JULY 02, 2009

Will Budget propel REIT's chapter in Real Estate growth story?

By Vijayashree R & Priyanka Singhal, PwC

REAL Estate Investment Trusts (REIT) are popular investment vehicles for investment in real estate sector world over. This concept originated in US in 60s and was adapted by Australia in 70s, and since then the REIT concept has been constantly developing and varying to suit the changing times and requirements of the economies of the countries where the concept was introduced. Countries like Australia, Japan, China, Singapore, etc have benefited immensely from introduction of REIT in their economic system.

India has recently introduced regulations for Real estate Mutual Fund (REMF). This concept is effectively a form of REIT in India , though separate regulations for REIT have been drafted by SEBI, which have not been finalized.

There is huge potential in India for real estate development (residential, retail and commercial) but the sector is largely unorganized and developers depend heavily on banks, finance companies and foreign investments. With high demand in the sector (need for development of residential, retail and commercial real estate) and liquidity crunch, REMF could serve as a boon to address the problems faced by real estate sector, whilst making it organized and competitive.

What is REMF?

REMF is a pooling vehicle which raises monies by sale of units to the public or a section of public. They invest primarily in the Real estate sector. The schemes floated by REMF are required to be close-ended schemes and listed on a recognized stock exchange. Investors in REMF would benefit from income as well as capital appreciation in the assets.

Who will benefit?

Currently, there is a low volume of retail investment in real estate as these investors find it difficult to invest directly in real estate due to skyrocketing prices and the option to diversify the risk in this sector is minimal. REMF presents them with an opportunity to own properties like a mall or an office premise. Further, investors could earn higher and stable returns. REMF would help real estate developers to raise funds domestically, bringing about stableness in the real estate sector. The listing of REMF units on the stock market would infuse the much needed liquidity without fear of withdrawal by investors from the funds, as the schemes launched are required to be close- ended.

From an overall market perspective, REMF are likely to increase transparency, which in turn would help investors, developers and other related parties to take informed and timely decisions, lower the cost of capital for investment in real estate and reduce the extent of reliance on money lenders, etc.

REMF with an adequate back up system would lead to a justifiable and equitable geographic development of real estate in India and would give opportunity to all investors (small/large) to benefit from this growth and development.

Concerns

Though the REMF regulations have been finalized and the players are ready to launch their REMF scheme, the regulation has major operational hurdles viz., the regulations lack clarity as regards the number of years for which fund should be closed ended, the method of valuation for arriving at the net asset value on a daily basis, etc. Further, the absence of an organized pricing platform could lead to complexity in valuing investments in real estate projects thereby resulting in vague and subjective valuations. The REMF regulations also do not stipulate any income distribution criteria for REMF.

Another possible reason for reluctance of players to consider setting up a REMF is that the fee structure for an Asset Management Company of REMF is not in line with the risk and efforts involved in the management of REMF as compared to management of any other mutual funds.

It is also unclear whether REMF will be treated as debt-oriented or an equity-oriented fund, which is important from an investor's perspective in the determination of return and the taxability thereon in their hands. The regulations are also silent on the eligible investors in a REMF. Since the functioning of REMF is akin to any other mutual fund, foreign institutional investors and non-resident Indians should be allowed to invest in REMF also.

Conclusion

All said and done, REMF is likely to make a desired impact on the Indian economy only when the bottlenecks in their implementation are removed and much needed clarity is brought about by way of amendments in the SEBI regulations and other laws such as income tax, etc.

What is to be seen is whether the forthcoming budget addresses the concerns for REMF and brings about the required change to smoothen the creases for their efficient operation thereby meeting the expectations of the market and furthering the all round and diversified development of the real estate sector in India , which is the need of the hour.