The Hindu Business Line : A new real(i)ty on the ground

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A new real(i)ty on the ground

Real Estate Mutual Funds

Companies active in the real estate space, rather than those used to managing equity or bond investments, may be better placed to get REMFs quickly off the ground.

— N. Sridharan

Realty assets are priced largely on a case-to-case basis and tend to be very region and location specific.

Aarati Krishnan

At last, the decks have been cleared for the launch of Real Estate Mutual Funds (REMFs) in India, with the Securities and Exchange Board of India (SEBI) notifying amended regulations for such products last week. For mutual fund investors, this may mean a welcome relief from the stream of new equity fund offerings, playing on every imaginable theme, that have clamoured for attention over the past three years. But don’t hope for this to happen too soon!

It may be some time before fund houses queue up to offer REMFs with the same enthusiasm that they now display for equity funds. Though SEBI’s recent notification clarifies some of the grey areas in REMF regulations relating to valuation and disclosures, getting such products off the ground may prove to be quite a challenging exercise for the existing fund houses.

Realty cos better placed?

Investors confused about which equity fund to go for, usually benefit if they go by the pedigree of the fund house launching the scheme. For equity funds, factors such as the investment team’s experience and track record in managing Indian stocks, are key to a new fund’s performance. But the opposite may be true for REMFs.

Companies active in the real estate space, rather than those used to managing equity or bond investments, may be better placed to get REMFs quickly off the ground in the Indian context. That SEBI has stipulated a five year track record for realty players seeking to launch REMFs is a positive, as only seasoned players will then enter the fray.

Real estate, as an asset class, is not familiar ground to India’s mutual fund companies, given that their current asset base is dominated by debt, equity or, at best, combination products. This being the case, their entire investment team and security selection process has been built around selecting the best stocks and bonds for their fund portfolios.

That the real estate sector has been a relatively recent entrant to the listed stock market universe, also suggests that limited expertise may have been built by mutual funds in evaluating real estate markets and factors that drive it.

Outsourced investment management?

A key factor that distinguishes Indian realty markets from the stock or debt markets is its relatively localised nature. Trends in the Chennai realty market, for instance, may bear no resemblance to those in the Mumbai market. Yet it is knowledge of these trends that may help potential investors identify the best investment opportunities in real estate. Unlike stocks and bonds where assets can be acquired for one transparent and common price, realty assets are priced to a large extent on a case-to-case basis and tend to be very region and location specific.

Under these circumstances, the current mutual fund sponsors may have to partner with external consultants from the domestic realty business or set up separate investment teams from scratch- who are specialised in the property markets, before they line up their first REMFs.

Indian arms of global asset management companies which already manage such products in other markets may have an edge on the processes used to select realty investments, but even this may not obviate the need to have a local team which closely tracks Indian property market trends. While MFs have actively outsourced functions such as accounting and customer service o third parties, investment management has hitherto been strictly an in-house function.

Tricky path

There are also other operational aspects to these funds that may be tricky to navigate in the beginning. The stipulations which say that REMFs will be required to maintain a minimum 35 per cent investment in direct real estate assets, with not more than 30 per cent in one city and no more than 15 per cent in one project, are designed to avoid concentration risks in REMFs.

However, this suggests that fund houses may have to get developers to specifically tailor projects to their requirements or may have to collaborate with other investors, to make sure their funds adhere to the stipulations.

REMFs may also require a much longer window to deploy the funds raised, and thus a much longer gestation period, than is the case with their current debt or equity fund offerings.

The daily NAV disclosures and listing requirements of such funds may also face a few challenges. Though NAVs of such REMFs are to be disclosed on a daily basis, it is unlikely that they will capture blips in property prices on a daily basis, as do the NAVs of existing equity or debt funds.

This is because the valuation of REMF’s property portfolios is bound to be a periodic, rather than a daily exercise.

The regulations stipulate that every asset that finds place in a property fund’s portfolio will be valued by two independent valuers, once in every 90 days, to determine its fair price. This suggests that material changes to the NAV may occur only at 90-day intervals, depending on when assets are acquired.

Given that REMF units are to be listed and traded on the stock exchanges, however, the market prices may be influenced by the market’s assessment of how a fund’s portfolio is actually faring and may not strictly lag the NAV, as with other closed end funds. Will this subject listed REMF units to speculative blips on the market? We may have to wait and watch on that.

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