HOME FINANCE THROUGH REAL ESTATE MUTUAL FUNDS
REPORT OF THE SUB-COMMITTEE APPOINTED BY AMFI
BY COL (Retd) NARNE RANGA RAO,
CHIEF PATRON & ADVISOR – APREDA
I. INTRODUCTION:
AMFI formed a Sub-Committee to formulate a working plan for launching Real Estate Investment Schemes based on the recommendations of the Satwalekar Committee on Real Estate Funds. The Satwalekar Committee conducted a detailed study and prepared an exhaustive report on the above subject. The purpose of the Sub-Committee is to formulate a working plan for launching Real Estate Investment Schemes based on Satwalekar Committee recommendations.
The Sub-Committee has the following members and invitees:
Mr. K.N. Atmaramani – Chairman
Mr.Milind Barve – Member
Mr. S.V. Prasad - Member
Mr. A.D. Rebello & Mr.T.P. Ostwal – Invitees from Tata Housing Development Co. Ltd.
Mr. Neel C. Raheja & Mr. Virani – Invitees from K. Raheja Corpn.
II. RECOMMENDATIONS OF SUB-COMMITTEE – STRUCTURE:
The Sub-Committee deliberated on the appropriate structure to be recommended for the introduction of Real Estate Funds in the country.
In this context, the Sub-Committee discussed the International experience regarding Real Estate Funds.
In the United States, real estate investment is through Real Estate Investment Trusts (REITs). REITs are formed as companies that have an issued share capital. Further, they have the flexibility to raise funds through preference shares and debt. In this structure they are always close-ended and listed on the exchanges.
REITs were started without tax benefits and did not do well till the US Tax Laws were amended in 1986 to provide them with tax benefits, if they conform to certain requirements that have been laid down. REITs are very popular now in the United States. As per data available, there are around 300 REITs operating in the country with assets in excess of US $ 300 billion.
In the United Kingdom, real estate investments are done through ‘Pooled Managed Vehicles’. While these are different from Open-ended Investment Companies (OICs), they can be in the form of Trusts. The regulator for these PMVs is the Financial Services Administrator (FSA), as is the case for OICs. They, however, have a variable capital and are similar to open-ended funds.
PMVs may get tax benefits based on the investor profile. Off shore funds as well as pension fund investors qualify for benefits. However, there are no tax benefits for the regular PMVs. This is similar to there being no tax benefits for typical OICs. The PMV has the ability to delay redemption if there is excessive pressure to exit the fund.
The company structure followed in the USA (REITs), which allows the flexibility to raise funds by leveraging the balance sheet was deemed inappropriate by the Sub-committee for pooling of small savings in the area of Real Estate Investment. The PMVs in UK are in the form of Trusts and similar to the Mutual Fund/Collective Investment Schemes which are regulated by SEBI. The Sub-committee therefore recommends the Trust structure as appropriate for Real Estate investments.
The Sub-committee at this stage noted that REITs in the US became a popular structure for investing in Real Estate only after they were granted tax benefits by the US Congress.
Thereafter, the Sub-committee spent considerable time and effort comparing the features and suitability of the Collective Investment Scheme structure versus the Mutual Fund Structure for Real Estate Investments.
The Sub-committee recommends the follows:
The Securities and Exchange Board of India (Collective Investment Scheme) Regulations, 1999 (CIS Regulations) can be modified to include real estate as an investment objective. However, the following points need to be considered:
a)The CIS Regulations do not have a concept of a Sponsor. Thus any company having a networth of Rs. 5 crores and the appropriate main objectives in its Articles of Association can set-up a Collective Investment Scheme.
b)Due to the lack of a sponsor for the business, the CIS Regulations do not have a concept of a group/associate company. Therefore, the CIS Regulations do not seem to emphasise the concept of arms length relationship between group companies. The Sub-committee believes that the existing Securities and Exchange Board of India (Mutual Fund) Regulations 1996 (MF Regulations) incorporate several checks and balances that further the cause of investor protection and fair treatment.
c)The CIS Regulations appear to be made keeping a specific project in mind. Therefore, these regulations prescribe a maximum subscription level and recommend proportionate allotment of units. The Sub-committee notes that Real Estate Funds are not project specific and therefore do not have predetermined size of subscription. The Sub-committee strongly believes that keeping a maximum limit on subscription would disadvantage small investors desirous of taking exposure to the real estate sector.
d)Further, being fundamentally based on a specific project rationale, CIS Regulations do not have any investment restrictions. The Sub-committee notes the extensive investment restrictions recommended by the ‘DeepakSatwalekar Committee’ to avoid over exposure to certain projects, groups or geographic locations. The Sub-committee believes that investment restrictions are vital for ensuring safety of the investors monies. The Sub-committee also noted that the existing MF Regulations contain investment restrictions similar to the ones recommended by the Satwalekar Committee.
e)Another issue with the CIS Regulations is the concept of an appraising agency. This is again appropriate for a specific project that would need to be appraised, as a measure of abundant caution. The Sub-committee believes that the appraisal concept is misplaced in a situation where multiple properties are being invested in. Also, the appraising concept reduces the flexibility of the managers of the scheme and may impair the possibility of better returns.
f)Another important aspect of CIS is that the CIS Regulations do not necessitate the calculation of NAV. Thus, there is no underlying value of the investments o rthe units that can be calculated on an on-going basis. Thus, Real Estate investments done under the CIS Regulations would not provide a fair and transparent underlying NAV, against which the market price could be benchmarked. The Sub-committee noted that in the case of Pooled Managed Vehicles in the UK, valuation of properties is done on a quarterly basis and NAVs reported on a daily basis. Thus, even the international experience suggests NAV calculation as a central concept of Real Estate Investment.
g)Finally, the Sub-committee recognizes that tax benefits available to mutual funds are a vital determinant of the success of the domestic mutual fund industry. The Sub-committee recalls the experience of the USA where REITs gained popularity after receiving tax benefits. The need of appropriately structured Real Estate investments can be hardly over-emphasised. The Sub-committee noted that the Deepak Satwalekar Committee went into great detail on the benefits of Real Estate Funds, including channelising small savings into the housing sector, which currently faces a huge shortage, as well as providing investors with another investment alternative, hitherto unavailable.
The Sub-committee notes that the Deepak Satwalekar Committee suggested the Mutual Fund Structure for introducing Real Estate investments and has provided detailed rationale and advantages of the Mutual Fund structure. Post the issuing of comprehensive guidelines by SEBI, the mutual fund structure is now well understood and trusted. Selling of real estate investments through the mutual fund route would therefore be easier and energies could be directed towards selling the product rather than the structure. Based on the above deliberations, the Sub-committee strongly feels that Real Estate Investments should be structured in the form of Schemes of Mutual Funds.
III. RECOMMENDATIONS OF SUB-COMMITTEE – LEGAL ASPECTS
a)Launching of Real Estate Investment Schemes:
The Sub-committee deliberated whether based on the present legal status in this regard, Real Estate Investment Schemes can be launched or the launching of such Mutual Funds can be subject to various changes in the legal framework. The Sub-committee recommends that the launch of Real Estate Mutual Fund Schemes should be permitted as soon as the necessary changes in the Regulations are carried out. The legal framework in respect of stamp duty and property taxes can be recommended to the respective authorities to consider the required changes in future so as to make the launching of mutual fund schemes more meaningful and effective in the near future. A list of such changes recommended by the Sub-committee appears later. However, Real Estate Investment Schemes should be introduced even before these changes are effected.
b)Amendments to the Securities and Exchange Board of India (Mutual Fund) equations, 1996
Chapter VII of this report gives clause-wise recommended amendments in SEBI (Mutual Fund) Regulations, 1996 – enclosed, so as to enable the Mutual Funds to launch Real Estate Schemes.
IV. RECOMMENDATIONS OF SUB-COMMITTEE – SCHEME CHARACTERISTICS
The Satwalekar Committee has discussed this aspect in detail and suggested various structures for Real Estate Schemes. The Sub-committee deliberated on this point and felt that it would be appropriate to provide Mutual Funds floating Real Estate Investment Schemes the flexibility to determine the appropriate structure. The Sub-committees however advises that given the illiquidity of the underlying investments, Mutual Funds may initially look to launch close ended or interval funds. However, in future, the Real Estate Investment Schemes can be open-ended once the liquidity in the underlying investments is comfortable.
The characteristics of a typical interval fund for Real Estate Investment Schemes could be as under:-
a)The Scheme will be close ended for a minimum period of 3 years.
b)The Scheme would open at the end of every quarter for sale of fresh units based on the quarterly NAV calculation and remain open for a minimum period of 15 days. This will enable the fund to grow by soliciting fresh inflows from investors, while giving potential investors a chance to participate in the Scheme after its Initial Offer.
c)The Scheme should offer redemption/repurchase to the investors at the end of 3 years in a staggered manner. For example, at the end of 3 years, 20% of the investment can be redeemed at NAV; at the end of 4 years, 30% of the investment can be redeemed at NAV; at the end of the 5th year, balance 30% can be redeemed to the investor at NAV.
d)As the Scheme would be an interval fund, and offers redemption at the end of 3 years, the Scheme may be listed on any Stock Exchange to provide the liquidity to the investors.
e)The Scheme will calculate the NAV on quarterly basis as per the valuation of the underlying investments, but NAV can be disclosed daily also.
f)The Scheme shall operate within the regulations of Mutual Funds as amended from time to time and comply with all the requirement of the SEBI (Mutual Fund) Regulations.
g)Being part of a Mutual Fund, Real Estate Investment Schemes would be eligible for all tax benefits applicable to Mutual Funds in general. This would enhance the attractiveness of these schemes to investors.
- RECOMMENDATIONS OF SUB-COMMITTEE – INVESTMENT OBJECTIVES AND RESTRICTIONS
The exposure of Real Estate Investment Schemes can be in the following types of investments as recommended in the report of the Satwalekar Committee:-
a)Equity Shares/Bonds/Debentures of the listed Companies which deal in properties and also undertake property development. However, at present, in India there are very few such Companies which are listed.
b)Mortgage-backed securities i.e. the securitization of housing loans. At present, these are not yet available. However, one expects that this avenue will be open once the Bill seeking amendment is passed in the next Budget session.
c)The Real Estate Investment Schemes can undertake or finance the properties e.g. ready buildings with a view to lease where the lease rentals will be a regular income to such Mutual funds which can then be distributed as dividends to the investors in the fund.
d)Direct estate project finance, construction finance, purchase/option to purchase of buildings under construction with a view to sell it again; investment in the debt securities issued by development and construction companies (placed privately).
VI.RECOMMENDATIONSOF SUB-COMMITTEE – PROCEDURE FOR LAUNCHING SCHEMES
a)As recommended by the Satwalekar Committee, the sub-committee believes that SEBI registered Mutual Funds in India should be allowed to launch Real Estate Investment Schemes.
b)Real Estate Investment Schemes would need the approval of SEBI and will also have to file the Offer Document as per the existing SEBI (Mutual Fund) Regulations.
c)Real Estate Investment Schemes can be launched by an Asset Management Company. The Sub-committee recommends that the AMC should include the appropriate Investment Management Skills or could use the services of an advisor, as it may consider appropriate.
VII. RECOMMENDATIONS OF SUB-COMMITTEE – RISK MANAGEMENT
a)As already recommended by the Satwalekar Committee, with the amendment in SEBI Regulations enabling the SEBI to regulate the establishment and functioning of the Real Estate Mutual Fund schemes with all the existing Regulations applicable to such Mutual Funds pertaining to networth of AMC; existing fee structure; initial launch expenses restricted at 6%; maximum limit of expenses; etc as already provided in the Mutual Fund Regulations.
b)The existing Regulations also have a restriction on investment where any investment in one corporate should be restricted upto 10% of the corpus and similarly, any investment in the properties owned and managed by sponsor should be restricted upto 25% of the corpus.
c)The Satwalekar Committee has recommended Investment Restrictions based on a Project, a Promoter Group and a Geographical Area. The Sub-committee finds these restrictions as appropriate to mitigate the concentration risk of the investment portfolio of a Real Estate Investment Scheme. Details of the Investment Restrictions proposed in the report of the Satwalekar Committee can be found on Page 24 of that report.
d)At present, we have “Registered Valuers” as approved by Government of India/Income Tax Departments/Insurance Regulatory Development Authority. It is recommended that SEBI approves Registered Valuers for the purpose of valuing properties held by Real Estate Investment Schemes.
VIII. RECOMMENDATIONS OF SUB-COMMITTEE – OTHER LEGAL ASPECTS
Other legal areas which are recommended to be considered later on by SEBI and recommended to the respective authorities were suggested as under:
a) Stamp Duty:
This is a State subject and unless the Central Government decides to make it uniform, it will be difficult and time-consuming to expect any changes in the stamp duty framework. The Sub-committee felt that the Government may be requested that there should be no levy of stamp duty when the asset is purchased by the SEBI registered Real Estate Mutual Fund. Alternately, if Stamp Duty needs to be paid on purchase, a set-off of the amount paid should be allowed against future stamp duty payments, when the property is sold.
b) Property Taxes:
This is again a State/City subject. The Sub-committee recommends that the relevant authorities provide exemption from annual Property Taxes to Real Estate Investment Schemes. This would help Real Estate Investment Schemes to provide better returns to investors.
c) Records:
A significant issue in dealing with properties is the custody of title and paper form of transaction. The Sub-committee recommends that all Land Records be computerized and property transactions be done in a dematerialized manner, as in the case with listed securities.
d) Rent Control Act:
The provisions of the Rent Control Act have been amended in some of the states. However, several states continue with the ancient Rent Control provisions. The Sub-committee recommends that representations be made to states where the provisions have not been modified to expedite the process.
SUGGESTED AMENDMENTS
SECURITIES & EXCHANGE BOARD OF INDIA (MUTUAL FUND) REGULATIONS 1996
NO. / CLAUSE NO. / PAGE NO. / AMENDMENT1. / 1. (q) / 25 / …..investing in real estate and securities, including money market securities and mortgage backed securities.
2. / 1. (ss) / 25 / “real estate broker” means a person carrying on the activity of broking in the real estate market.
3. / 1. (sss) / 25 / “real estate scheme” means a scheme launched by a mutual fund that owns, manages and develops pools of properties – from apartments and office buildings to undeveloped land – for the benefit of the unit holders.
4. / 1. (z)(ii) / 25 / “valuer” means a person who has been granted a certificate of registration to carry on the business of valuation of real estate by the institute or valuers.
5. / 7.(g) / 27 / …..to keep custody of the title to assets including securities and…………
6. / 18. (4)(b) / 29 / ……past experience in the securities and/or real estate market with…..
7. / 18. (5) / 29 / ……monitoring securities and real estate transactions….
8. / 18.(17) / 30 / ……all transactions including purchase and sale, lease, rental etc. of real estate……
9. / 21.(i)(b) / 32 / ……finance, financial services and real estate related fields and………
10. / 24.(2) / 34 / ……management of insurance funds, real estate advisory, financial consultancy.
11. / 32.(e) / 38 / If the said scheme is a real estate scheme, in which case the scheme shall be listed within six months from the closure of subscription.
12. / 43. / 42 / ……such funds may invest in asset backed securities including mortgage backed securities, provided further that the monies collected under any real estate scheme may be invested in real estate or real estate related assets.
13. / 44.(3) / 42 / Provided however, that a real estate scheme may advance loans in the form of construction finance to developers.
14. / 48.(2) / 43 / …..scheme for special target segment or a real estate scheme or any monthly income scheme which are…..
15. / 52.(4)(b)(xiv) / 45 / Valuation expenses in case of real estate schemes