Column: The sad reality of realty funds in India

(DNA 23/04/2006) Mumbai - The mutual fund industry has seen many new product innovations in the last few years. The industry is growing and to sustain the interest of the investing public, product innovations should continue. Though real estate funds have a huge potential, they have not caught investor fancy yet. These funds are structured just like mutual fund schemes.

Typically, these funds own large properties, commercial office spaces, hotels etc, and earn rental income as well as gain from capital appreciation. They buy, develop and sell property and share profits with investors as in any other mutual fund scheme. Thus, they have the potential of being very popular with small investors. But sadly, real estate funds are yet to take off in India in a big way.

The real estate market in India is currently on a high growth curve, and several factors such as a booming economy, favourable demographics and a liberalised FDI regime, have helped it even further.

There are certain issues though, such as land reforms and absence of substantial tax incentive for real estate development which need to be addressed.

Indians, traditionally, have an affinity for fixed asset investments such as land and gold, and property has always been looked up to as an investment area that only the large ticket investors can afford. Due to the local nature of real estate and complexity of transactions, it is not easy for investors to identify good investment opportunities on their own, in different cities and locations.

Real estate funds thus serve the most basic purpose, which an equity-oriented mutual fund scheme does - making the investments relatively risk-free and convenient, compared with direct investment in underlying securities.

Today, real estate funds are available only to high net-worth individuals (HNIs) and institutional and global investors with a high minimum investment criteria. Therefore, funds operating in India are more like real estate venture capital funds than mutual funds with no or negligible retail participation.

The issue plaguing the sector is low liquidity, which is not very good. There is very little transparency on the valuations front. Regulatory issues like waiving of stamp duty and annual property taxes to reduce the high cost involved are also important.

Real estate funds are good for the industry as they help in bringing organised money in this fragmented market. India is one of the few markets, along with China, where the growth in real estate looks sustainable in the near future.

Some of the Industry players who have taken the initiative are Kotak, HDFC, Anand Rathi, IL&FS, ICICI Ventures, among others.

Kotak Realty Fund, established in May 2005, is one of the first private equity funds with a focus on real estate and real estate intensive businesses. It operates as a venture capital fund.

The fund’s corpus has been contributed by leading banks, domestic corporate, family offices and HNIs. The fund is closed-ended and has a life of seven years. It has raised around $ 100 million from domestic investors. The strategy of the fund is to make investment at project level with developers as well as at an enterprise level in realty development companies. The fund has the mandate to make investments in retail, hotels, healthcare, education etc.

HDFC India Real Estate Fund is a seven year closed-ended real estate venture fund. The fund has been launched in association with State Bank of India. HDFC holds close to 80% and SBI the remaining stake while the fund is managed by HDFC Venture Capital Ltd. The scheme had a minimum contribution of Rs 5 crore per investor.

AnandRathi Real Estate Opportunities Fund (AR REOF) is a closed-ended fund, for domestic and overseas investors. The fund focuses on growing markets such as Pune, Bangalore, Chennai, Hyderabad and other cities that are witnessing substantial urban development. The fund’s investment strategy is to focus on acquiring secured rental income producing real estate assets with quality blue chip tenants and picking up equity stakes in specified real estate projects, developed by reputed developers.

IL&FS Realty Fund is a private equity fund. The fund seeks to achieve a gross investment-level leveraged annual internal rate of return in excess of 25%. In addition, the fund will target a cash-on-cash stabilised yield on equity exceeding 8% per annum for income-generating projects.

ICICI Ventures has also launched a property fund, the funds seeks to invest in the commercial, residential, retail and other world-class real estate assets, both in developed and developing projects, in the potentially growing cities of India. The fund seeks to deliver a compounded annual rate of return in excess of 20-25% per annum over seven years.

The progress has been very slow so far, and as of now there is a lot of ambiguity on this subject. Increasing awareness about these kinds of funds operating in India and the advantages and convenience that they offer are sure to catch investor fancy sooner or later, and we feel it is just a matter of time before market regulators introduce investor friendly norms in this sector, too.

By Aditya Agarwal, joint MD of mutualfundsindia.com, a unit of Icra Online. The views expressed by the author are personal.