Real estate plays a dominant role in the total wealth of an individual or family. Housing is one of the biggest expenses for any person; it provides shelter and steady capital appreciation.
However, many people also look at real estate as an investment avenue, which provides rental income as well as capital appreciation. Thus, the extension -real estate funds -- has emerged as an opportunity worldwide for investors.
As an asset class, real estate has many benefits. Owning one's personal residence is a forced saving and acts as a fall back asset in unfavourable times like in rampant inflation or financial setbacks.
It also plays an important role in a multi asset portfolio by providing necessary diversification and reducing volatility. Another big advantage is that it gives you leveraging power. That is, you can get loan against property, if required.
However, it also has its unique drawbacks. There is lack of transparency in property deals and the market lacks proper price discovery as well as adequate liquidity. Then there are transaction costs, which are also very high.
Brokerage and legal expenses are to the tune of over one to two per cent of the property value. This cost, along with stamp duty, mutation fees for property registration and property tax, makes it a costly and often, a cumbersome investment vehicle.
However, instead of investing directly in a property, one has the option of real estate funds, which provide many benefits and yet insulate you from most of the disadvantages of direct property investments.
Worldwide, real estate investments are mainly done through Reits (real estate investment trusts), which are like realty mutual funds or through real estate portfolio management services (PMS). In India, Reits or realty mutual funds are expected to be allowed soon.
At present, real estate investments are being done through private equity funds or real estate PMS, launched by many entities like ICICI Prudential, Pantaloon and the Piramal group. Let us look at these schemes from the global and the Indian perspective.
Reits are professionally managed entities, which buy, develop, manage and sell real estate assets, in order to provide rental income as well as capital appreciation for its investors. According to international norms, they must distribute all or most of their income.
Globally, it is governed by a Reit code, depending on the laws of the country. To enforce corporate governance, strict guidelines are laid out for ensuring manageable gearing levels, investment restrictions with a single entity or quality of investments, transparency as well as timely disclosures.
The structure of a Reit is quite similar to that of a mutual fund in many ways. The management comprises of an independent trustee and often an external Reit manager. Most Reits are allowed to be pass-through entities, which do not pay tax on their earnings, but rather distribute it to their unit holders, who pay tax upon these gains at their own marginal tax rates.
To qualify as a pass-through entity, the Reit must be structured as a corporation, business trust or similar association, which is managed by a board of directors or trustees.
Its shares must be fully transferable, with a minimum number of shareholders, generally 100, to ensure broad-based holding. It should distribute at least 90 per cent of its income. At least 75 per cent of total investment assets must be in real estate and it should derive at least 75 per cent of gross income from rents or property mortgage interest.
Reits can be of three types:
- Equity Reits can invest in or own real estate.
- Mortgage Reits can lend to property builders, owners and developers against property mortgages, or invest in financial instruments secured by mortgages, such as securitised rent receivables, etc.
- Hybrid Reits, which are a blend of Equity and Mortgage Reits.
In India, these are present in the form of private funds. They generally create close-ended PMS structures for six to nine years and seek a minimum investment commitment from the investor, ranging from Rs 25 lakh to Rs 2 crore.
Out of this commitment amount, about 25 per cent to 40 per cent has to be invested upfront and the balance in one or more instalments as and when the fund gets other investment opportunities or existing funded projects advance.
Generally, a few weeks notice is given to the investor to contribute their respective portions. These funds invest in realty projects from the formative stage and act as incubators, with the idea of selling off once the project is complete.
Therefore, the main focus of these funds is capital appreciation. Investments are made in projects across the country, as well as across sectors like residential to commercial, including IT/ITES, retail, hospitality etc. Since these funds are close-ended, exit is quite difficult.
If investors want to exit, they have to find a buyer for their units and that too at an approximate valuation. This is because Reits do not disclose their NAVs. They just make a portfolio disclosure quarterly or annually, valued by an independent property consultant.
Since Reits/realty funds enter projects at very early stages when they are being conceptualised, the cost of entry is very low and potential returns much higher than for an investor entering a project directly at the official launch stage. Most funds in this segment seek to deliver around 20 per cent annualised returns, making them very attractive.
The writer is director, Touchstone Wealth Planners.
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