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: pawan.agrawal@crisil.com

Somasekhar Vemuri

Senior Director – Rating Criteria and Product Development

Email: somasekhar.vemuri@crisil.com

Ramesh Karunakaran

Director – Rating Criteria and Product Development

Email: ramesh.karunakaran@crisil.com

Analytical Contacts

Sudip Sural

Senior Director – Corporate & Infrastructure Ratings

Email: sudip.sural@crisil.com

Sushmita Majumdar

Director – Corporate & Infrastructure Ratings

Email: Sushmita.Majumdar@crisil.com

Manish Gupta

Director – Corporate & Infrastructure Ratings

Email: manish.gupta@crisil.com

In case of any feedback or queries, you may write to us at Criteria.feedback@crisil.com.

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Last updated: April 2016

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