#UnionBudget2016: FM Jaitley Prompts Real Estate Growth Through REITs

In agrarian societies such as India, wealth is accumulated in the form of real estate assets. However, real estate assets in our country are not yet traded the same way as other assets. When you invest in equity shares in a company, you pay a generally agreed upon price for the asset. The price is known to everybody. It is publicly listed, and when you sell your equity shares in a listed company, the value of the shares do not drop. You can quickly convert it into cash. However, if you sell your house overnight, you would probably not get paid anything close to its real value. Moreover, most people are not wealthy or financially savvy enough to buy real estate assets throughout India or even the world to have a well-diversified portfolio of real estate assets. How does this affect real estate markets in India?

• Households are not able to get full value out of their assets. 

• Real estate assets they own often do not generate a surplus that is easily marketable. 

• They are often unable to use their real estate assets as collateral to access funds from banks and financial institutions. 

• They do not trade in the financial markets. 

• Most importantly, real estate assets are not put to their best use when people cannot easily buy and sell real estate assets without them losing much value in the transaction. 

In other words, land will not be put to its best use when the transaction costs are high. The harm this does to the economy is immense in a country, where valuable urban land is scarce.

It is in this context that we should examine Finance Minister Arun Jaitley's announcement in his Budget Speech that Real Estate Investment Trusts (REITs) would be exempted from the Dividend Distribution Tax (DDT) under certain conditions. Among many other sops, this is one of the major step that would boost the real estate sector in India.

The good news

When you invest in a REIT to own chunks of real estate, you will be able to instantly find buyers and sellers. As REITs are expected to divide 90 per cent of their profits, it is likely that the dividend yields will be high. However, there was one way in which the structure of the proposed REITs is different in India, from the countries where it is successful. REITs were not so far exempt from dividend distribution tax. Developers and economists wanted the government to tax dividends only in the hands of the investors and not in the hands of the REITs. Without this, it would not have been possible for REITs to divide 90- per cent of the profits as dividends. The proposal is to exempt REITs from divided distribution tax would give India's real estate the much-needed fillip.

However, this is not enough. Even though the Budget proposed exempting REITs from dividend distribution tax, DDT will still apply to distribution of dividends out of profits that accrued before the REIT acquired the special purpose vehicle. Apart from that, for SPVs to be eligible for exemption from DDT, they need to transfer 100 per cent of the equity interest to REITs.

Earlier, the government had exempted REITs from long-term capital gains tax and minimum alternate tax. In every Budget, in fact, the government proposes reforms that makes the formation of REITs easier in India. It is probable that in the future, many of the remaining barriers will wean.