Decoding InvIT and REIT
In this week's FinMail we take a look at the inclusion of InvITs and REITs in NSE Indices and explore the reason behind their inclusion. We also understand InvITs and REITs in a simple manner.
The Story:
National Stock Exchange (NSE) on 23rd August 2021, announced that it has made changes in the eligibility criteria of Nifty Indices which will help include InvITs and REITs listed on NSE to be included in the NSE Indices as well. This change would be effective from 30th September 2021.
This inclusion news by NSE comes after an announcement by SEBI a few months back in which SEBI had cut the minimum investment amount of InvITs and REITs to a range of ₹10,000 - ₹15,000 in IPO or FPO. Earlier the minimum investment was ₹1,00,000 for InvIT and ₹50,000 for REIT.
Apart from this SEBI had also reduced the minimum trading size to 1 unit for REIT and InvIT both which earlier ranged from 200 to 1700 units. Now all these changes clearly suggest that SEBI is trying to promote REITs and InvITs amongst the retail investors by increasing their accessibility while also lowering the ticket size to enable them to invest in it.
But why exactly SEBI or the Stock exchanges are trying to promote them? We are going to understand the same right here, right now with this FinMail and we will also understand what InvITs and REITs actually mean. Let's start right away.
Understanding InvITs and REITs
To begin with, InvITs and REITs follow the same structure of functionality just like a Mutual Fund. Both have a fund manager just like a MF that manages the fund on behalf of investors, both InvITs and REITs pool investor's money to invest in various assets just like a MF (as per their theme). And they also have a trustee and a sponsor.
So basically, the structure is almost the same as Mutual Funds. And often InvITs and REITs are also referred to as 'First Cousins' referring to the common features in them.
It's like MF, REIT, and InvIT are like bungalows in the same society so yeah, the primary structure would be the same, just the interior is different.
InvITs
An Infrastructure Investment Trust (InvITs) is a Collective Investment Scheme similar to a mutual fund, which enables direct investment of money from individual and institutional investors in infrastructure projects to earn a small portion of the income as a return.
The InvIT is designed as a tiered structure with the Sponsor setting up the InvIT which in turn invests into the eligible infrastructure projects either directly or via special purpose vehicles (SPVs).
Now, this obviously doesn't explain InvITs clearly right? But then what are we here for if we don't break it down for you?
But why are InvITs even necessary? Isn't the Capital Market already complex to add one more complex product? Well, to be honest InvITs and in fact REITs as well are complex. (Heck, the Indian Population doesn't understand Mutual Funds completely) But with global markets evolving, we too couldn't be left behind with the developments happening around the world.
REITs and InvITs were introduced in USA in 1960 while in India it was introduced only in 2014. So it is relatively new here. But as we know Infrastructure is the core need and strength of any nation to be able to progress and we have been stretching the need of it in a couple of FinMails in the past as well. (Don't worry they are not connected at all)
So obviously, Infrastructure growth has to be paced up, and to do that a whole lot of money is required. Now traditionally, the infrastructure projects are funded by the government itself majorly, and also it used to carry on the project work itself only.
But now we are seeing that it is outsourced to large corporations. In and out, the taxpayer's money is used in the construction but the public at large (taxpayers and non-taxpayers included) are not involved directly in the funding of such projects.
To look at it the other way, if a Retail Investor has to invest in the country's Infrastructure, they have the following options:-
1) Invest in Infrastructure Companies directly
2) Invest in Infrastructure themed Mutual Funds
With the introduction of InvITs, an investor can choose to directly invest in the nation's infrastructure by investing in an InvIT from any of the 5 main categories like Energy, Transport & Logistics, Communication, Social & Commercial Infrastructure, and Water & Sanitation.
Now this will have two benefits here which is:
The financing of Infra-Projects can be taken care of as corporations/government could do it by issuing InvIT units to the investor and collecting money from them in return.
Secondly, it will enable retail investors to directly participate in the growing infrastructure facilities and also earn returns in form of regular income and capital appreciation.
So what exactly are InvITs?
We know the definition but let's understand the concept of InvIT via an analogy. We all love analogies, don't we?
Let's suppose that there are 5 villages that are located close to each other and all of these 5 villages are located at the outskirts of a city; say Bhavnagar. The total population of the 5 villages combined is 45,000. Now being just like other villages, these 5 villages too don't have a proper waste disposal system. The lack of a waste disposal system has often led to residents catching diseases due to it.
So one fine day the Panchayat of all the 5 villages meet and decide to solve the waste disposal problem. Instead of setting up a waste disposal and recycling plant, the Panchayat decides to make the problem into a profitable solution and decide to set up a biofuel plant at a place that is at a common distance between all the villages so that the waste could be collected and processed there. The waste would be taken care of as a result of this biofuel plant.
The residents also decide to put biofuel generated from the plant to use and decide to construct a Biofuel station for the residents as well as the other bypassers. This would provide them with a low-cost substitute for fuel. This fuel station too would be constructed near the plant and at a place where there would be high traffic volume in order to increase profitability.
The residents decide to fund this biofuel plant and fuel station by themselves and decide to create a pool account where all the villagers would chip in ₹1000 each and will get a unit in return for their contribution making them part-owners of the project. The pool helps collect about ₹4 Crores from interested residents.
They appoint a fund manager who would be responsible for managing all the finance-related work and also appoint the Sarpanches of the 5 villages as the 5 member sponsor committee who would oversee the management of the fund and the project as well.
Note here that the residents of these villages have "invested" in the project and hence would also expect some return out of their investment. But how exactly?
Pretty Simple! The fuel pump would obviously generate revenue as there would be lots and lots of travelers on the road on a daily basis and as the fuel is cheaper than the actual fuel, who would not save some bucks by preferring bio-fuel over traditional fuel. Now let's say the biofuel pump generates over ₹80 lakh of revenue in a year and after deducting all the expenses related to fuel production and fuel selling, the profit comes at ₹20 lakh. Now as all the villagers are investors in the pump they would definitely get a cut out of it. Let's say the committee decides that 90% of the profits would be distributed every year. Then for this particular year, the unitholders get ₹45per unit. (18 lakh/40,000 units)
That's just not it, if at a later stage the villagers decide to list the pool fund at a local stock exchange, they do that so that the existing investors could trade the pool units with each other or even increase/decrease their holdings accordingly. This trading would also enable the villagers to earn from capital appreciation of the units.
Now if you got hold on to this particular explanation, congratulations, you have understood the structure of how InvITs function for the investors. This is also the same for REITs as well. We will come onto REITs later, let's just stick to InvITs as of now.
InvITs too, pools investor's money and give them units in exchange for their investments, making them proportionate owners. InvITs use this pool of money collected from the investors to invest in Infrastructure projects (majorly complete projects & a little portion in under-construction projects) In the example we saw that the InvIT was created and was invested in only one project but, in reality, InvITs invest in more than one completed project as there are many investors and the fund collected is much much higher.
As a majority of the projects are complete and running, InvITs also start generating cashflows as early as in the first quarter itself. The income that is left after deducting expenses and reinvested profits are distributed to the unitholders in the form of dividends. These InvITs are also listed on the stock exchanges. And hence there's also a possibility of earning through capital appreciation. India currently has 3 listed InvITs namely Indigrid InvIT, IRB InvIT, & Powergrid InvIT.
Let's take the example of PowerGrid InvIT to help you understand better.
PowerGrid Corporation which operates in the power transmission sector and telecom infrastructure sector launched PowerGrid InvIT back in May 2021 in which the company itself is the sponsor and the Project Manager while IDBI's subsidiary is the Trustee. This InvIT was listed on the stock exchange in May with the face value of ₹100 and as of 17th Sep, the value of one unit stood at ₹119.99.
The InvIT had acquired 5 transmission projects from PowerGrid itself before listing which would help the InvIT generating revenue from its inception. The InvIT had raised ₹7734.99 Crores via IPO.
But what about REITs?
Remember that they are referred to as 'First Cousins'? Just replace the BioFuel Plant or any other Infrastructure Project for instance with a portfolio full of Commercial Real Estate Properties and that is basically Real Estate Investment Trust (REIT).
REITs pool the investor's money and invest in Commercial Real Estate Properties. These properties are then rented to corporations and the rental income is then distributed proportionately to the investors. Public REITs too are listed on the stock exchanges so that the investors can trade the units whenever they want to.
We have already explained REITs in detail (that too with an analogy) in our previous FinMail, so if you want to give it a read, click here. India currently has 3 listed REITs - Brookfield India REIT, MindSpace Business REIT, Embassy REIT.
But why promote InvIT or REITs?
InvITs and REITs are relatively new products here. In a country where a majority of the population is unaware of the Financial Markets and where Investment Products are sold as Insurance, it is obviously not a layman's job to understand REITs and InvITs until and unless a proper awareness program is promoted.
So the question is why promote them?
If we talk about InvITs, it provides the country an option to finance its infrastructure projects. The government doesn't need to borrow or wait for other investments to prosper to invest in the country's Infrastructure. InvITs allow the government and even the big corporations who were not so excited to invest in infrastructure because of high investment and low liquidity problems to take a leap and explore.
Including REITs and InvITs in Nifty indices and lowering the minimum units to trade criteria will allow retail investors to buy a small portion and thereby help increase volumes & liquidity in the products and also help better price discovery. As investors would get accustomed to such products, thereby encouraging more companies to launch their REITs and InvITs in the market.
What does the inclusion of REIT and InvIT in indices mean for an Investor?
As the indices will now include REITs and InvITs just like some other stock, the Passive Fund that follows an index will also have to invest in them. Therefore, the REITs and InvITs would start seeing increased inflows as a result.
The investors invested in Passive Funds will automatically get exposure in them as a result of the exposure of the passive fund that they are invested in. This would increase their diversification within the portfolio thereby reducing their overall risk.
It's a matter of joy for an existing Investor in any of the listed REITs/InvITs as they would get a better return on their investment due to more inflows, better liquidity, increased volumes, and better price discovery of the listed units.
End Notes
With REITs and InvITs now covered, we hope they would also emerge as a good Alternative Investment option in the near future. InvITs and REITs have existed in India for the last 7 years (on paper though) and now finally, they are starting to see some traction but as the saying goes "Better late than never".
We are seeing new and new innovative investments being brought up, better laws in place to tackle financial crimes, new investment avenues coming up, it's exciting to see what future holds.
Having the same confidence as Paresh Rawal in Uri when he spoke, "Ye Naya India Hai" (Sorry, Baki Ka Relevant nai hai), we too believe that Indian Markets are changing and definitely in a better way. Until we meet for the next time,
That is it for this week's FinMail. We hope you got InvIT & REIT cleared in your learning checklist. Keep learning and keep spreading love. We will see you in the next week.
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