It’s a matter of TRUST

Indian equities have had a challenging time decisively beating inflation, let alone deliver double-digit returns, over the last three years. Benchmark Nifty 50 TRI’s (total return index) compounded returns over the last three years stands at 6.7 per cent versus the consumer price inflation (CPI) index’s 4.1 per cent. The humble SBI FD would have delivered 6.5 per cent.

The story doesn’t change even when the investment horizon is extended to the last five years. Nifty TRI’s compounded gains stand at 5.4 per cent, while the CPI index has grown at a 4.95-per cent CAGR. The SBI FD would have offered 5.4 per cent.

Of course, these are par for the course when investing in equities. However, a breed of securities has delivered handsome risk-adjusted returns over the same period. We are talking about InvITs (investment in infrastructure trusts) and REITs (real estate investment trusts). While not only beating inflation, they have delivered healthy double-digit returns, while also being relatively less risky than pure equities.

Here we break them down, shine light on their outperformance and look at how to leverage them, going forward.

Today, there are a handful of listed REITs and InvITs, including some recent listings. Some of them are privately placed and the minimum bid quantity is rather high at 25,000 units on those counters. In this story, we analyse only publicly-traded REITs and InvITs (minimum bid quantity starts at one unit) that have a listed history of at least three years. The list includes Powergrid Infrastructure Investment Trust (PGInvIT), IndiGrid Infrastructure Trust (IndiGrid InvIT) from the power sector, Embassy REIT, Mindspace Business Parks REITs (Mindspace REIT), Brookfield India Real Estate Trust (Brookfield REIT), Nexus Select Trust (Nexus REIT) from the commercial real estate sector and IRB InvIT from the highways space. While the combined market cap of the seven entities adds up to ₹1.6 lakh crore which is relatively small, the segment is beginning to make a mark.

SM REITs (small and medium REITs) are also outside the scope of this article. SM REITs manage properties valued between ₹50 crore and ₹500 crore and they have a higher entry ticket-size of ₹10 lakh.

Let’s now break down how REITs and InvITs work. At the core of both REITs and InvITs is a trust. The trust has stake in SPVs that hold infrastructure assets such as power transmission projects, toll highways and IT parks. Think of SPVs like subsidiaries of a company. The trust issues units like how a company issues shares, and investors of the trust are called unitholders.

REITs and InvITs are chiefly designed for delivering stable, annuity-like cash flows to unitholders. These cash flows are called distributions, similar to how dividends are for companies.

Let us now understand how earnings of SPVs flow to unitholders as distributions. You can refer to the waterfall chart. First, operating cash flows (EBITDA after working capital changes and tax) of SPVs (after retaining a sum for maintenance capex) accrue to the trust. This is called NDCF or net distributable cash flows. Next, the trust meets its own expenses from NDCF, including paying interest on its borrowings. The surplus after taxes is called NDCF at the trust level, and this is available for distribution to unitholders. SEBI rules stipulate that SPVs must distribute 90 per cent of their NDCF to the trust and that trusts must distribute 90 per cent of their NDCF to unitholders.

The primary purpose of REITs and InvITs is to help infrastructure companies monetise their income-generating assets. These companies incur massive upfront costs to build assets such as office buildings and roads, and often the costs are financed by debt. While the investment is upfront, the payback stretches through the lifetime of those assets — and therein lies the problem. Infrastructure companies cannot wait until their capital is ploughed back to invest in the next project. They may borrow of course, but the debt taken so far may be weighing on their balance sheet — making lenders disinterested. Enter REITs and InvITs.

Under the REIT/ InvIT model, an infrastructure developer floats a trust as its sponsor (like a promoter). The trust now raises funds by issuing units (like a company’s IPO). With the proceeds, it then buys completed/ cash-generating assets belonging to the sponsor — which in turn become its SPVs or portfolio assets.

The model also solves for investors who are not looking to directly invest in the infrastructure developer (which could entail taking on more risks), but rather looking for annuity-like, stable cash flows from mature assets in a regulated environment.