InvITs & REITS: Moves in the right direction
The recent news regarding the Embassy Real Estate Investment Trust (REIT) listing and the possible listing by...
The recent news regarding the Embassy Real Estate Investment Trust (REIT) listing and the possible listing by Reliance of its fibre assets through an Infrastructure Investment Trust (InvIT) bring our attention to an important topic. Additionally, issues around participants in capital markets adopting sophisticated strategies to utilise capital for optimal projects and partnering with capital providers are worth analysing.
As activity picks up, regulations around InvITs & REITs will evolve to cater to the needs of the Indian capital markets. The relatively nascent debt capital markets in India require regulations that allow for flexibility around the borrowing that REIT & InvIT type structures can do. Additionally, Indian regulators will have to be mindful of the needs and challenges that India specific financial markets present. The vital driving factor is that a robust regulatory regime that facilitates not just large-scale marquee transactions, but also relatively smaller deals will be crucial.
From a business perspective, the advantages of an InvIT structure is there for both the demand and supply side. The demand side here is the businesses listing their assets, and hence the demand side looking to raise capital. The supply side pertains to the suppliers of money, i.e. the investors looking to invest in attractive assets.
The primary advantage for the demand side looking for capital is the ability to raise funds utilising assets that can be monetised without using debt or equity that would impact the balance sheet of the entire business. For the suppliers of capital, the ability to invest in specific assets that are easier to value and project returns from provides an opportunity to match asset-liabilities better.
For businesses, the real innovation comes from identifying segments they want to develop, such as telecom tower assets, to monetise versus segments, such as the consumer-facing business, that they choose to keep on their balance sheets since such segments are potentially more attractive for them from a Return on Invested Capital (ROIC) and strategy perspective.
There are segments, say telecom tower assets, where the business has the know-how to undertake construction risk to generate assets and earn the "construction premium" when monetising the asset. It makes sense for the company to monetise the telecom tower asset to invest in the core consumer business that yields a relatively higher ROIC.
Most importantly, there is a possibility that the ROIC of the consumer business is significantly higher than the cost of capital of the company.Such an arrangement helps boost shareholder value. Structures such as InvITs and REITs have a significant role to play in allowing businesses to demarcate sectors in terms of assets that will be held on the balance sheet for longer duration and assets to be monetised.
From an investor's perspective, as suppliers of capital, InvIT type financial vehicles allow them access to assets that suit their investment needs. Firstly, the investment return benchmarks that investors will have can be lower given their relatively low cost of funding. This allows investors to generate value from investment returns that a relatively low-rated corporate business might not find attractive.
For instance, the telecom tower assets mentioned earlier might be a perfect fit for an institution looking to invest in annuity-type infrastructure assets using funds with a relatively low-cost base.
Primarily, if done well, the InvIT structure will assist in utilising a variety of balance sheets that differ in funding costs, investment return expectations and investment horizons to fund investments.
Secondly, for sophisticated investors, a successful InvIT regime implies access to specific assets that might suit their investment focus better without having to invest in bonds and equity issued by companies. Therefore, focused investments and risk-taking are in the offing.
For the Indian market that is still recovering from large Non-Performing Assets (NPAs) in the banking sector, the success of the InvIT & REIT regime is vital. If done well, InvITs & REITs can create a system that significantly boosts the flow of capital in the investment space.
A successful InvIT & REIT regime will also ensure that companies are incentivised to develop successful track records for themselves in the budding market.
It is also vital that regulators, companies and investors realise that even as the NPA situation improves gradually, the banking sector due to a variety of factors such as a structural asset-liability mismatch and lack of specialised infrastructure expertise, cannot bear the burden of the majority of infrastructure asset financing in India. Innovative financial vehicles such as InvITs will have to start contributing gradually as a source of capital. News regarding large potential InvIT & REIT listings is encouraging to say the least.