly across regions. Cities like Bengaluru, Mumbai, and Delhi attract higher demand for office space due to the concentration of corporate headquarters, while smaller cities may see less demand. Regional economic development and infrastructure improvements, such as the development of new business hubs or Special Economic Zones (SEZs), can also affect demand patterns. For Indian REITs with portfolios concentrated in specific micro-markets, corresponding fluctuating demand directly influences their financial performance. REITs that diversify their portfolio geographically can mitigate the risks of regional downturns in demand.
Cap rate compression or expansion: Strong demand often leads to cap rate compression and vice versa, thus potentially disrupting the NAVs of the REIT’s portfolio.
About the Author: Divyesh Shah is a Director at CareEdge, with a total work experience of more than 20 years, of which he has been associated with CareEdge for about 18 years. He has worked in the research and ratings division at CareEdge and is the Vertical Head of the Real Estate sector. Divyesh is part of various rating and criteria committees at CareEdge and is an MBA (Finance) by qualification.
