Realty mutual funds, investment trusts to open up new channels of funding

Written by Sajan C Kumar | Chennai | Updated: Dec 31 2009, 04:50am hrs
Initial public offerings (IPOs) in the near-term, real estate mutual funds (REMFs) and real estate investment trusts (REITs) in the medium-term are likely to emerge as new channels of real estate financing in the country. Property funds are also expected to enhance their activities in coming quarters.

The market capitalisation of countrys real estate firms, which equals to just 2.2% of the aggregate equity market capitalisation, far below than the 10-15% level found in advanced economies, is an indicator of the future potential, said Ramesh Nair, managing director (Chennai & Hyderabad), Jones Lang LaSalle Meghraj, a global realty consultancy firm.

According to estimates, the real estate sector will require an additional $3.66 billion to construct undertaken commercial projects and fulfil the unmet housing demand. While sources of funding have become scarce in the aftermath of the 2008 global financial crisis, there are some emerging channels, which are likely to help the sector continue its high-growth story.

With several real estate players having submitted red herring prospectus to the Sebi, a total of $3.31 billion is expected to be raised in coming months. Given that the Sebi has recently allowed anchor investors to participate in this fund-raising channel, IPOs can be an attractive vehicle to tap domestic as well as foreign institutional investment. Additionally, they provide a good exit option for most PE investors that have a short-term to medium-term investment horizon, Nair told FE.

According to a study on emerging trends in real estate finance carried out by Jones Lang LaSalle Meghraj, REMFs and REITs have played an important role in institutionalising real estate investment in many countries. The essential difference between them is that while investment made by REITs are only permitted in income-generating physical real estate assets, REMFs can take exposure in securities of real estate companies as well. Currently, both of these vehicles remain a future prospect in India.

As per Sebi regulations, REMFs in India have to invest in direct ownership of real estate (that accrues rentals and capital appreciation), mortgage-backed securities and securities of companies dealing in the development of real estate. However, a minimum of 35% of net assets have to be invested in direct ownership, leaving an upper limit of 65% on security exposure by REMFs, says the study.

According to the study, real estate developers HDIL, HDFC, ICICI, L&T and Unitech are some of the players that have expressed interest in launching REMFs. While issues related to valuation and taxation are currently holding back this emerging vehicle, the government is expected to clear these uncertainties soon. Similarly, regarding REITs, many policy issues are yet to be resolved, and authorities concerned have yet to come up with clear regulations.

The study says there are challenges that must be addressed in order to bring about a smooth improvement in the sources of funding. Establishing a nodal real estate regulator will be a welcome step in enhancing transparency and making the sector more organised. Clarifications pertaining to taxation and valuation issues for existing REMF and REIT guidelines will also be expected in the coming quarters.