Future of Real Estate Investment Funds

Student Projects ( Posted on 11/11/2006)

Introduction

In India’s fast-growing economy, real estate has emerged as one of the most appealing investment areas for domestic as well as foreign investors. The real estate sector will continue to derive its growth from the booming IT sector, since an estimated 70 percent of the new construction is for the IT sector. Besides the demand from the IT sector, the need for modern real estate would provide lucrative opportunities for investment.

Low interest rates, modern attitudes to home ownership (the average age of a new homeowner is now 32 years compared with 45 years a decade ago), economic prosperity along with a change of attitude amongst the young working population from that of save and buy to buy and repay and liberalised FDI regime have all contributed to define the future prospects of this sector which till now has not received the industry status in our country. the future of these funds depends on many factors, the most important of them being the Government’s policies. One of the most important challenges for the real estate market in India is that the Indian Government’s tax policy was not in tandem with the liberalisation initiatives being undertaken in this sector.

But recently reform process in real estate sector has garnered unprecedented momentum and with vast untapped opportunities, India could well be the desired location for real estate developers/investors in the not too distant future. A parallel can be drawn from China, which receives almost three times of the FDI inflows in India and almost half of this FDI inflow in China is in the real estate sector compared to minimal in India despite fundamental differences between these two countries, i.e., government was the sole owner of land in China and has started to privatize recently compared to private sector ownership of the most of the land in India, the potential gains from real estate sector in India are also undeniably tremendous. Two major steps taken by Indian government allowing foreign direct investment and setting up real estate mutual funds or real estate investments trusts – would catalyze real estate sector in India in not too distant future.

In this assignment we will try to focus majorly on these aspects of real estate funds: (a) FDI (b) Private Equity Funds (c) Mutual Funds & REITs (d) FIIS

Demand for real estate investment in India may reach more than $50 billion in the next five years, with nearly two-thirds predicted to come foreign capital. And the opportunities extend beyond the office sector. Global retailers are eyeing India’s youthful middle class, the fastest growing in the world , according to Primary Real Estate Advisors. The country of 1.1 billion people has only 40 malls – that number will grow to 250 by 2010; however, 75 percent of new retail space is concentrated in five major cities. India has 67 cities of more than 5,00,000 people. Best buy, Starbucks and Wal-Mart already have expressed interest in establishing an Indian foothold, according to CBRE.

India’s manufacturing sector grew by 11 percent last year, and it is fast becoming the worlds primary exporter of auto parts. General motors expects to source $1 billion annually in auto parts from India by 2008, up from $120 million in 2005. In addition, increased investment in infrastructure will lead to growth in construction- related industries such as cement and steel manufacturers.

In other sectors, residential experts predict a shortfall of 22.7 million housing units by 2007, requiring an investment of $25 billion in the next five years, according to PREA. The hospitality market is largely undeveloped, with only 79,000 rooms in the entire country according to Knight Frank’s 2005 India retail review.

Future of FDI in Real Estate

Development in all sectors may ramp up quickly due to fewer foreign investment restrictions. The new foreign direct investment rules allow foreign companies to bid on construction projects without Indian partners; they also lower the minimum development size from 100 acres to 25 acres, “ a more managing principal of Gumbiner Savett’s national real estate practice. “The Liberalized FDI guidelines will lead to more than 1 billion U.S. dollars annually invested into India’s development and construction industry, “ he adds.

Already, GE commercial finance real estate in investing $63 million in the India IT parks fund, and Tishman Speyer has invested $250 million in a joint venture with India’s largest venture capital company. Last fall Nevada-based Royal Indian Raj International Corp. announced a partnership with new York-based Royal real estate investment finance company Greenwich group International to raise $1 billion to finance commercial and residential projects.

“Given the positive outlook for the Indian economy, this may just be the tip of the iceberg,”

Future of Real Estate Mutual and Private Equity Funds

Proposals for launching over $1 billion worth real estate funds have been filed with the securities and exchange board of India. With the opening of foreign direct investment in the construction sector, there is a lot of interest from global investors to participate in the potential boom of the real estate industry in India.

A large part of these investors are not keen on tying down their investments in a small number of select projects but want to broad base the investments as far as possible. Real estate investment trusts (REITs) are seen as the way to achieve optimum exposure at calculated risk levels and hence the large number of applications with SEBI.

The frenzy in the real estate sector is high as returns from this sector currently exceed most other investment areas, according to investment experts. Yields on commercial real estate across metros in India are higher than those of many global real estate markets and investors are now keen on sinking their teeth into part of this pie. Once cleared, these trusts will allow retail investors also to diversify into real estate investments.

REITs are being promoted by Indian companies in the real estate sector and investment houses. These companies and fund managers have received several enquiries from institutional investors abroad, including CalPERS. “This is an opportunity waiting to tapped. We are only waiting for regulatory clearance now, we already have enough clients waiting to invest, “ said the chief finance officer of a construction company.

While the securities and exchange board of India has not offered any response to the applications it has received so far, it is understood to be formulating methods to regulate these. So far, venture funds have been allowed to float real estate investment products.

In their absolute avatar, real estate investment trusts are securities that sell like a stock, whether listed on the exchange or not, and invest in real estate directly, either through properties or mortgages.

Globally , REITs receive special tax considerations, and are known to often offer investors high yields as well as liquid method of investing in real estate. These REITs are usually equity-based, mortgage-based or Hybrid. Equity REITs invest in and own properties, typically where opportunities of high rentals are available . mortgage REITs loan money for mortgages to owners of real estate, or purchase existing mortgages or mortgage-backed securities. Their revenues are generated by the interest that they earn on these loans. Hybrid REITs are combinations of these two.

HDFC ventures have both recently launched products in this category. HDFCs India real estate fund invests in equity and equity linked instruments of companies engaged primarily in real estate in major cities in India. The 7 year close-ended fund requires minimum contribution of Rs 5 crore per investor. ICICI Venture also initiated its foray into the real estate and property investment management sector through the launch of a dedicated real estate fund, the India advantage Fund III, with a corpus of $300 million.

Conclusion

Although the future seems to be a lot brighter for real estate sector but still a lot needs to be done and especially in the implementation of real estate mutual funds and REITs as the nature of the real estate funds is vastly different from that of normal securities it needs a hole new set of regulatory provisions. These need to be recognized and the existing committee’s recommendation must be looked at seriously and the requisite action must be expedited. The existing laws and the procedures are archaic and irrelevant and create hindrances to the development of the real estate sector in the country. as the existence of the of the real estate mutual funds is dependent on the development of the sector, it is the responsibility of the government to reform the existing legal procedures and taxation laws to ensures its smooth implementation. The prospective real estate fund developers and mutual need to make themselves completely aware of these troublesome laws and form a strong lobby and present their case to the regulator. It is essential to create a strong support structure for the real estate mutual fund industry, by involving experts from the real estate industry in the valuation and grading of real estate properties, tax consultants for simplifying taxation of the real estate taxation, insurance industry for the insurance of real estate, accreditation bodies for deciding eligibility & association of real estate developers for ensuring co-operation and transparency. Mutual funds need to recruit professionals with the requisite experience in the real estate, for operating the fund effectively.

The rights of the small investor need to be safeguard. Checking malpractice’s by strict supervision can make this possible. On implementation , the real estate mutual funds also need to make regular disclosures about their performance and their diversification.