Friday, May 9, 2008

Sebi Allows Real Estate Mutual Funds

India’s first real estate mutual fund could be just around three months away. What will it offer?

How often have you stared at a gleaming skyscraper in a tony address in your town and wished you could afford to buy a house there? If you have ended up sighing wistfully and walking away, here's some good news. Now, you may easily be able to own a small portion of a very swanky address.

After years of deliberation and planning, the Securities and Exchange Board of India (Sebi) has approved the launch real estate mutual funds (Remf); it issued a detailed set of guidelines on 16 April. All you may now need to shell out is as low as Rs five to 10 thousand to participate in real estate investing.

How will it work?
A Remf is a scheme much like any other MF scheme (which invest in shares and bonds) but it will invest in real estate. The Sebi guidelines mandate that a Remf has to invest at least 35 per cent in completed real estate assets (read flats, row houses, bungalows, shops). These could be either residential or commercial properties, but must be finished and ready-to-use and not under construction. The Remf will get title deeds and will be owners of these premises – it’s like you buying a second home or a small office. In simple words, instead of reading a name like ‘Ms Shirin Batliwala’ against, say a first floor flat number on the name-plate board at your building’s entrance, you could now have a neighbour by the name of, say, ‘HDFC Real Estate Fund.

Your Remf will then rent out these properties and earn rental income that it will pass on to you – the unitholder. When your Remf’s tenure ends, it will sell off these properties and earn – and eventually pass - capital appreciation to you. With as low as Rs 5,000, you can now own a part of this flat through your Remf. Assume your Remf collects Rs 500 crore and invests Rs 200 crore out of it (40 per cent of the collections) in 40 flats costing Rs 5 crore each. If you have invested Rs 10,000 in this fund, then your share out of the appreciation and rental income of these flats would be 0.0002 per cent.

Over and above this, your Remf can invest in under-developed properties. But it can neither buy a barren land nor can it undertake construction activities. What then? It will partner with a real-estate developer and then take a stake in a special purpose vehicle (SPV), that the developer would have set up for constructing a particular project. Note, that your Remf will take a stake in that project and not in the developer company or its other projects across the country. Your Remf will buy unlisted shares in that SPV. Once the project is ready and complete, the gains arising out of it are your Remf’s to the extent to its stake.

Additionally, your Remf can also invest in debentures of real estate companies and mortgage-backed securities and equity shares of real estate companies listed on stock exchanges. All of the above must be at least 75 per cent of the scheme’s corpus. A Remf will be closed-end (this means limited tenure and no on-going sales of units) and units will be listed on the stock exchanges. You can trade units on the exchanges though, much likes shares.

Remf not the same as Reit
If you remember sometime back Sebi had issued a draft set of guidelines for Real Estate Investment Trusts (Reit) So what is the difference between a Reit and Remf?

A Reit is also an investment vehicle to invest in real estate. Like Remfs, these too are closed-end schemes and listed on the stock exchanges. But there’s a big technical difference between the two though. A Reit is mandated to distribute at least 90 per cent of the gains that it makes in a year, to its unitholders. Secondly, Reits can only invest in finished projects and not those that are under-construction. Hence it earns its major chunk from rental income. “While Reits help you to earn a regular income, Remfs give you capital appreciation”, adds Milind Barve, managing director, HDFC MF and head of the Amfi appointed sub-committee to recommend norms for Remfs.

Note that Sebi guidelines mandate a Remf to invest at least 35 per cent in completed and ready-to-use properties, it resembles a Reit to that extent and can infact invest this portion in a Reit.

Many countries across the world, especially the developed markets like US, have both Reits and Remfs running simultaneously. India is set to follow that path as Sebi has shown enough intent to allow both these products to be launched.

Of checks and balances
For a beginning, the Sebi Remf guidelines cover a lot of ground. They mandate that each real estate property is to be valued by two valuers - these must be rated by a credit rating agency - and the Remf will invest in that property at the lower of the two values. Each property will be valued once in 90 days. So if your Remf has invested in four properties, say in March, June, September and December, respectively, then each of those four properties will be valued once each of them completes 90 days.

However, your Remf will have to declare its net asset value daily. Your fund’s NAV will also change on a daily basis because apart from real estate assets, it would have also invested in marked-to-market securities such as debentures and mortgage-backed securities.

While your Remf will charge you an expense ratio of a maximum of 2.5 per cent, just like equity funds, the tax status is unclear. Sources say that Remfs will carry a tax status akin debt funds – long-term capital gains tax of 11.33 per cent, and short-term capital gains tax as per your income-tax rates. This compares well to investing in physical real estate directly, as there the long-term capital gains tax kicks in after three years as against a year in a Remf.

…but beware of risks
Although a Remf opens up a new asset class to investors that was otherwise restrictive, it comes with its set of risks.

The ‘others’: A Remf is mandated to invest at least 75 per cent of its corpus in real-estate securities. Beyond that it is free to invest in any security, related or unrelated to real-estate. It can either invest this 25 per cent corpus directly across equity market or debt instruments or can even sit on cash; Sebi has left it for Remfs to decide. How your Remf decides to invest this portion can have a bearing on its risk profile.

Flexible asset allocation: That’s not the only flexibility that Sebi has awarded to Remfs. Beyond the mandated 35 per cent in finished real-estate projects and within 75 per cent of the scheme’ corpus, it has about four different types of securities to choose from. Here’s where one Remf can significantly look and behave different from another.

For instance, a Remf can choose to hold 35 per cent in completed real-estate assets and hold the next 40 per cent in equity shares of real-estate companies and then hold the balance 25 per cent in another set of equity shares. Or a Remf can invest up to 50 per cent in completed real-estate assets and the rest in an SPV of an under-construction project. Such Remfs will be riskier compared to those that have a healthy dose of mortgage-backed securities and debentures of real-estate companies that earn a fixed interest income. Look up the Remf’s asset allocation before investing.

Mis-selling: The same agent through whom you invest in MFs will now also sell you Remfs. Only time will tell whether they will be able to tell the nuances of one Remf from another. And although Barve says that the MF industry is geared up to train the agents and spread awareness, it will take some time - and possibly some heart-burn - before investors realise the true worth and potential of Remf. Your only genuine hope currently will be your Remf’s offer document. And, of course, keep reading Outlook Money.

Apart from Sebi’s nomination of cities in which Remfs can invest their finished-projects’ composition and the taxation incidences on unitholders, most other things are in place. Hopefully, India’s first Remf should be born in another three months.

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