|
| |
Real Estate Mutual Fund
Student Research Project ( Posted on 9/1/2007)
Real Estate Defined
The term real estate is defined as land, including the air above it and the
ground below it and any buildings or structures on it that are intended to be of
a permanent nature. It covers residential housing, commercial offices, trading
spaces such as theatres, hotels and restaurants, retail outlets, industrial
building such as factories and government buildings. real Estate involves the
purchase, sale and development of land, residential and non-residential
buildings. the main players in the real estate market are the landlords,
developers, builders, real estate agents, tenants, buyers, etc. the activities
of the real estate sector encompass the housing and construction sectors also.
Real estate fund
Real estate fund is a fund that buys, develops, manages and
shells real estate assets and allows various participants small and large to
invest in a professionally managed portfolio of real estate properties. This
concept is still in its infancy in India as it is ion Much of Asia. But like
most other novel financial instruments, there should be no problems for this new
concept to be accepted. Real estate funds are one of the hottest things in the
developed world as an investment tool. They have become a rage in the developed
world mainly because it does not have any correlation with the movements in the
equity markets and thus providing diversification benefits to the investors
along with stable returns.
Reasons for investing in Real Estate Sector in India via
Mutual Funds
There are many reasons why one should invest in real estate,
the following are the reasons:
-
To be part of the India story since the real estate prices
generally have a correlation with the country’s growth rate.
-
Real estate investment provides the investor a chance of
portfolio diversification and thereby reducing the risk associated with
investing in single asset class.
Monthly Correlation of REIT Total Returns and Other types of
Investments
|
Years |
Large Stock |
Small Stock |
Long-term Debt |
International Stocks |
|
1993-2002 |
0.26 |
0.33 |
0.03 |
0.24 |
-
Real Estate generally provides for steady returns. This is
shown by the graph given below which shows the performance of Dow Jones
Industrial Average (DJIA) an equity index and Dow Jones REIT Index (DJREIT) a
real estate index over the period of 2000 to 2004.
-
Real estate investments can provide for an effective
inflation hedge as investing in real estate involves investing in a real asset
and thus the property prices tend to increase with increase in inflation and
also the rent or lease payments can be increased with increase in inflation.
-
Protection from legalities: With legal expertise in the
hands of REMF, it can save investors from legal hassles, such as duties,
documentation, etc. and going through the nitty-gritty of real estate.
-
Affordability: Individual investor may not have the
financial strength to invest in real estate properties. REMF will allow
investor to invest in real estate property by holding units of REMF.
-
Liquidity: When an investor invests directly in an
individual property, buying and selling is a complex, time-consuming and
lengthy process. By contrast, his invest in a real estate mutual funds can be
brought or sold just like any other mutual fund. Because many REMF shares
would have traded on the major stock exchanges and they would be more readily
converted into cash than direct investments in properties.
The introduction of Real Estate Investment Schemes in Indian
seems to be pliable option, which would result in increase in rental housing
generation.
In India these schemes would provide enough support to the
local corporations and municipalities through the payment of the house tax and
water tax.
Benefits to the real estate sector
-
Flow of funds in the sector
-
Sector will become more organized
-
REIS will also help to tap the investments from larger
section of Indian Market
-
More credibility to the sector
-
Availability of foreign investments
Economic and social benefits
-
Growth of real estate sector can boost the GDP
-
Opportunities of employment
-
Growth of ancillary industries
-
Help in the process of slum development
-
Availability of funds to the government for infrastructure
development
-
It can also help in improving the penetration of mutual
funds in India. There is a general acceptance in India for investment in Real
Estate
-
Help in development of tourism
-
Funds for the development of B & C grade cities
Now since we are sure of the attractiveness of the real
estate markets let us now look at the framework under which a real estate mutual
fund (REMF) is likely to operate.
Here,
-
Investor is one who has an affinity towards realty
investments. Investor profile can range from Insurance Companies, Corporate
bodies to retail investors. The investors are the source of funds in the whole
framework.
-
Real Estate Mutual Fund or the REMF acts as a conduit or a
link between an investor and real estate and helps manage the funds of the
investors and invest them in the real estate sector.
-
Investments: REMF can invest in a developed property, and
as the value appreciates over a period of time, it can offload its investment
to make capital gains. It also has an option of developing the property on its
own and then selling it at an appropriate time ensure adequate returns.
Furthermore, it can realize regular stream of returns through leasing,
financing to developers and mortgage backed financing. The investment avenues
are the users of funds in the whole framework.
-
The functions, which REMF performs, includes entering into
real estate transactions on behalf of its investors, performing valuations of
the properties either internally or through external agencies. The REMF is
also responsible in maintaining liquidity in case of any redemption pressures
or to fulfil any financial obligations or to undertake trades. The REMF is
also responsible for maintaining the properties, which it has bought or are
under its control.
-
The regulatory bodies involved in the working of the REMF
include the finance ministry, the SEBI, the RBI and any other body as per the
rules formed by the concerned authority.
After understanding the framework under which one can expect
a potential Real Estate Fund to work we now need to determine the structure
under which such a fund might follow.
REMF Structure
Internationally there are two structures, which real estate
funds follow. These two structures are:
-
Real Estate Investment Trust (REIT) structured followed in
America and Canada.
-
Pooled Managed Vehicle (PMV) or the Mutual Fund Structure
Followed in United Kingdom.
But these structures are explained below:
-
REIT Structure: REIT is a corporate structure, which
collects money from the investors and invests in real estate assets to earn
money in the form of rentals and lease. It also earns money on the profit from
the sale of any assets. In the USA, by law REITs need to give at least 90% of
their net income as dividend to its investors every year. An REIT is a closed
ended fund, which does not accept fresh investment after its Public Offering,
is over and also does not allow everyday redemption. To provide for liquidity
to its investors it gets itself listed to an exchange and the REIT
certificates are then freely traded on the exchange. To fund fresh investment
REIT can raise debt from banks and financial institutions just like any other
corporate.
-
PMV or mutual fund structure: In this structure, which is
prevalent in UK, the funds is in the form of a trust and operates just like an
open ended mutual fund. Such funds are not allowed to use leverage in the form
of institutional loans or bank loans. The fact that they are open ended helps
them provide liquidity to the investors as redemptions are possible but at the
time of the heavy redemption pressure they have the power to suspend
redemption till the next valuation of properties it holds takes place. Since
it provides for liquidity there is no need to list them on exchanges and
that’s why most of them are not listed on the exchanges.
Thus we see that there are three fundamental differences
between these two structures, which are listed in the table given below:
|
REIT Structure (USA) |
Mutual fund structure (UK) |
|
Close ended fund |
Open ended fund |
|
Uses leverage |
Does not use leverage |
|
Are listed on the exchanges |
Not listed on the exchanges |
Real estate mutual fund in India
There is a hot discussion floating in India about which model
the Indian market should adopt. Should it adopt the Us structure or the UK
structure or follow an altogether new structure for a fund, which invest in Real
Estate. There are proponents of close ended mutual fund and of open ended mutual
funds.
The proponents of close ended mutual funds argue that the
Indian real estate markets is highly illiquid and require long term investment
horizon which might create a problem for open ended mutual funds are there wont
be enough liquidity to enable smooth redemption as in the case with equity
investments.
The proponents of open ended mutual funds state that the fund
is not project specific and thus it cannot be a close ended fund and they feel
that it is easier for an open ended fund to get funds for investing in new
properties in the absence of ability to raise debt, which could be dangerous for
the investors. They also feel that the problem of heavy redemption can be over
come by the ability of the fund to suspend redemption till the next valuation
date.
A study conducted by the sub-committee called Satwalekar
Committee constituted by AMFI to appraise SEBI about the product studied the two
structures and recommended using the open ended mutual fund route which is
prevalent in UK. This structure they noted needed certain modification based on
the prevailing market condition in India.
Real estate index
In USA there are funds, which invest in different REITs based
on certain Index, which are formed as a benchmark. US has a few of these indices
based on the REIT prices in the stock exchanges in which these REITs are listed.
The index weightage of those REITs is based on the total market capitalization
of each REITs. Some of the examples of such indices are Dow Jones Composite all
REIT index, Morgan Stanley REIT index, S &P/TSX Capped REIT Index.
The mutual funds, which invest, based on this strategy aim to
match these benchmark indices if not outperform them. Such indices are
non-existent in the UK market because there are no listed Real Estate Funds.
this might also be the case in India few years from now.
Investment Avenues for the Fund
It is important for us to know what are the investment
avenues, which an Indian fund can look at while investing in real estate assets.
Some of the avenues are given below:
-
Equity Shares / Bonds / Debentures of the listed companies
which deal in properties and also undertake property development. however, at
present, in India there are very few such companies, which are listed.
-
Mortgage backed securities i.e. the securitisation of
housing loans. At present, these are not yet available. However, one expects
that this avenue will be open once the bill seeking amendment is passed in the
next budget session.
-
The real estate investment schemes can undertake or finance
the properties i.e. ready buildings with a view to lease where the lease
rentals will be a regular income to such mutual funds, which can then be
distributed as dividends to the investors in the fund.
-
Direct estate project finance, construction finance,
purchase / option to purchase of buildings under construction with a view to
sell it again; investment in debt securities issued by development and
construction companies (placed privately).
-
Along with other avenues a part of the funds assets should
be invested in call and money market instruments to ensure required liquidity.
Risk associated with property investments
There are certain risks associated with investing in Real
Estate, given below:
-
Liquidity risk
-
Risk because of high maintenance burden
-
Risk due to high government controls
-
Risk due to real estate cycles
-
Risk due to legal hurdles and complexity
-
Risk due to high transaction cost thus forming barriers to
entry and exit.
-
Risk due to lack of information.
Some of these risks are natural and inevitable but a lot of
these risks can be controlled to some extent. A real estate mutual fund should
work in such a way that the overall risk is optimized and matched to the
investors needs. Regulations in this direction will go a long way in reducing
the risk levels.
Risk management would be addressed in the following way:
-
Amendment in SEBI – As recommended by the Satwalekar
Committee, a amendment in SEBI regulations is suggested enabling the SEBI to
regulate the establishment and functioning of the real estate mutual fund
schemes with all the existing regulations applicable to such mutual funds
pertaining to net worth of AMC; existing fee structure; initial launch
expenses restricted at 6%; maximum limit of expenses; etc. as already provided
in the mutual fund regulations.
-
Investment restriction – That present regulations have a
restriction on investment where any investment in one corporate should be
restricted upto 10% of the corpus and similarly, any investment in the
properties and owned and managed by sponsor should be restricted upto 25% of
the corpus.
-
Restriction based on project, Promoter Group and
geographical area – The Satwalekar Committee has recommended investment
restrictions based on a project, a promoter group and a geographical area.
With these restrictions appropriate to mitigate the concentration risk of the
investment portfolio of real estate scheme. Details of the investment
restrictions proposed in the report of the Satwalekar Committee can be found
on Page 24 of that report.
-
Valuation – At present, we have registered valuers as
approved by government of India / Income tax departments / insurance
regulatory development authority. Thus it becomes imperative for SEBI to use
them and approve these registered valuers for the purpose of valuing
properties held by real estate investment schemes. the funds should appoint
two valuers to value the properties and if the difference in the valued price
is more than 10% then a third valuers should be appointed and his valuation
should be considered.
Legal aspects that need change
Along with the regulatory issues, there are some legal issues
that are caused by our antiquated laws and which will hamper the smooth and
profitable functioning of the real estate mutual funds. thus these laws need to
be reformed since they also increase the risk level of a real estate investment.
Some of these laws and proposed changes are given below:
-
Stamp Duty – This a state subject and unless the central
government decides to make it uniform, it will be difficult and time consuming
to expect any changes in the stamp duty framework. It is recommended that
either there should be no stamp duty for a SEBI registered REMF or even if a
minor stamp duty is imposed it should take the form of value added stamp duty
structure and thus double stamp duty will be avoided in case of frequent
transfers of the properties.
-
Property taxes – This is a state/city subject. It is
recommended that the relevant authorities provide exemption from annual
property taxes to real estate investment schemes. This would help real estate
schemes to provide better returns to investors.
-
Records – A significant issue in dealing with properties is
the custody of title and paper form of transaction. It would be very helpful
to the REMF if all the property records are computerised and the properties be
transacted in a dematerialised format, exactly how the securities are traded
right now.
-
Rent control act – The provisions of the rent control act
have been amended in some of the states. since, several states continue with
the ancient rent control provisions and it is believed that the rent control
act is one of the main reasons why people are not very enthusiastic in
building a house and giving it on rent.
-
Urban land ceilings and regulations act – This act lays a
ceiling (generally around 500 to 2000 square meter) on the land which a person
can hold in an urban area, the access land is either to be handed over to a
competent authority or is to be developed by the owner for a specified
purposes only. Here a person stands for an individual, corporation, firm,
association or body of individuals etc. thus if the REIT has to come to any
meaningful existence this law has to be scrapped.
Approval procedures
Another serious malaise affecting investment in the real
estate sector and housing development in the tardy process of planning
approvals. A system of deemed approvals for all planning permissions by
registered architects operating on the basis of self-regulation much like
chartered accountants do, would enormously speed up the entire plan approval
process. This will ensure that far larger quantum of housing stock is supplied
every year, at more reasonable prices than is the case presently.
All these issues are major hindrance to the real estate
investment schemes in India. A country like India having ample of land and set
of huge investors requires attention on these problems. A major step in these
directions will benefit the society.
Potential players
India has very few listed companies that operate in the real
estate sector in Indian context for the success of these schemes it needs the
participation and willingness on the part of reputed construction groups as well
as asset management companies. this combination of professional fund management
and expertise in real estate will be an appropriate model for Indian market.
Conclusion
It can be concluded that there is a tremendous potential for
a real estate mutual fund to be introduced in India. The proposed fund will
mainly follow the structure already being followed in UK, which is that of a
mutual fund with some changes. Though the demand for such a fund is huge there
are lot of concerns, which are still to be answered in terms of the antiquated
laws, which govern the real estate business, the existing laws of SEBI and
regulatory mechanisms to be used. If these concerns are taken care off by the
government then the proposed real estate funds are poised to have an exponential
growth in India and thereby lead to greater economic growth and overall progress
of the country. mutual fund houses should take an active interest in such a
fund, as it can be a big money earner for it. but introducing such a fund and
ensuring stable returns to the investors will be only possible after the
regulations are more favourable for real estate mutual funds.
References:
| |
|
