Real Estate Funds
- Unlocking Value in Real Estate Assets
Krishnan Sitaraman
Head – FundServices and Fixed Income
CRISIL
4th April, 2008
Agenda
No Topic Slide
1 Avenues for investing in Real Estate 2
2 Real Estate Funds – the meaning 5
3 Real Estate Funds – the Indian scenario 9
4 Real Estate Funds – are we prepared? 18
5 Conclusion 27
2.
1
Avenues for investing in real estate
3.
Avenues for investing in real estate
Real Estate Investments
Direct Investment Indirect Investment
Listed Non – listed
Property Stocks Close end funds Open end funds REITs
REITs Property stocks Property stocks
Fund of funds MBS MBS
Partnerships Mutual funds
Syndication
Pooled Funds
Joint Ventures
TIC Contracts
Close ended funds may also be listed based on local regulations to provide
liquidity to investors
4.
2
Real Estate Funds – the meaning
5.
Real Estate funds
• Real Estate Funds are generally available in two forms, depending on their
structure:
– Real Estate Mutual Funds (REMFs)
– Real Estate Investment Trusts (REITs)
• Real Estate funds typically have an investment universe encompassing:
– Real estate properties;
– Mortgage (housing lease) backed securities;
– Equity shares/ bonds/ debentures of listed/ unlisted companies which deal in properties and
also undertake property development; and in,
– Other securities
• In India, Securities and Exchange Board of India (SEBI) has recently come out
with its draft norms for launch of Real Estate Investment Trusts (REITs).
– SEBI is also expected to shortly announce regulations for the launch of Real Estate Mutual
Funds (REMFs) by mutual funds in the country.
• CRISIL FundServices (CFS) expects these funds to present investors with an
excellent avenue to capitalize on the potential gains from the property markets
and at the same time, help in bringing in greater transparency, liquidity and
institutionalization in these markets.
6.
3
Key characteristics of Real Estate funds
• Pooling of resources: Individual investments are small and are represented by
transferable units
• Organisational Structure: Varies between companies and trusts depending on
local regulations and eligibility criteria
– Funds may be both close ended and open ended
• Property and Asset Management: Property management can be outsourced / in
– house
• Operating framework: Minimum percentage of assets that must be in the form
of real property or mortgages
– Minimum proportion of the income that must be generated from such investments.
– Minimum proportion of the income that has to be generated as dividends and distributed to
avail the tax benefits that these funds typically have.
• Leveraging: Normally allowed to raise debt
• Tax Advantages: Based on local regulations, may be exempt from corporate
taxes
• Governance and disclosure: Local regulations with respect to the number of
independent directors and trustees.
7.
Benefits of Real Estate funds
• Predictable revenue stream with regular incomes
– High dividend yields
– Good hedge against inflation
• Diversification benefits
– Low correlation with other asset classes
• Higher risk adjusted returns supported by favorable taxes
• Affordability and Liquidity
• Professional asset management: REIT managers are skilled,
experienced real estate professionals
• Oversight: Independent directors of the REIT, independent
analysts, independent auditors, and the business and financial
media monitor a public REIT's financial reporting on a regula
basis.
• Disclosure obligations
8.
4
Real Estate Funds – the Indian scenario
9.
Real Estate funds – the Indian scenario
• Presently, in India, only venture funds have been offering real
estate funds
– Presently available only to high net worth individuals and institutional
and global investors
– Funds launched in this space include HDFC India Real Estate Fund,
India Advantage Fund from ICICI Venture Funds, Kotak India Real
Estate Fund, IL&FS Investment Managers, IndiaREIT Fund, Unitech’s
CIG Realty Fund, etc
• Draft regulations for REITs announced by SEBI in December
2007
– Regulations for REMFs expected soon
10.
5
Real Estate Mutual funds
• REMFs refer to schemes of a mutual fund with an investment objective to
invest typically in real estate companies
– Governed by the provisions and guidelines under SEBI (Mutual Funds) regulations.
– Launched by an Asset Management Company
– Close ended structure with units listed on stock exchanges
– In mid-2006, SEBI first came out with the basic guidelines for REMFs in India.
Areas such as valuation, related party transactions and taxation of these funds yet to be
addressed
Daily NAV disclosure after deducting administrative and management fees
Separate custodian responsible for custody of securities
• Investment universe:
– Mortgage (housing lease) backed securities;
– Equity shares/ bonds/ debentures of listed/ unlisted companies which deal in
properties and also undertake property development; and in,
– Other securities
– Directly in real estate properties within India;
• It is expected that REMFs would typically invest in debt or equity based
securities issued by entities in the real estate space.
11.
Real Estate Mutual funds
• Indian mutual fund industry growing at a compounded annual growth
rate of about 35% over the last five years ended 2007
• Equity fund AUM has risen to about 35% of the industry from 15%
levels two years back
– This however is still lower than AUM of income-oriented schemes, including debt
and money market schemes
• REMF offers an investment option that combines both reliable income
and strong growth prospects
– A favorable alternative for domestic investors
– Can potentially enable the mutual fund industry in growing more rapidly.
12.
6
Real Estate Investment Trusts
• Investment vehicles that invest in real estate directly, either through
properties or mortgages
– Operate primarily with the objective of earning regular income and improving risk-
adjusted returns.
– Globally enjoy a favorable tax treatment in many countries
May have significant restrictions on investment universe and distribution of income.
• According to NAREIT (National Association of REITs), “a REIT is a
company dedicated to owning and, in most cases, operating income-
producing real estate, such as apartments, shopping centers, offices
and warehouses. Some REITs also are engaged in financing real
estate.”
• REITs are generally of three types as given below:
– Equity REITs
– Mortgage REITs
– Hybrid REITs
13.
Typical REIT structure
Unitholders Lenders of
Debt
Investment in Distributions Principal and
REIT units interest
Debt
Act on behalf of
unitholders
REIT Trustee
Manager
REIT
Sub contract Ownership of assets Net Property income
Property Property
Property management services The global scenario
Manager
14.
7
Real Estate Investment Trusts
• Draft norms on REITs from SEBI in 2007
– Mandate an architecture comprising the Trustee and Real Estate
Investment Management Company model
– Banks, public financial institutions, insurance companies and corporate
houses can be trustees of REITs
At least fifty per cent of the trustees and directors of the real estate
investment management company have to be independent directors
– Close ended scheme structure with units listed on stock exchanges
– Allowed to invest only up to 20% of total assets in incomplete and non-
income generating properties
Investment in vacant land is not allowed. Investment in securities or own
schemes not allowed unless specified
Concentration limits of upto 15% in any single real estate project upto 25%
of all the real estate projects developed, marketed, owned or financed by a
single group of companies.
15.
Real Estate Investment Trusts
• Mandatory valuations from a property valuer at least once a
year
– Disclosure of NAVs as and when annual valuation is done
• Mandatory rating of schemes by rating agencies
• Leverage limits of upto over one-fifth of the assets
• At least 90% of the post tax income to be distributed as
dividends every year
• SEBI’s draft norms however do not mention anything on
taxation of REITs.
– Globally, favourable tax treatments have enhanced the attractiveness of
these schemes to investors.
16.
8
Key differences between REMFs and REITs
17.
Real Estate Funds – are we prepared?
18.
9
Real Estate Funds and India’s real estate sector
• Key areas in which Real Estate Funds can positively impact India’s real
estate sector:
– Enhancing liquidity of the sector
Lack of liquidity impairs secondary market transactions
Real Estate Funds can provide liquidity through a more broad-based, and wider
participation of domestic retail investors
– Institutionalization
Enhanced competition with institutional investors competing in a bigger way with the
unorganised sector for market dominance
Higher professionalisation
– Greater acceptability for real estate as an investment asset class
Opportunities to retail investors to participate in the real estate sector
Asset diversification to corporate investors
– Help build a vibrant, secondary real estate market
– Improve sector transparency
19.
How big is the Indian Real Estate Funds opportunity?
• Real estate stocks expected to grow around three fold to above USD
1400 billion by 2010.
• Real Estate Funds expected to have the potential to hold at least a 5 per
cent share (more than USD 70 billion) of the total real estate market by
2010
– India offers a greater opportunity for Real Estate Funds than any other
country in the world.
The yields on commercial real estate across metros in India are higher than
those prevalent in the global real estate markets.
Apart from the information technology (IT) and IT-enabled services (ITES)
sectors, retail, insurance, banking, healthcare, hospitality and consulting
businesses have also been growth segments in recent times driving the
demand for real estate.
A higher demand can be seen in the retail segment with an expected influx
of clothing and lifestyle stores, restaurants and beverage chains,
entertainment and leisure complexes.
20.
10
Key issues that need to be addressed however…
• Limited availability of world-class realty:
• Quality of the asset a key factor that determines its ability to
successfully survive economic downturns and maintain stable
rental rates and occupancy levels
– Presently, there is a shortage of good assets in the real estate sector in
India in terms of scale and quality
Regulations such as the Urban Land Ceiling Regulation Act have played a
part in constraining the development of these assets.
As a result, a few good projects are being chased by all the large funds,
resulting, in turn, in fears of over valuation affecting investor confidence.
21.
Key issues that need to be addressed however…
• The reasons for limited availability of quality developments are:
– Unorganised, largely fragmented sector, characterised by small players
with a local presence
– Limited number of professionally managed world-class companies with a
pan-India presence
– Significant scope for improvements in terms of location, layout and
design, construction techniques, material quality, amenities offered to
create long term value and face industry downturns
– Absence of an enabling role by ensuring the supply of quality real estate
as in Hong Kong and Singapore
– Limited number of property management companies, providing quality
services such as construction, development, repair and maintenance on
properties.
22.
11
Key issues that need to be addressed however…
• High transaction costs:
• Current regulations in India involve high transaction costs, and
present problems in ensuring clear land titles, and prolonged
delays in obtaining clearances.
• The sector also faces the following problems:
– Lack of proper land records
– Inadequate town and infrastructure planning for a sustained, planned
growth
– Bankruptcy laws which have a lot of scope for improvement
– Multiplicity of development laws and non-standardisation of laws across
states leading to delays and increasing costs
23.
Key issues that need to be addressed however…
• Lack of transparency and information:
• Lack of adequate disclosures on land/property transactions,
underreporting of taxable income and absence of uniform accounting
norms for revenue recognition.
– As land/property transactions need to overcome regulatory constraints, avoid
stamp-charges on multiple transactions, and lack of clarity on titles, disclosures
are usually low.
– Taxable income is under-reported in cash transactions.
– The accounting norms allow both percentage completion and project completion
methods to be adopted, which results in non-uniform revenue recognition in the
industry.
• There is also a near complete absence of a credible database on real
estate markets, in terms of property demand and supply, absorption
rates, geographic price data, occupancy rates, rentals, and
capitalisation rates for commercial, retail, and residential property
segments.
24.
12
Key issues that need to be addressed however…
• Illiquid secondary markets:
• An efficient secondary real estate market facilitates a price discovery
process by enabling market demand-supply forces to arrive at the
efficient price.
– In such a market, whenever the prices fall below their intrinsic value, the demand
would rise to the extent the price equilibrium is restored. Similarly, whenever the
prices rise above their intrinsic value, sellers would increase in the market to
ensure rationality in the market.
• Currently, the lack of information and transparency and the high stamp
duty/registration charges constrain the development of the secondary
market.
25.
Key issues that need to be addressed however…
• Valuation of properties is not standardised:
• There are no standardised, accepted practices for property valuations
at present.
– No meaningful benchmarks available among properties.
– In the absence of standardised valuation techniques, it is difficult to identify
intrinsic valuations from the premium assigned by speculators.
• The impact of extraneous variables such as interest rates and inflation
are also not factored in adequately into the valuations of properties.
26.
13
Conclusion
27.
Conclusion
• Multiple benefits through the launch of Real Estate Funds in India
– Ease of access to realty markets for retail investors
Affordable to investors who in turn can own the good quality properties and have
access to expert management.
Provides investors with an efficient medium for diversification and asset
allocation.
Mortgage realty funds can provide a fillip to mortgage finance by creating a
secondary market.
– Medium to infuse large doses of capital into the realty sector.
– Aids in making the sector more organized and transparent.
– Offers developers and other companies, avenues to release property assets
from corporate balance sheets into professionally managed firms. Realty
sector can have access to funds at a cheaper cost, and thereby access to
better margins.
28.
14
Conclusion
• Real Estate Funds help meet two crucial ends
– Stable, income – oriented investment options for long term investors
– Liquidity and depth for the secondary market
• CRISIL believes that Real Estate Funds can be a potent tool in
institutionalising the real estate sector in India
– There is however, a need for strict disclosures and other regulatory norms as
well as an enabling framework, before Real Estate Funds can be formally
introduced in the country.
29.
Annexure
15
Correlation of real estate stocks to other asset classes
Correlations of Real Estate stocks to other asset classes (1990 - 2006)
Finland
International US Large Cap Luxembourg
US Small cap International
Korea
Canada UK
Cash US Bonds Bonds stocks stocks Stocks
Global Real Estate 0.05 0.18 0.25 0.51 0.51 0.71
Japan
Netherlands
Germany Taiwan
USA Belgium Hong Kong
France
Malaysia
Mexico
Bulgaria Singapore
Israel Australia
Turkey
New Zealand
Source: Charles Schwab Investment Management Perspectives
31.
Category wise market capitalisation of US REITs
US REITs - Category wise market
capitalisation
Equity
93%
Mortgage
6%
Hybrid
1%
32. Source: NAREIT
16
Increasing participation of countries across the globe in REITs
Finland Luxembourg Korea
Canada UK
Japan
Netherlands
Germany Taiwan
USA Philippines
Belgium Hong Kong
France
Pakistan Malaysia
Mexico
India
Italy
Bulgaria Singapore
Israel Australia
Turkey
New Zealand
Blue lines indicate countries that are close to finalizing REIT structures
33.
Global REIT market by region
Breakdown of Global Finland Luxembourg
Canada UK REIT market by region Korea
North
America ,
56.40% Japan
Netherlands
Germany Europe, Taiwan
USA Belgium 12.60%
Hong Kong
France
Malaysia
Mexico
Oceania,
Africa, 0.30% 13.20%
Far East , UK, 8%
Singapore
9.50% Bulgaria
Israel Australia
Turkey
New Zealand
34. Source: NAREIT
17
Global REIT market by number (February 2007)
Finland Luxembourg Korea
Canada UK
Japan
Netherlands
Germany Taiwan
USA Belgium Hong Kong
France
Malaysia
Mexico
Bulgaria Singapore
Israel Australia
Turkey
New Zealand
35. Source: AME Capital – Global REIT Report - 2007
Global REIT market by capitalisation (February 2007)
Finland Luxembourg Korea
Canada UK
Japan
Netherlands
Germany Taiwan
USA Belgium Hong Kong
France
Malaysia
Mexico
Bulgaria Singapore
Israel Australia
Turkey
New Zealand
Source: AME Capital – Global REIT Report - 2007
36.
18
Global REIT market by returns
Global REITS - Total rate of return - Three year to 30 June 2007 (%)
Finland Luxembourg Korea
Canada UK
South Africa 41.56
Turkey 40.12
Singapore 33.56
Japan
France Netherlands 29.55
UK Germany 27.82 Taiwan
USAJapan Belgium
24.46
Hong Kong
South Korea 24.26
Canada
France 23.85
Malaysia
New Zealand 20.87
Mexico
Netherlands 20.48
Australia 18.13
US Bulgaria
16.09 Singapore
Belgium 14.49
Hong Kong 10.66
Israel Australia
Malaysia 8.51 Turkey
New Zealand
0 5 10 15 20 25 30 35 40 45
Source: Ernst & Young Global REIT Report - 2007
37.
CRISIL Limited
38. www.crisil.com
19
