New venue for investors

REMFs offer a mid-path between low risk REITs and high risk venture funds.

Vidya Bala

Real estate mutual funds (REMFs) hold promise as a viable option for retail investors to participate in real estate as an asset class. While this could be a challenge to the mutual fund industry to manage a different asset class, the scheme could prove to be a boon for the real-estate industry that often struggles to churn capital due to difficulty in offloading assets developed.

The product

REMFs would be close ended with units listed on a recognised stock exchange. The funds can invest in real-estate assets, equity and debt instruments of real-estate companies or those dealing in such assets.

The fund’s NAV would be declared on a daily basis, although valuations of real-estate assets held by the fund would be done on a quarterly timeframe. This essentially means that there would be little change in NAVs on a daily basis; changes in the price of securities held by the fund would be the only dynamic component in the NAV on a daily basis.

Less risky

REMFs seek to gain exposure to three segments — completed real-estate assets, stocks of realty companies and mortgage-backed securities that yield income. While investors may be familiar with the last two classes of investments, exposure to real-estate assets is the new feature these funds will seek to offer.

REMFs are required to hold at least 35 per cent of their total funds in real-estate assets and are also subject to a cap on exposure to individual projects or a single city.

Investments in real-estate assets can however be made by funds only in completed projects. This essentially means that REMFs would generate income through lease of assets held by them or capital appreciation through sale of such assets.

Traditionally, profitability of real-estate companies has come from developing low-cost land. REMFs may not be able to participate in such gains given that they cannot invest directly in projects under development. They can at best invest in securities of such companies that are developing the projects.

Mr Anurag Mathur, Joint Managing Director, India, Cushman & Wakefield, agrees with this view. “Returns from real-estate assets invested by REMFs may not be as profitable as investing directly in properties under development. However, the idea is to reduce the risks that retail investors are exposed to.” “Income generated from these assets may be distributed to investors thus providing returns” he adds.

What for investors?

Investors in REMFs can at best view this product as an exposure to another asset class — viz. real estate. “Investments of REMFs would be illiquid,” says Mr Jai Mavani, Executive Director, KPMG. “However they offer a mid-path to investors, between low risk, low return REITs and high risk, high return real-estate venture funds.”

Investors equating these products to equity investments or those looking to see their NAVs move like stock prices may be in for disappointment as the funds may not be selling and buying property frequently. The close-ended nature would also provide fewer exit options. REMFs would also not get the status enjoyed by equity funds for tax purposes as they would be required to invest not less than 35 per cent in realty assets. Investors would, therefore, suffer long term capital gains or short-term capital gains at applicable rates. However, without an equity fund status, they would not be subject to securities transaction tax.

On the positive side, income generated through leases may be distributed in the form of tax-free dividends, thus providing an income-generating investment.

Prospects for the developer

The key benefit for a developer would be the creation of a secondary market for projects developed. “There are very few investment grade assets at present and hardly any established secondary market for them,” says Mr Mavani. Hence REMFs can provide capital unlocking for developers he said.

There are a number of projects that are not FDI compliant and, hence, do not receive funding. Mr Mavani raises the issue of whether REMFs would turn out to be vehicles for FIIs to enter such projects. While clarity is awaited on this front, a possible entry of FIIs poses the risk of yet another real-estate bubble, fears Mr Mavani.

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