Real Estate Mutual Funds (REMFs)

[Vicky78]

Real estate has always been a much-valued investment in India. From individuals who have inherited property to corporates with huge land banks, the sector has seen unprecedented activity. However, the very nature of the industry and its high-pricing make it inaccessible to many. The Securities and Exchange Board of India (SEBI) has attempted to enable the common man reap the gains of this sector by permitting Real Estate Mutual Funds (REMFs).


Dos and Donts

The norms stipulate that at least 35 per cent of the net assets of the scheme shall be invested directly in real-estate assets. Investments in these and related securities ( that is, real-estate companies and mortgage-backed securities) shall together not be less than 75 per cent of the net assets.

Real estate being what it is, the diktat states that not more than 30 per cent of a scheme’s net assets shall be invested in a single city, not more than 15 per cent in a single real-estate project and not more than 25 per cent of the total issue capital of any unlisted company. There is a specific bar on investment in real-estate assets owned by the sponsor or the AMC (asset management company) or in assets in which they have tenancy or lease rights.

The list of embargos continues, with a refusal to permit REMFs to undertake lending or housing finance activities. With cash playing a major role in deals in this sector, there is a specific instruction that all financial transactions under the scheme shall be routed through banking channels and cannot be cash or unaccounted. Title deeds of the assets should be kept in the custody of a custodian registered with the Board.


Acceptability?

Thanks to the wild gyrations on the bourses, mutual funds have caught on as a concept in India. There have been funds which have given stellar returns. However, expectations from the real-estate sector have always been optimistic. Considering the restrictions posed on REMFs, one would not be surprised if the sector performs like any other mutual fund scheme with no mega returns. Real-estate companies make huge profits by selling landholdings at a premium, but operating incomes are not expected to spiral as rents and the like are already at a high.


Disclosures and Valuation

The real-estate assets held shall be valued at cost price on the date of acquisition and at “fair price” every 90 days from the day of purchase by two valuers accredited by a rating agency. The lower of the two values shall be taken for the computation of NAVs (net asset values).

The NAV itself will be computed on the basis of the most current valuation of the real-estate assets. “Fair value” is the value which would be given by current prices in an active market for similar real-estate assets. Leaving the issue a little open-ended, one of the rules is that in case there is an absence of prices in an active market, information from a variety of sources would be considered with no specific mention of what would constitute variety of sources.

The rules also state that where the fair value of the asset is not easily determinable on a continuing basis, Accounting Standard 10 (Fixed Assets) issued by the Institute of Chartered Accountants of India (ICAI) would be applied.

The definition of real-estate asset includes identifiable immovable property in the country, including SEZs, while the exclusion are projects under construction, vacant land, deserted property and land specified for agricultural use or land reserved for the Government.


Revaluation

Unlike International Financial Reporting Standards (IFRSs), accounting standards in India permit revaluation of fixed assets and it has been a trend that when assets are actually re-valued, real estate occupies prime place.

Although the concept of “fair value” is being disputed, a recent study by the International Accounting Standards Board (IASB) on simplifying complexity in financial instruments suggests that in spite of its inherent limitation, fair value should be the measure to use. If it is simply impossible to arrive at a fair value, cost would be the only option. REMFs could also be given only these options.

http://www.thehindubusinessline.com/2008/05/01/stories/2008050150260900.htm

 

[Vicky78]

What do REMFs offer stakeholders?

With the recent announcement of the much-awaited regulation of Real Estate Mutual Funds (REMFs), stakeholders are excited with the prospect of investing in the much-sought-after avenue of real estate. Currently, retail investors have limited options to diversify their portfolio. Their portfolio might be restricted to outright purchasing of real-estate assets or investing in listed Real Estate (RE) companies. Given the phenomenal rise in the prices, it is almost impossibl e to invest in a mall or a commercial property.

Effectively, an REMF can purchase properties like your neighbourhood mall or an office premises and get the two-fold benefit of income generated from rentals and capital appreciation.

Like all investments, real estate has its own risk and returns profile and, accordingly, provides an excellent avenue to lower the overall portfolio risks. Simply put, the returns from real estate are not correlated to those of equity or debt instruments. However, it would be interesting to observe how existing and new asset managers (mutual funds) cope with managing the unique nature of such investments in real estate. Put differently, unlike a securities-oriented portfolio, REMFs would require a refined understanding of the sector.

The funds would be directly exposed to macroeconomic trends and micro trends such as location of assets that determine the ultimate returns for its unit holders.


Income-generating asset

Fund managers (of mutual funds) prepared to view their investment into this asset class as different in terms of being actively involved in managing the assets, are the ones who are likely to succeed. For example, owning a listed security of a company that is governed by Securities Exchange Board of India (SEBI) and other regulations would pose an entirely different challenge to purchasing a mall owned by a local RE developer looking for an exit.

Accordingly, skills such as valuation of a property would be the new specialisation that would be vital to start the operations or convince the investor. Internationally, the valuation is a matured exercise where standards are set and followed in a transparent manner. Indian valuers are still coping with this challenge. Additionally, a deep understanding of nuances such as local laws, locational analysis and future potential of a specific property would be fundamental.


Owning and maintaining

Unlike securities investment, asset managers will be required to play an active role in getting the desired returns for the unit holders. For example, mutual funds may be interested in entering tenant negotiations to enhance the rentals and instil continuous effort to enhance the property’s value through brand positioning.

Asset managers would be now required to either create teams or outsource key functions such as marketing of space to tenants, having the right tenants-mix that yield good risk adjusted returns and finally ensuring the physical upkeep and security of the properties. Such activities are entirely new dimensions of a typical asset manager’s role.


Exiting the asset

A vital component of the return to the unit holder is the ultimate capital appreciation of the underlying property. If the asset managers have been able to protect and enhance the value of the specific prime property, unit holders could expect good returns. However, exiting or selling a property is not as simple as selling a part of a security portfolio. Having access to good broker networks and market intelligence of the locality or suburb where the asset is based would be an invaluable benefit.


Existing owners of property

For a real-estate developer or an owner of an income generating assets it is important to consider what a typical REMF would look for while buying a property. Properties in prime locations are likely to have a distinct advantage of retaining higher rents and value, given that REMF would also focus on the potential sale value of its property. Good governance standards within the owner’s business and the ability to show strong processes to run the commercial property may also be crucial to making the property attractive.


REIT versus REMF

Fundamentally, both investments in income-generating real-estate assets and regulations relating to Real Estate Investment Trusts (REITs) are still at the consultation stage while REMF guidelines have now crystallised. REITs are expected to distribute a majority (90 per cent) of their income from such assets to its unit holders while REMFs may plough the income back into the portfolio and make such funds available for new investments within the scheme. While the REITs are still not an option, as the regulation evolves, it would provide an alternative type of cash flow stream for investors.

http://www.thehindubusinessline.com/2008/05/15/stories/2008051550170800.htm

 

[firewire1234]

Thanks... for the posts.. very informative...