Building Assets

Real estate mutual funds are not far off now. Will they turn investors’ dreams into realty?
Hemant Rustagi
REAL estate has been one of the most intriguing investment classes for Indian investors. Considering that one needs a large sum of money to invest in real estate, owning it remains a distant dream for many. Besides, the lack of transparency and the illiquid nature of the market make direct investment in property a risky proposition. One often comes across instances of investors facing legal hassles relating to property, or getting a much lower price than the fair valuation of the property. But this is likely to change soon. Realty mutual funds, which allow even investors with modest sums of money to participate in the growth of the real estate sector, are going to become a reality in India soon. Although real estate mutual funds (REMFs) are a new concept for Indian investors, they have had a long and successful history in the US, UK, Australia, Japan, Hong Kong, Singapore, and elsewhere. In the US, they are known as Real Estate Investment Trusts (REITs), and were introduced in 1960 to allow investors to invest in real estate in the same way as in other sectors or industries. Over the years, REITs have grown phenomenally in size and importance. In 2001, Standard & Poor’s recognised the evolution of REITs by adding them to its major indices, including the S&P500. In India, too, realising that a REMF could limit the risks the average investor would face in real estate investments, the capital market regulator, the Securities and Exchange Board of India (Sebi), initiated the process for launching them a couple of years ago. However, the process was delayed by debates over valuation norms and the frequency of calculation of the net asset value (NAV). These issues have reportedly been sorted out, and the revised guidelines are likely to be out soon. So, what are REMFs, and what do they offer investors? REMFs can invest in real estate projects in India, mortgage-backed securities as well as equity, debt, and debentures of real estate companies. REMFs earn returns from property through rents and capital appreciation, as well as through interest, dividends, and appreciation in the value of securities of real estate companies. From an investor’s point of view, REMFs make it affordable for someone with a relatively small sum of money to participate in the property market. They also give investors one more way to diversify their investment portfolio, and cut down property-specific risks. As you can imagine, REMFs are likely to bring more liquidity to, and improve the organisational level of, the real estate market in India. There are many reasons why investing in real estate is a good idea. The most obvious one is emotional: to buy a house for oneself and one’s family. The other major reason is that real estate offers tremendous potential for growth. It is common knowledge that the real estate sector has become increasingly important as the Indian economy has liberalised. Ever-increasing business opportunities have resulted in higher demand for commercial and residential property. So it seems reasonable to expect that the real estate sector in India will grow at a healthy rate. Although it is unorganised compared to its counterparts in developed countries, the sector has attracted foreign investors in a big way. Indian as well as foreign institutions have increased their investments in real estate. It is also important for investors to understand that, over the long term, returns from real estate are comparable with those on equity. Moreover, the volatility in real estate prices is generally lower. This makes real estate a better risk-return trade-off. In other words, real estate investments are a good hedge against inflation over the long term, and yield positive real rate of returns. However, as with other investment options, REMFs derive their risk from the underlying asset, that is, property. The risk is reduced substantially by diversification across multiple investments. At the same time, REMFs can be riskier than diversified equity funds, as they focus singularly on the real estate sector, so a downturn in the sector could be a much greater risk. Another issue that REMF investors are likely to face is related to liquidity. Although REMFs are sometimes projected as the answer to the real estate industry’s liquidity woes, this must be qualified. As per Sebi’s guidelines for REMFs, these will be closed-ended funds. In other words, investors in an REMF will not have the option of selling their units back to the fund. Although investors will be provided with an exit option by way of listing on the stock exchanges, the effectiveness of the medium is questionable, especially as listing has not proved an effective exit medium for investors in normal closed-ended funds. REMFs are likely to face similar problems. It is possible that the market price may be at a discount to NAV, and that investors will have to go through the tedious process of selling through a broker. So it’s important for an investor in an REMF to be in it for the long haul. Another reason to think long-term is that real estate projects have long gestation periods.