Why SEBI’s REIT-InvIT Split Risks Distorting Market Logic

SEBI’s recent decision to classify Real Estate Investment Trusts as equity for mutual fund categorisation marks a notable shift in India’s evolving real-assets market. The change allows equity schemes to hold REIT units, eases inclusion in indices, and signals an intent to mainstream these vehicles within retail portfolios. Yet the same regulatory generosity has not been extended to Infrastructure Investment Trusts, such as the National Highways Infra Trust, which pool operating assets and are widely owned by pension funds and institutional investors.

This divergence has triggered debate among market participants: if two instruments share similar structural DNA, why is one treated as equity while the other remains in a grey zone? The answer lies partly in liquidity needs and partly in regulatory expedience—but it comes at the cost of conceptual clarity.

The essence of equity is simple: a residual claim on profits, theoretically unlimited upside, and volatility linked to the performance of a growing enterprise. REITs meet none of these criteria meaningfully. Large portions of their cash flows must be distributed, leverage is capped, and rental escalations occur in slow, cyclical steps. They are designed not for explosive capital appreciation but for steady income.

InvITs go even further down the fixed-income spectrum. Road InvITs rely on toll or annuity revenues, while power transmission InvITs operate on predetermined tariffs. Their cash flows resemble long-duration, quasi-bond streams—stable, contracted, and largely insensitive to economic cycles.

Structurally, both REITs and InvITs sit within the same “real-assets” family. Economically, both behave more like income-oriented instruments than growth-oriented equities. Yet Indian regulation now treats them differently.

The explanation is straightforward: REITs need liquidity; InvITs already have it.

REITs in India have struggled with thin trading volumes, modest institutional depth, and lukewarm retail participation. Their absence from mainstream indices reinforced this problem, which discouraged mutual funds from adding REIT exposure in equity schemes.

By classifying REITs as equity, SEBI aims to broaden the pool of eligible buyers, bring them into SIP-driven flows, make them index-eligible, and deepen liquidity. Whether this ultimately stabilises or distorts prices remains to be seen.

InvITs, by contrast, already enjoy strong, long-term institutional demand. Global pension funds, sovereign investors, and insurance companies dominate their investor base. For these vehicles, retail liquidity is neither expected nor required. With no immediate market-development objective to serve, regulators simply found no compelling reason to reclassify them.

But the outcome is logically inconsistent: if REITs—yield instruments with limited upside—qualify as equity, InvITs should too. Or neither should.

Equity Criteria
If India insists on including REITs within the equity bucket, a selective, criteria-based approach is essential.

REITs that reasonably fit the equity category include:

• Large, liquid REITs with strong governance and diversified portfolios.
• Operating-asset REITs (commercial, retail, logistics) with predictable rental cashflows.
• REITs meeting free-float and turnover thresholds for index inclusion.

These behave somewhat like “public equities with yield,” and many global indices treat them as such.

REITs that should not be classified as equity:

• Thinly traded REITs where fund flows can distort prices.
• Single-asset or geographically concentrated REITs with unstable income.
• Development-oriented REITs or sponsor-heavy entities exposed to construction cycles.
• Mortgage REITs, which are effectively leveraged fixed-income vehicles.

A blanket classification risks forcing unsuitable structures into equity funds.

Global Limits
SEBI’s move draws on global precedent, but transplanting practices without contextual alignment is risky.

1. India’s tax design is different.
US and Singapore REITs enjoy clean, investor-level taxation. India’s distribution components—interest, SPV debt repayment, capital receipts—remain complex for retail investors and distort fund accounting.

2. Market depth is incomparable.
The US has hundreds of sizable REITs; Singapore has over 40 active S-REITs. India has only a handful. Forcing REITs prematurely into equity indices risks creating flow-driven volatility.

3. Global indices include filters.
Many benchmarks treat REITs as a distinct subsector; mortgage REITs are often excluded. India must replicate these filters if it wishes to replicate the classification.

4. Retail financial literacy is lower.
Investors may misinterpret REITs’ inclusion in equity funds as a sign of strong capital appreciation potential—an expectation these vehicles are not built to deliver. India has already seen the consequences of misinterpreting complex instruments, as with AT1 bonds.

Hidden Risks
If implemented mechanically, the classification could create avoidable distortions:

1. Misallocation of capital as equity investors are inadvertently pushed into yield instruments.
2. Liquidity stress during redemptions, with forced selling in shallow REIT markets.
3. Misaligned valuation metrics—REITs require NAV and cap-rate frameworks, not P/E ratios.
4. Flow-driven volatility if passive funds enter before sufficient liquidity develops.
5. Conceptual incoherence vis-à-vis InvITs, which remain unclassified despite being even more bond-like.

Coherent Path
India can deepen its real-assets market without stretching definitions.

• Create a unified “Listed Alternatives” category for REITs and InvITs.
• Apply eligibility filters so only large, liquid, diversified REITs qualify as equity.
• Build dedicated real-estate and infrastructure indices to manage flows sustainably.
• Harmonise tax treatment so classification aligns with economic substance.
• Require clearer disclosures on cashflow sensitivity and valuation frameworks in mutual fund portfolios.

India’s REIT and InvIT ecosystem is a genuine capital-market innovation. But classifications should reflect economic reality, not regulatory convenience. Labelling REITs as equity while excluding InvITs stretches definitions and risks confusing investors. Global practice offers guidance, not a template.

If India wants market depth without volatility, it needs a clearer taxonomy, stronger guardrails, and a more coherent regulatory philosophy. Otherwise, investors may discover that what they believed was equity was, in substance, something entirely different.