The real estate sector in India has been booming for some years. Rising incomes, higher savings, easy credit, and greater infrastructure spending have spurred property prices. Yet there’s little retail investment in real estate. High property prices make it difficult for small investors to invest in real estate directly. But now, help is at hand. The market regulator, the Securities and change Board of India (Sebi), recently spelled out norms for the launch of real estate mutual funds (REMFs) in India, which would invest in real estate directly or indirectly through assets associated with, or benefiting from, the real estate sector. REMFs would be like any mutual fund, but with real estate and related security as underlying assets.
Real estate the largest asset class in the world, can serve as a hedge against other asset classes like debt or equity. Including it in your portfolio reduces risk and helps achieve stable returns. Unlike other asset classes, real estate rarely earns negative returns, and does not suffer high volatility. Over years, the value of real estate usually increases manifold. This also makes it a good hedge against inflation. Real estate is a good long term investment.
It’s important to clarify the difference between real estate investment trusts (REITs) and REMFs. REITs are companies or trusts that own and often manage income-generating commercial real estate. Some RIT invest in loans and other obligations that are secured by real estate collateral. REITs invest in and manage malls and office complexes, which fetch them rental plus long term capital appreciation, to be passed on to investors after deducting expenses. Each REIT may have its own rules and regulations, and fund specifications. REITs have been privately launched in India, and have cumulatively collected a few million dollars. Most have a high initial investment Rs 25 lakh to Rs 1 crore, and are targeted at high net worth investors.
REMFs on the other hand, would invest in a mix of real estate projects (residential and commercial) real estate securities and other securities including mortgage backed securities, in addition to REIT type investments. REMFs would follow standardized rules and be regulated by Sebi. They would be transparent and would cater to small investors. They would fundamentally alter the investment scenario by presenting a viable new option to millions of retail customers.
Their biggest advantage is that small investors can benefit, as they can buy units, instead of directly buying a flat or a plot of land. With REMFs, an investible surplus of even a few thousand rupees lets you participate in the real estate sector.
REMFs are easier than direct investment in real estate. The latter requires research and groundwork, which requires time and expertise. Even if you raised money to buy real estate, you might run into complications – identifying a property, negotiating the deal, registration and tax, potential legal disputes and so on. And another set of issues would await you at selling time. REMFs let you circumvent these hassles, and just reap the benefits. They greatly reduce the pain of investing in real estate, a sector that remains unorganized, unregulated and opaque in India, dominated as it is builders and developers. By investing in REMFs, you can leave the afore mentioned issues to professional asset managers. Additionally, you could benefit from commercial and infrastructure real estate projects, which are generally beyond the reach of retail investors.
Anther benefit of investing in REMFs is diversification. If you are investing in a single plot or flat, it may be to yield good returns for some reason – an unpopular locality, poor climatic conditions, government restrictions on land use, water shortage, electricity problems, flooding, poor maintenance and so on REMFs would invest in a large number of projects in different locations, thus diversifying the portfolio and reducing risk.
Sebi has finally allowed fund houses to launch REMFs. Accordingly will be closed ended funds, and will be listed on stock exchanges. At least 35% of the net assets of each scheme would be invested directly in real estates assets. Besides, these funds will invest in mortgage backed securities of companies that deal in real estate assets or undertake real estate development projects. To ensure adequate diversification, Sebi proposes to cap investment in a single city, a single projects, and securities issued by a sponsor or associate companies. Sebi has mandated that each asset be valued by two valuers accredited by a rating agency, every 90 days from the date of purchase. The NAVs of these funds would be declared daily.
There are still some areas where clarity is lacking. It’s not clear for how many years a fund would be closed ended. There is ambiguity with respect to taxation: it’s unclear whether these funds will be treated as debt oriented or equity oriented which as important implications for net returns. Also, because of the lack of an organized pricing platform, and the complexity of valuing project investments, valuing the real estates properties would be quite a vague exercise. There are many past instances of hugely differing valuations for a real estate project by differing valuing agencies. This would create a valuation gaps ad result in a systematic risk. Keep in mind also that while listing of REMFs would be allowed on the exchanges, most, if not all, would trade at a discount to their NAVs. An important area of concern is that reign investors may flock to REMFs, allowing them to by pass project and sector norms, and defeating the very intent of REMF to service retail investors.