Pakistan stumps India; rolls out South Asia’s 1st REIT while we still try to axe the tax

India 0 Vs Pakistan 1. It’s not the outcome of a ODI series between the traditional rivals but a progress card on reforms in the world of real estate. At a time Indian realtors and investors are struggling to roll out real estateinvestment trusts (REIT) amid regulatory complications and tax uncertainties, Pakistan has gone ahead to launch South Asia’s first REIT at a premium of 10% to the offer price, earlier this month.

A REIT is a financial instrument where the underlying asset is real estate. The rental income from the property assets are distributed by the Trust as dividends to the investors or unit holders of the trust. Typically therefore, a REIT invests in completed, revenue generating commercial realestate assets.

Mid-June, Pakistan-based Dolmen City launched its REIT offering that got subscribed 1.7 times. It owns a commercial property which has a mix of mall and office space and an occupancy of 96%. The company expects a net income of $21.9 million in first year while dividends are expected at $20.7 million. This was also the first REIT listing in Pakistan after the country came out with the regulations.

Interestingly, yields for the Dolmen City REIT’s investors in the first year are a percentage point lower than the current yields on Pakistan’s government securities (GSec) that are now trading at 9.75%. Typically,world over REITs notes trade at positive spread. This was based on estimation of rental income from the asset, 90% of which are to distributed back to investors. But even then, there were few global investors who bit the story — only 0.6% of HNIs/Institution allocation.

For starters, Pakistan has streamlined the process significantly to make it attractive for investors. For example, their REITs attract a withholding tax of 10% (in-line with Mutual fund taxation) with no further tax liability for individual investors. Moreover, the regulators there have agreed to concessional tax regime for transfer of an asset into a REIT with significant reduction in stamp duty across the region.

In comparison in India — despite the recent relaxations on taxability like MAT exemption, tax pass through to REIT – and simplification of structuring, the REIT controlled special purpose vehicles are still subject to corporate and dividend distribution tax ( DDT) which limits the pass through nature of REITs. This makes it imperative on the SPV to restructure to reduce the tax blow. Analysts feel while debt infusion at SPVs could improve the yields of the instrument, a simplified structure allowing tax pass throughs would improve transparency and improve visibility of returns to investors.

“Indian REITs in the current form have a significant tax disadvantage with double taxation in SPV-REIT structure and high transaction cost in direct holding structure,” said Abhishek Anand of JM Finance in his report on India REITs on June 12. “We believe tax regime needs to work towards simplifying the domestic REIT structure, and needs to reduce double taxation in order to make returns more attractive for investors.”

“Typically REIT is successful in the mature economies where it gives returns of 7 to 9% and government securities gives returns in the range of 1.5 to 2.5%,” says Hemal Mehta, senior director of Deloitte. “While, in India, government securities gives risk free returns in the range of 8 to 9% and hence, to make this instrument very attractive fiscal benefits like dividend distribution tax, minimum alternate tax and capital gain should be waived off to make the REIT attractive for Indian investors.”

Echoing this, a senior official of a leading real estate focussed PE fund says if the government considers such waivers, REITs alone have the potential to attract investment in the range of $15 to $20 billion from FII and NRIs.

According to Chandubhai Mehta, Managing Partner of Mumbai-based law firm Dhruve Liladhar & Co, which advises many developers, complexities in taxation to unit holders in REIT as well as to owners of the assets are the hindrance in the way of making this a popular instrument.

“REIT is beneficial to both the investors and the industry because it provides the investors with an investment avenue, which is comparatively less risky than investing in under construction properties and provides regular income,” says Mehta.

In India, many marque PE investors including Blackstone together with real estate JV partner Embassy or developers DLF were reportedly planning to go ahead with mega REIT listings, but till date have stayed away due largely on account of the tax complications. But realtors are hopeful of an early resolution. “There are issues related to taxation but as the market evolves, am sure the government will also change the rules according to market needs,” said Rajeev Talwar, Group Executive Director, DLF.

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What China learned from Lee Kuan Yew… and India didn’t

One of the asymmetries of history is the lack of correspondence between the abilities of some leaders and power of their countries,” Henry Kissinger famously wrote of Lee Kuan Yew. Kissinger’s contention was that a technocrat like Lee deserved to lead a bigger country than Singapore, the city of 5 million he ruled for three decades. Yet, given the huge influence Lee had on the late Deng Xiaoping’s policies after Deng decided to move away from Communism in the late 1970s, it’s possible to argue that Lee’s economic principles helped create the Chinese juggernaut.

Deng’s decision to open up special investment zones for foreign investors, starting with Shenzhen at the tip of southern China in late 1979, was prompted by a visit toSingapore in 1978. Deng quickly dispatched several hundred Chinese officials to study Singapore, a special economic zone all its own, soon after. Today, Shenzhen boasts one of the busiest ports in the world, total foreign direct investment of $30 billion, skyscrapers and tropical gardens, and looks like a Singapore knock-off. Several elements of the Singapore development formula laid the foundation of what Beijing calls “capitalism with Chinese characteristics”.

The anomalous hybrid of state capitalism led by what Beijing believes is a benign dictatorship in China should more truthfully be called “capitalism with Singaporean characteristics”. Singapore remains the busiest port in the world, but half the world’s largest ports are now in China. Hewlett-Packard (HP) and its computer assembly factories were among the earliest foreign investors in Singapore along with Texas Instruments. Today, HP is a big investor in Chongqing, a 30 million city-state of a sort in China, where one in every four laptops in the world is made.

The Chinese bureacracy’s ‘build it, investors will come’ approach to infrastructure was perfected first by Singapore’s trade promotion arm, the Economic Development Board (EDB) in the 1980s and 90s. No other country in Asia pursued economic diplomacy quite like the EDB did. By the mid-1990s, half of Singapore’s output was electronic products. China’s obsession with exports and electronics assembly can also be attributed to having learned from the Singaporean textbook. Consider the outsized imprint China and Asia has on global trade: in 1990s, Asia accounted for a little over a quarter of global manufacturing output. By 2013, that figure was about 46 per cent — with China responsible for half of that.

In repeated visits dating back to the death of Zhou Enlai in January 1976, Lee reached out to China in a way that the leaders of Japan, colonial Hong Kong and Taiwan were neither inclined to nor able to for complicated historical reasons. Nor did these countries display the Singaporean-style single-mindedness that China does in courting foreign investors today. Recently, Vivek Chaand Sehgal, chairman of Samvardhana Motherson Group, the massive Indian auto parts multinational with operations in China and Europe, recounted how surprised he was to receive a visit in New Delhi some years ago from the mayor of a city near Shanghai who was not only prepared to provide land, but even ensure that it had the right vaastu.

Like Lee, who was famously a critic of Western values of unbridled democracy and relaxed social policies, Deng was agnostic about using capitalist ideas to help transform China. Emblematic of this attitude of pragmatism were remarks Lee made in an interview with Fareed Zakaria in Foreign Affairs in 1994: “If we did not have the good points of the West to guide us, we wouldn’t have got out of our backwardness. We would have been a backward economy with a backward society.”

Much of Lee’s notions of ‘Asian values’ and democracy not being right for Asia were nonsense and proven wrong when the baton of free elections and a free press was passed across Asia, from Korea to Taiwan to Indonesia. His idea pushing graduates to marry graduates was even worse. President Xi Jinping’s current plans to ‘reform’ the Chinese judiciary while rounding up most human rights lawyers are not dissimilar to Lee’s tendency to use the courts in Singapore to impose ruinous damages for libel on opposition politicians and Western publications, while ensuring the courts were efficient in enforcing contracts. Even when governing Hong Kong, Beijing is guided not by Hong Kong’s own liberal values and its history of independent courts and a free press, but by Lee’s problematic political legacy in Singapore, a much tamer city.

In occasional dispatches from Singapore, I could not help ridiculing editorials in The Straits Timesthat called on people to be punctual in the horrified tones of someone criticising thievery. Its malls, seemingly erected above every other metro station, drove me insane. But look how shopping dominates the landscape of Dubai, Hong Kong and parts of Mumbai and Delhi today and it is hard not to conclude that we are all Singaporeans now. Photos in the local newspaper shaming people who did not flush in public toilets seemed absurd, but perhaps less so when you are an inhabitant of a country with a shortage of public toilets and where clean public loos are only to be found in Singaporean-styled shopping malls. Having listened to Lee address American Fortune 500 CEOs in Singapore two decades ago, I can attest that few leaders sermonised quite as annoyingly as he did, but he was often right.

When India started opening its economy in the early 1990s, Singapore rushed in with offers of help. The Singaporeans were rebuffed time and again by India’s sclerotic bureaucracy. By contrast, China’s good fortune was that it had leaders who adapted the successful blueprint that city-states such as Hong Kong and Singapore offered because they realised China urgently needed employment for hundreds of millions in just the labour-intensive industries those two cities had built their fortunes on decades earlier. Perhaps Deng’s pragmatism in importing ideas from the tiny city-state Lee built would never have worked in a country as uniquely complicated as India. The tragedy is none of our leaders really tried.

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