The Hindu Business Line : Will REMFs deliver?

Real estate has always been a much-valued investment in India. From individuals who have inherited property to corporates with huge land banks, the sector has seen unprecedented activity. However, the very nature of the industry and its high-pricing make it inaccessible to many. The Securities and Exchange Board of India (SEBI) has attempted to enable the common man reap the gains of this sector by permitting Real Estate Mutual Funds (REMFs).

Dos and Donts

The norms stipulate that at least 35 per cent of the net assets of the scheme shall be invested directly in real-estate assets. Investments in these and related securities ( that is, real-estate companies and mortgage-backed securities) shall together not be less than 75 per cent of the net assets.

Real estate being what it is, the diktat states that not more than 30 per cent of a scheme’s net assets shall be invested in a single city, not more than 15 per cent in a single real-estate project and not more than 25 per cent of the total issue capital of any unlisted company. There is a specific bar on investment in real-estate assets owned by the sponsor or the AMC (asset management company) or in assets in which they have tenancy or lease rights.

The list of embargos continues, with a refusal to permit REMFs to undertake lending or housing finance activities. With cash playing a major role in deals in this sector, there is a specific instruction that all financial transactions under the scheme shall be routed through banking channels and cannot be cash or unaccounted. Title deeds of the assets should be kept in the custody of a custodian registered with the Board.

Acceptability?

Thanks to the wild gyrations on the bourses, mutual funds have caught on as a concept in India. There have been funds which have given stellar returns. However, expectations from the real-estate sector have always been optimistic. Considering the restrictions posed on REMFs, one would not be surprised if the sector performs like any other mutual fund scheme with no mega returns. Real-estate companies make huge profits by selling landholdings at a premium, but operating incomes are not expected to spiral as rents and the like are already at a high.

Disclosures and Valuation

The real-estate assets held shall be valued at cost price on the date of acquisition and at “fair price” every 90 days from the day of purchase by two valuers accredited by a rating agency. The lower of the two values shall be taken for the computation of NAVs (net asset values).

The NAV itself will be computed on the basis of the most current valuation of the real-estate assets. “Fair value” is the value which would be given by current prices in an active market for similar real-estate assets. Leaving the issue a little open-ended, one of the rules is that in case there is an absence of prices in an active market, information from a variety of sources would be considered with no specific mention of what would constitute variety of sources.

The rules also state that where the fair value of the asset is not easily determinable on a continuing basis, Accounting Standard 10 (Fixed Assets) issued by the Institute of Chartered Accountants of India (ICAI) would be applied.

The definition of real-estate asset includes identifiable immovable property in the country, including SEZs, while the exclusion are projects under construction, vacant land, deserted property and land specified for agricultural use or land reserved for the Government.

Revaluation

Unlike International Financial Reporting Standards (IFRSs), accounting standards in India permit revaluation of fixed assets and it has been a trend that when assets are actually re-valued, real estate occupies prime place.

Although the concept of “fair value” is being disputed, a recent study by the International Accounting Standards Board (IASB) on simplifying complexity in financial instruments suggests that in spite of its inherent limitation, fair value should be the measure to use. If it is simply impossible to arrive at a fair value, cost would be the only option. REMFs could also be given only these options.

(The author is a Hyderabad-based chartered accountant.)

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