SPECIAL REPORT: REAL ESTATE MUTUAL FUNDS

• SEBI allows setting up of Real Estate Mutual Funds(REMFs), issues guidelines

• A new investment opportunity in the $12 billion Indian real estate market
• SEBI guidelines allow REMFs to invest directly in real estate property or equity and other
securities of developers
• Indian REMFs expected to outperform diversified equity funds

The Securities and Exchange Board of India (SEBI), apex regulatory body in India for the securities
markets has approved the guidelines for the real estate mutual funds (REMFs). The advent of REMFs
has opened a new vista of investment opportunities in the $12 billion real estate market of India that
is growing by 30% year-on-year. Analysts from Merrill Lynch & Co., world's leading financial
management and advisory company have predicted the Indian real estate market to grow at $90
billion in 10 years.
As per the new SEBI guidelines, all the schemes having an objective to invest directly or
indirectly in real estate property will be governed by the provisions and guidelines under SEBI
(Mutual Funds) regulations. SEBI has made it clear that the structure of the REMFs, initially,
shall be close ended. The units of REMFs shall be compulsorily listed on the stock exchanges,
and NAV of the scheme shall be declared daily.
The scope of the REMFs has been kept quite wide open, as the guidelines allow these
schemes to invest:
• Directly in real estate properties within India,
• Mortgage (housing lease) backed securities,
• Equity shares/bonds/debentures of listed/unlisted companies which deal in
properties and also undertake property development, and in
• Other securities.
According to SEBI guidelines, REMFs need to appoint a custodian who has been granted a
certificate of registration to carry on the business of custodian of securities by the Board.
The custodian will safe keep the title of real estate properties held by the REMFs.
Earlier, in the absence of real estate mutual funds, companies setting up real estate funds
had to restrict themselves to financial institutions, corporate sector and high net worth
individuals for creating their investor base.
HDFC Property Fund, a joint venture of India’s largest housing finance company Housing
Development Finance Corporation (HDFC) and the largest Indian commercial bank State Bank
of India (SBI), had announced the closing of its first real estate venture fund scheme called
HDFC INDIA Real Estate Fund (HI-REF) about a year back with a cumulative corpus of $222
million (Rs. 1,000 crore). It was claimed to be India’s first real estate venture fund scheme
that achieved closure. The scheme that was open for subscription from domestic institutions
and high net worth individuals had a minimum contribution of $1.1 million (Rs. 5 crore) per
investor.
HDFC, Prudential ICICI AMC Ltd., the largest Indian Mutual fund and a joint venture between
Prudential Plc, UK's leading insurance company and ICICI Bank Ltd, India's leading financial
institution, $2.7 billion fund Kotak Mahindra Mutual Fund (KMMF), Infrastructure Leasing &
Financial Services Limited (IL&FS) that has assets worth more than $1.3 billion under its
control, and some other domestic and foreign entities have raised about $1 billion through
real estate funds of their venture capital arms.
A number of real estate mutual funds are now expected to come into picture in just a few
months. Unit Trust of India (UTI), the second largest mutual fund of India, and other mutual
funds as well as real estate developers are expected to float schemes soon. ICICI and HDFC,
the two major Indian financial institutions, are already in an advance stage of drafting the
proposals to launch their REMFs, as some media reports suggest.
The REMFs will offer the real estate developers another source of funds, as the SEBI
guidelines allow the funds to invest in the equity of public listed or privately held real estate
developer companies as much as 65% of the fund size. In a situation where the rising interest
rates and the reduced borrowing limit are leading to a cash-crunch situation for many
builders, the REMFs may become a good alternative for them to source capital. The minimum
investment norms stipulated in the SEBI guideline have been thoughtfully designed to
promote pure investment in the sector rather than speculation.
The guideline says that the Real Estate MF will invest at least 35% of the assets in real estate
properties that are already completed and usable. Under construction projects, vacant land
or properties specified for agriculture use won't be considered as "real estate property" for
satisfying the 35% minimum investment norm under the guidelines.
Also, minimum 75% investment has been earmarked for real estate properties, mortgage-
backed securities, equity or bonds or debentures of publicly listed or privately held
companies dealing in real estate and in other securities. Here, the other securities would
mean only debt and money market instruments.
Clearly, SEBI wants the REMFs to abstain from investing in under-construction projects or
vacant land, as such investments are supposed to take a longer period to produce a decent
yield and the retail investors may not be willing to wait for that long. Also, such investments
may have higher risks attached and gray areas about valuations.
Will the opening of real estate sector for mutual funds result in the realty prices going up?
There are mixed views on this possibility, as some people believe that REMFs will bring in
more money into the real estate market and thus will firm up prices. On the other hand,
there are people who don’t buy this theory as they say Foreigh Direct Investment (FDI) and
High Net-worth Individuals (HNI) money has already been in play in the realty market. Some
experts also find more supply a natural outcome of this development. In any case, more
money in the hands of organised sector is certainly good for the industry.
The advent of REMFs is also expected to encourage cleaning up of the Indian real estate
market. These funds, being governed by the SEBI guidelines, will have transparent dealings
and the developers transacting with them will also have to adhere to the same level of
transparency. This will certainly reduce the use of black money in the real estate operations.
The developers willing to receive the institutional funding will have to improve their
corporate governance level. Also, it may intensify the competition in the real estate market,
as even the tier II & tier III developers may get easy funding.
The performance of Real Estate Investment Trusts (REITs) in other countries has been
comparable to equity funds. The compounded annual return of Morgan Stanley Capital
International Inc., a leading provider of equity, fixed income, and hedge fund indices, MSCI
US REIT has been 19.5% for a five-year period, and 14.6% for a ten-year period, as of May 31,
2006. In India, however, REMFs are expected to deliver better returns than diversified equity
funds, given the high growth rate of the real estate sector here.