To me, it is an ominous sign that stock prices of cash-strapped realty companies should jump for joy when Securities Exchange Board of India (SEBI) notified its regulations for Real Estate Investment Trusts (REITs) last week.

Yes, developers and the analysts who track them are pleased that realty companies such as DLF, which have found few buyers for their malls in recent times, can now offload these assets to the brand-new REITs and pare down debt. Property consultants are hoping that REITs will pump anywhere between ₹60,000 and ₹1 lakh crore into the beleaguered sector, ‘unlocking’ cash from illiquid assets for players to carry on with business as usual.

But what about the investors in REITs? Isn’t all this a little err… worrying for them? If realty companies are so cash-strapped and debt-burdened, how lucrative are these assets in reality? Plus, if a flood of new money really chases these commercial assets, would REITs end up buying them at bloated valuations?

If returns from such assets neither provide high yield nor easy liquidity, how would they turn out to be lucrative for retail investors?

The truth is that while REITs may be a good idea to open up new sources of funding and resolve myriad problems of the Indian real estate sector, they’re not yet a great proposition for Indian investors.

To start with, unlike in Singapore, Hong Kong or other developed nations, Indian investors do not invest in real estate so that they can earn modest regular income.

These investors have plenty of other options to earn that — bank deposits that deliver 9 per cent, small savings schemes that offer 8-9 per cent, and debt mutual funds that offer similar returns with any-time liquidity. So, when an Indian investor buys property, he’s looking for an investment that delivers hefty capital gains and soundly trounces inflation over the long term.

This is quite evident from the segments of the property market which retail buyers flock to — affordable homes for first-time buyers, roomy apartments at good locations for home owners who are keen to upgrade, independent villas and bungalows at the outskirts for high net worth investors.

Commercial property, if it is in the reckoning at all, comes last on this list. And there is good reason for this. Given large unfulfilled demand for residential homes in India, residential property has traditionally delivered far better price appreciation and proved more resilient to economic downturns than commercial property.

Even today, while the residential property market has picked up, the commercial market is yet to revive. It carries a heavy burden of over-supply, precisely why developers such as DLF or Unitech have found it difficult to sell commercial assets.

But REITs, the world over, are designed to earn most of their returns from rental income and that too on commercial property. Indian REITs too are set to faithfully replicate this model. SEBI’s recent regulations make it mandatory for the upcoming REITs to invest at least 80 per cent of their funds in completed income-generating commercial properties and to distribute 90 per cent of their income to investors as dividends, at half yearly intervals.

Clearly, while policymakers are looking at REITs as a fixed-income option that will invest in commercial property, retail investors would prefer to bet on residential property for capital gains. To make retail investors change their mindset, REITs will have to generate returns that are far higher than the fixed income options that are already available to the Indian investor.

This may prove quite a tall order. The rental yields on good commercial properties in India tend to be in the range of 8-10 per cent. Assuming that the managers of REITs charge a modest fee of 2 per cent, the net returns to the investor by way of dividends will be 6-8 per cent — certainly not what he is used to from his other, less risky, fixed income investments.

Then there’s the tax angle to consider. As per SEBI regulations, REITs are to be listed entities that will hold majority equity stakes either directly in commercial properties or through Special Purpose Vehicles (SPVs). Their income will be earned through dividends distributed by these SPVs or rents from projects. While the REIT itself has been granted pass-through status and will pay no tax on its income, the SPVs may have to pay dividend distribution tax. Similarly, investors who earn returns from REITs too currently have to bear both dividend distribution tax and capital gains tax.

Unless REITs manage to win further tax concessions for investee companies and investors, they will find it quite hard to compete with even traditional fixed income options on returns.

This brings us to the final issue. If Indian investors are to be attracted to REITs, the units must earn not just the above dividends but also see their prices appreciate on the stock exchanges. That will depend on how the REIT’s net asset value (NAV) behaves. SEBI regulations require all REITs to get their portfolios valued twice a year and the NAV to be disclosed to investors.

Now, given the nature of the property market in India where prices can vary wildly even between neighbouring localities, arriving at a true mark-to-market ‘value’ for a REIT portfolio is likely to prove a difficult task. If this is done, fairly sharp swings in the ‘valuation’ every six months cannot be ruled out.

A textbook valuation based on future cash flows will involve several groping-in-the-dark assumptions about the economic cycle, property values and interest rates.

Overall, the NAV may turn out to be just a ballpark figure around which market prices of the REITs swing quite significantly. This may make it difficult for the listed REITs to give an impression of stability to investors.

Of course, all this does not even take into account the structural grey areas in the Indian real estate market. Most property deals in India today involve a ‘black’ component, which a listed and tightly regulated REIT simply cannot factor in.

Given the many regulatory approvals needed both for building and dealing in properties, corruption is a fact of life in the sector and players in the sector aren’t known for a pristine governance record.

Policymakers, regulators and the developer community are now hoping that REITs will usher in much-needed transparency, best practices and good governance into the sector. But this is putting the cart before the horse. If I were a REIT investor, I wouldn’t invest in REITs until good governance is a given.