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REIT and InvIT A primerAugust 2016
Ratings
Ratings
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Monetise revenue-generating real estate and infrastructure assets
Lower the cost of capital by tapping the right set of long-term investors (pension funds)
Enjoy favourable tax treatment, including exemption from dividend distribution tax and relaxation of
capital gains tax
Have diverse sources of funding
Once listed, provide regular source of capital to the sector
Sponsor holding mentioned above refers to minimum holding required over the first three years, as per existing guidelines
Indicative structure
75% 25%
Investors Sponsor
TrusteeInvestment
managerREIT or InvIT
Asset management fee
Property or project manager
SPV1
>50%
SPV2
Asset Asset Asset
>50%
1. What are REITs and InvITs?
2. Key benefits to the sponsor
REITs & InvITs
The Securities and Exchange Board of India (SEBI) notified regulations for investment trusts – specifically, real
estate investment trusts (REITs) and infrastructure investment trusts (InvITs) – in September 2014.
An investment trust is a vehicle created to primarily invest in revenue-generating real estate or infrastructure
assets. These entities are ‘trusts’ by definition, and their ‘units’ (shares) are to be mandatorily listed on exchanges
and regulated by SEBI. The units are traded based on their net asset value.
These entities have a pass-through structure and are therefore required to distribute majority of their earnings to
unit holders. Globally, these are positioned as high-dividend-paying investments suitable for investors looking for
long-term, stable cash flow with moderate capital appreciation.
1SEBI vide its discussion paper has sought views for reconsidering the minimum sponsor holding from 25% to10% in case of InvIT2SEBI vide its discussion paper has sought views for reconsidering the investment limit in under construction properties for REIT from 10% to 20%3SEBI vide its discussion paper has sought views for allowing investments by REIT and InvIT in two-level SPV structures, where the intermediate SPV is a holding company
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Invest in real estate or infrastructure without actually owning the asset
Benefit from favourable tax norms (tax-exempt dividend income; no capital gains tax if
units are held for more than three years and sold through stock exchange; and withholding tax at
5% for interest income to non-residential unit holders )
Structure of investment trust
Sponsor to hold not less than 25% of the total units of the investment trust after initial offer, on a post-
issue basis, for at least three years from the date of listing of such units (unless such holding is 1disallowed by government or regulatory provisions)
Investment trusts to invest not less than 80% of the value in completed and revenue-generating
projects, and not more than 10% in under-construction projects. Units of InvITs investing more than 210% in under-construction projects to be privately placed
Investment trusts to hold assets either directly or through special purpose vehicles (SPV)
Investment trusts to hold controlling interest and not less than 50% equity share capital or interest in
the SPVs (except in the case of public private partnership projects where such holding is disallowed
by the government or regulatory provisions)
SPVs to hold not less than 80% of assets (90% in case of InvITs) directly in properties (infrastructure 3projects for InvITs) and not invest in other SPVs
SPVs to not engage in any activity other than those pertaining and incidental to the underlying
projects
Stipulations to ensure transparency
Trustee to hold assets for the benefit of unit holders, oversee activities, and ensure compliance
with respect to reporting and disclosure requirements
A full valuation to be conducted by an independent valuer at least once every year
All related-party transactions to be on an arm’s-length basis
Distribution requirements
• Not less than 90% of net distributable cash flow of the SPV to be disbursed to the investment trust in
proportion to its holding in the SPV subject to applicable provisions in the Companies Act, 2013, or the
Limited Liability Partnership Act, 2008
• Not less than 90% of net distributable cash flow of the investment trust to be distributed to unit
holders
3. Key benefits to the unit holder
4. Salient features of SEBI regulations on investment trust
Ratings
• Such distributions to be declared and made at least once every six months for REITs and publicly
listed InvITs
• If any asset is sold by the investment trust or SPV, it can reinvest the proceeds into another property or
infrastructure asset and will not be required to distribute the sale proceeds. However, if no such
reinvestment is made, it will be required to distribute not less than 90% of the sales proceeds
Leverage restrictions
• The aggregate consolidated borrowing and deferred payment of the investment trust net of cash and
cash equivalents should never exceed 49% of the value of the investment trust assets
• If the aggregate consolidated borrowing and deferred payment of the investment trust, net of cash
and cash equivalents, exceeds 25% of the value of the assets, for any further borrowing, credit rating
to be obtained from a registered credit rating agency
Rating methodology for investment trust focuses on the following aspects:
• Quality of asset portfolio : Quality of assets determines the quality of underlying cash flow and is,
therefore, the key determinant of the trust’s business risk profile. Factors that CRISIL considers for
its assessment include:
- Analysis of contracts governing future cash flow, tenure of contracts and its permanency,
and repricing risk of contracts
- Potential for increase in cash flow based on demand-supply situation
- Counterparty credit risk that cash flow is exposed to
- Diversification benefits emanating from both multiple customers and geography
• Coverage, leverage and financial flexibility: CRISIL evaluates whether the debt service coverage ratio
provided by expected cash flow in relation to the debt obligation over the life of the instrument is
commensurate with the rating assigned. A part of the debt raised may rely on refinancing and
therefore, the financial flexibility of the entity is also critical. Leverage in case of an investment trust
is measured with respect to the market value of its investments and is an indicator of the refinancing
ability of the investment trust.
• Management risk: Experience of trustee and investment manager, and stipulation and efficacy of
risk management policies carry significance.
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5. CRISIL's approach to rating investment trusts
AB
CD
E
4CCR reflects the relative degree of strength with respect to honoring debt obligation; refer http://www.crisil.com/ratings/corporate-credit-rating-scale.html
Given that investment trusts have pass-through structures and are being rated for the first time in India,
CRISIL has tried to elucidate their nuances here:
a How is rating an investment trust different from rating a corporate?
The principles of rating debt in investment trusts and in corporates are basically the same. In case of
corporates, management has the discretion of reinvesting cash flow. However, in the case of
investment trusts, the nature of the product and investor expectation require majority of the cash
flow to be distributed. Therefore, quality of assets and cash flow coverage are key drivers of rating an
investment trust.
Given regulatory oversight of these entities (such as mandatory listing and strict guidelines on
distribution of cash flow), transparency and discipline in cash flow as well as investment
management are expected to be higher than real estate and infrastructure companies per se, lending
a positive credit bias to them.
b From a rating perspective, is there any difference between REIT and InvIT?
No. CRISIL assesses the quality of the assets and cash flow coverage, which are the primary drivers of
rating for both.
Having said that, real estate assets have a longer life and enjoy a contractual agreement to increase
rental rates. With upfront visibility of future increase in rental rates, real estate enjoys an established
track record of lending against valuation of the asset. However, in the case of InvIT, the life of the
asset is restricted by the concession period and any upfront visibility on the upside to cash flow is
relatively limited. Therefore, ability to favourably structure debt at REIT is higher compared with an
InvIT. This, in turn, may get reflected in the cash flow coverage.
c Is rating mandatory for these entities?
The regulator has capped the net consolidated debt at 49% of the market value of assets. As per SEBI
guidelines, rating is mandatory if the net consolidated debt exceeds 25% of the market value of
assets. Given the current debt levels in real estate and infrastructure assets, CRISIL believes almost
all investment trusts will probably need to be rated. Even if there is no debt, the trust can seek a 4corporate credit rating (CCR) .
d Will CRISIL rate units of investment trusts?
Units of investment trusts are akin to shares of a company and derive their value from the value of
underlying assets. Though these are equity-like, their returns are expected to be stable and
benchmarked to debt market instruments.
Given that investment trusts are equity-like, CRISIL does not rate the units of investment trusts on a
credit rating scale.
e Will the investment trusts be rated or the underlying SPV?
As debt can be raised by both the investment trust and the SPV, rating can be sought for debt residing
in the books of both. SEBI mandates rating of debt if the consolidated net debt exceeds 25% of the
market value of assets.
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6. Frequently asked questions
Ratings
f If debt in an SPV needs to be rated, what is the approach that CRISIL follows?
CRISIL assesses debt in SPVs based on cash flow coverage in them. CRISIL may also assess the
possibility of a notch-up in the rating based on articulated support from, and credit risk profile of, the
investment trust.
g Is it possible for debt at the investment trust to have a different credit risk profile compared
with the aggregate credit risk profile of the underlying SPVs?
The credit risk profile of the debt in the investment trust may be different from that of the aggregate
credit risk profile of the SPVs based on the following:
1 Debt repayment and other safety mechanisms inbuilt in the structure of the debt residing in the
investment trust
2 Possible subordination of cash flow from the SPVs
3 Diversification benefits on account of accessing cash flow from multiple SPVs
4 Headroom for additional debt based on the value of assets in the SPVs
h What are the factors that influence subordination of cash flow from the SPVs to the investment
trust?
Factors that may typically influence the subordination are as follows:
1 Level of external debt in SPVs
2 Any working capital requirement in SPVs
3 Any ongoing capital expenditure in SPVs
4 Percentage of shareholding held by the investment trust in SPVs
i How does CRISIL view the presence of a holding company as an intermediate layer while arriving
at the rating?
In case there is an intermediate holding company between the investment trust and the SPVs, CRISIL
evaluates the possibility of cash flow leakage at the intermediate level and thereby its impact on the
quality of cash flow at the REIT or InvIT.
j How does CRISIL factor in the presence of construction loan at an SPV level while rating an
investment trust?
In case the debt in the SPV is exposed to project execution risk, it will be reflected on the cash flow
trickling from SPVs to the REIT.
k What is the acceptability of the asset class globally and what has been the experience on rating
of these entities?
REITs and InvITs (commonly known as business trusts elsewhere) have been prevalent in the overseas
market, with REITs being more popular. More than 30 countries have REITs, which were introduced in
the US in the 1960s. The US currently has over 200 REITs with a market capitalisation of about
$1 trillion. Historically, dividend yield of these entities has been around 1% more than the treasury
yield.
S&P Global Ratings, CRISIL's parent, has a rated portfolio of over 80 REITs, with a median rating of
BBB. Its approach to rating these entities is similar to its approach to rating corporates.
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Criteria Contacts
Pawan Agrawal
Chief Analytical Officer – CRISIL Ratings
Email: [email protected]
Somasekhar Vemuri
Senior Director – Rating Criteria and Product Development
Email: [email protected]
Ramesh Karunakaran
Director – Rating Criteria and Product Development
Email: [email protected]
Analytical Contacts
Sudip Sural
Senior Director – Corporate & Infrastructure Ratings
Email: [email protected]
Sushmita Majumdar
Director – Corporate & Infrastructure Ratings
Email: [email protected]
Manish Gupta
Director – Corporate & Infrastructure Ratings
Email: [email protected]
In case of any feedback or queries, you may write to us at [email protected].
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Last updated: April 2016
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