Real estate options

The Securities and Exchange Board of India's announcement allowing real estate mutual funds (REMF) is to be welcomed. The Indian real estate market has been through a boom phase, raising general interest in the sector. However, investment directly in real estate is lumpy, sticky and involves high transaction costs. Those wishing to benefit from the boom have had the option of investing in the shares of real estate companies, but these have been exorbitantly priced. Even the shares of companies that have surplus real estate which can be developed had reached stratospheric levels. Now there is a correction in the market, but on a medium- to long-term basis, there can be little doubt that the real estate sector holds considerable promise. REMFs will present retail investors with a new set of investment options, and also help legitimise funding for the industry, which has traditionally not had access to finance from the organised sector and therefore been mired in murky deals involving different shades of money.

The Sebi announcement is well-timed because it has come in the wake of the correction in real estate prices. It has also come at a time when retail investors are not quite so enamoured of the stock market and are looking soberly at alternatives, other than fixed income securities that barely keep step with inflation. Real estate investments have a longer gestation period than many other sectors, but they are likely to be lodged between equities and fixed income options in terms of risk and returns, as long as the debt-equity balance is rational. Besides, REMFs will provide increased liquidity and transparency, compared with buying property directly. For real estate companies and even companies developing the special economic zones, a new source of financing has been opened up.

While Sebi has not issued the guidelines yet, there will be some operational issues that need to be addressed. First, it is possible to value mortgage-backed securities and stock or bond prices of real estate companies even if they are not traded regularly, but how are real estate properties such as land bank or commercial/dwelling units in work-in-progress to be valued and marked to market on a daily basis, so that the fund house can announce the net asset value? Will REMFs be liable to pay stamp duties and property taxes or will these duties be waived or set off? Since these duties are governed by the states or local governments, the central government will need to intervene. There will also be issues concerning transaction costs like brokerage, which could be high in property transactions, and which may also need to be regulated. Some of these issues go well beyond Sebi's mandate.

Some funds already exist which have invested in real estate, but these were floated as venture capital funds and are less regulated. The retail participation in these funds has been negligible as the ticket size runs into lakhs of rupees. Nevertheless, there are a few companies and fund managers who have experience of investing in real estate today. There is no doubt that some of the existing mutual funds have the capability of running such a fund. So, the market could see some new specialised asset management companies that focus on REMFs. Some real estate developers, who are familiar with the terrain, may also team up with financial players and get into this new line of business.