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SPECIAL REPORT: REAL ESTATE MUTUAL FUNDS SEBI allows setting up of Real Estate Mutual Funds(REMFs), issues guidelines A new investment opportunity in the $12 billion Indian real estate market SEBI guidelines allow REMFs to invest directly in real estate property or equity and other

securities of developers Indian REMFs expected to outperform diversified equity fundsThe Securities and Exchange Board of India (SEBI), apex regulatory body in India for the securitiemarkets has approved the guidelines for the real estate mutual funds (REMFs). The advent of REMFhas opened a new vista of investment opportunities in the $12 billion real estate market of India thais growing by 30% year-on-year. Analysts from Merrill Lynch & Co., world's leading financimanagement and advisory company have predicted the Indian real estate market to grow at $9billion in 10 years.

As per the new SEBI guidelines, all the schemes having an objective to invest directly oindirectly in real estate property will be governed by the provisions and guidelines under SE(Mutual Funds) regulations. SEBI has made it clear that the structure of the REMFs, initiallshall be close ended. The units of REMFs shall be compulsorily listed on the stock exchangeand NAV of the scheme shall be declared daily.

The scope of the REMFs has been kept quite wide open, as the guidelines allow thes

schemes to invest: Directly in real estate properties within India, Mortgage (housing lease) backed securities, Equity shares/bonds/debentures of listed/unlisted companies which deal

properties and also undertake property development, and in

Other securities.According to SEBI guidelines, REMFs need to appoint a custodian who has been granted certificate of registration to carry on the business of custodian of securities by the BoardThe custodian will safe keep the title of real estate properties held by the REMFs.

Earlier, in the absence of real estate mutual funds, companies setting up real estate fund

had to restrict themselves to financial institutions, corporate sector and high net worindividuals for creating their investor base.

HDFC Property Fund, a joint venture of Indias largest housing finance company HousinDevelopment Finance Corporation (HDFC) and the largest Indian commercial bank State Banof India (SBI), had announced the closing of its first real estate venture fund scheme calleHDFC INDIA Real Estate Fund (HI-REF) about a year back with a cumulative corpus of $22million (Rs. 1,000 crore). It was claimed to be Indias first real estate venture fund schemthat achieved closure. The scheme that was open for subscription from domestic institutionand high net worth individuals had a minimum contribution of $1.1 million (Rs. 5 crore) pinvestor.

HDFC, Prudential ICICI AMC Ltd., the largest Indian Mutual fund and a joint venture betweePrudential Plc, UK's leading insurance company and ICICI Bank Ltd, India's leading financiinstitution, $2.7 billion fund Kotak Mahindra Mutual Fund (KMMF), Infrastructure Leasing Financial Services Limited (IL&FS) that has assets worth more than $1.3 billion under icontrol, and some other domestic and foreign entities have raised about $1 billion througreal estate funds of their venture capital arms.

A number of real estate mutual funds are now expected to come into picture in just a femonths. Unit Trust of India (UTI), the second largest mutual fund of India, and other mutufunds as well as real estate developers are expected to float schemes soon. ICICI and HDFCthe two major Indian financial institutions, are already in an advance stage of drafting thproposals to launch their REMFs, as some media reports suggest.

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The REMFs will offer the real estate developers another source of funds, as the SEguidelines allow the funds to invest in the equity of public listed or privately held real estatdeveloper companies as much as 65% of the fund size. In a situation where the rising intererates and the reduced borrowing limit are leading to a cash-crunch situation for manbuilders, the REMFs may become a good alternative for them to source capital. The minimuinvestment norms stipulated in the SEBI guideline have been thoughtfully designed promote pure investment in the sector rather than speculation.

The guideline says that the Real Estate MF will invest at least 35% of the assets in real estatproperties that are already completed and usable. Under construction projects, vacant lanor properties specified for agriculture use won't be considered as "real estate property" fsatisfying the 35% minimum investment norm under the guidelines.

Also, minimum 75% investment has been earmarked for real estate properties, mortgagbacked securities, equity or bonds or debentures of publicly listed or privately hecompanies dealing in real estate and in other securities. Here, the other securities woumean only debt and money market instruments.

Clearly, SEBI wants the REMFs to abstain from investing in under-construction projects ovacant land, as such investments are supposed to take a longer period to produce a deceyield and the retail investors may not be willing to wait for that long. Also, such investmenmay have higher risks attached and gray areas about valuations.

Will the opening of real estate sector for mutual funds result in the realty prices going up

There are mixed views on this possibility, as some people believe that REMFs will bring imore money into the real estate market and thus will firm up prices. On the other handthere are people who dont buy this theory as they say Foreigh Direct Investment (FDI) anHigh Net-worth Individuals (HNI) money has already been in play in the realty market. Somexperts also find more supply a natural outcome of this development. In any case, momoney in the hands of organised sector is certainly good for the industry.

The advent of REMFs is also expected to encourage cleaning up of the Indian real estatmarket. These funds, being governed by the SEBI guidelines, will have transparent dealinand the developers transacting with them will also have to adhere to the same level transparency. This will certainly reduce the use of black money in the real estate operationThe developers willing to receive the institutional funding will have to improve thecorporate governance level. Also, it may intensify the competition in the real estate markeas even the tier II & tier III developers may get easy funding.

The performance of Real Estate Investment Trusts (REITs) in other countries has beecomparable to equity funds. The compounded annual return of Morgan Stanley CapitInternational Inc., a leading provider of equity, fixed income, and hedge fund indices, MSCUS REIT has been 19.5% for a five-year period, and 14.6% for a ten-year period, as of May 312006. In India, however, REMFs are expected to deliver better returns than diversified equitfunds, given the high growth rate of the real estate sector here.