Column: Real estate funds offer a God-sent opportunity

(DNA 10/07/2006) Mumbai - The doors have opened for mutual fund companies to launch real estate mutual funds (REMF) with the stock markets regulator giving the green signal for asset management companies to roll out these funds.

In my last article, we talked about the problems with investing in real estate and how, with favourable regulatory policies, their turn was just round the corner. Well the cookie has crumbled and at least two AMCs are reportedly ready with their offerings.

The mutual funds industry has seen many innovative products in the recent past, but REMFs are not just another variation of mutual funds. The product has the potential to become a distinct asset class if handled well.

The interest in property as an investment option has always been very strong in India, but has so far been out-of-reach for most investors. Direct investment in property was unaffordable due to the ever-escalating rates for retail or commercial spaces in tier I or tier II cities. On the other hand, the gestation period is too long if one invests in a secluded place and then waits for the civilisation to discover it.

The option of investing through a private venture capital fund was also not very very feasible because of the high entry barriers and a minimum lock-in period.

Therefore, Sebi approvals may seem like a God-send for many who have been waiting in the sidelines to get a share in the burgeoning real estate markets.

The guidelines issued by the regulators have been carefully thought out and seem to be quite investor-friendly. For eg, the closed-ended nature of a REMF and their proposed listing on major stock exchanges will ensure that the fund manager is not unduly bothered about the cash flows.

This is of paramount importance as investment in property requires longer waiting periods to reap maximum benefits - especially if the investment is in an underdeveloped property - and a ‘but and hold’ strategy akin to equity investment has to be employed, in most cases.

Secondly, frequent portfolio churning and rebalancing may not be possible at all, due to the high costs involved, unlike in an equity fund.

The factors favouring the real estate market in India, which currently is on a high growth curve, are several — a booming economy, favourable demographics, government’s spending on infrastructure and a liberalised FDI regime. There are still certain issues — land reforms and the absence of substantial tax incentive for real estate development — that need to be addressed.

With the introduction of REMF, it is not only the investor who stands to gain but the overall industry will benefit. The capital influx that these funds are likely to bring in will contribute to the sector’s development. Property valuations, which were the biggest concerns for the real estate sector till date, will improve as the sector comes under the scanner of more and more analysts.

Though, an initial hysteria regarding these funds seems likely, what investors should try and understand before lapping them up is that they are structurally and functionally very different from the typical equity fund, with a low correlation to the stock markets. Thus REMFs can be an excellent diversification tool for someone with a predominantly equity-oriented portfolio.

And within the category, each real estate fund will tend to be different, depending on the areas where it invests, because of the highly localized nature of real estate investment and also the nature of investment, i.e. whether they own large properties, commercial office spaces, hotels etc. and earn rental income or they buy, develop and sell property and share profits with investors as in any other mutual fund scheme.

Thus, as is wont before the launch of any new product, the onus this time will again be on investor education, more than anything else.

By Aditya Agarwal, joint MD of mutualfundsindia.com, a unit of Icra Online.