Most of us are used to having real estate as a physical asset without viewing it as an investment in our portfolio.  In fact, for most of us, there are emotions attached to this asset. 

While real estate has given most of us good returns, the negatives are that it is illiquid and as an asset is difficult to handle operationally. For those who want to invest in real estate without the attendant negatives, a whole new world has opened up – one that has the benefits of real estate, with the ease of a financial asset. 

Real Estate Funds provide us an opportunity to go beyond the typical real estate that we are used to. These are managed by fund managers and allow us to participate into commercial real estate and invest into equity of real estate development projects (and share in the developer margins)

While Real Estate Mutual funds (RSMS) and Real estate investment trusts (REITs) are not available in India; they are a very popular investment class in developed markets. India however has its flavor through Real Estate Venture Capital / Private Equity Funds and Real Estate PMS.  These are products not available to retail investors.  The minimum investment is in the Rs 10-25 lakh range ,depending on the fund. 

Real estate funds typically allow this investment to be done in phases over 2 years, with a maturity period that normally ranges between 4-7 years.  Considering that they are not actively traded, investors are typically locked in for a certain tenure.  Exits maybe possible; but for that to happen, there should be another investor who is willing to buy the product from the person wanting to exit.

About Real Estate Funds

These funds are professionally managed, but rarely create projects of their own. They invest into projects of developers, either in equity or debt. If they invest into the equity of the project; they share in the profits of the developers.  If the funds invest in debt, they give loans to developers and earn fixed interest rates which can be attractive considering that availability of funds to real estate companies are restricted especially in the initial phases of the projects. 

The funds also use mezzanine structures which have a minimum fixed return with profit share.  There are funds that invest in rental yielding properties as well and try to provide a combination of regular returns plus capital appreciation when they sell the property.  As stated, the lock-in of these funds could range between 4-7 years.  After their tenure, these funds would exit their projects and if they do not see reinvestment opportunities could end up passing back the returns as and when they exit these investments. 

Most funds pass on any interest/ rental received from their investments on a yearly basis.  These product have no capital protection, but try and lower risk by diversifying across projects (commercial /residential), cities and developers.  Real Estate funds are close ended funds and are open for a fixed period.

Accessibility

The housing / commercial realty market has started to improve steadily; the prices have also moderated sharply, thus generating investor interest. Real Estate funds come with a minimum ticket size of Rs. 10 – 25 Lakh, thereby restricting the access to High Net Worth Individuals (HNI); typically they are the ones who look at real estate from an investment perspective and still would not want to go through the cumbersome process of due diligence, extensive paper work, maintenance and monitoring. 

As per data available with VCCEdge, there are 44 domestic real estate funds totaling to $11,226.8 million (Rs. 49,813 crore).  Some of the large funds include HDFC Real Estate PMS, Milestone, ICICI Venture Funds, Kotak Realty Fund, etc.

Risks

This is a high risk/high return strategy and ideally suited for High Networth Investors. While they are diversified, any one property could have a 10-15% exposure.  Considering that there have been issues relating to title of properties of even leading developers, any property getting into trouble will have an impact on performance. There are always concerns relating to transparency in real estate deals and that poses a big for these funds.  An investor should thus restrict real estate funds to a maximum of 15% of their overall portfolio. 

Cost & Upside

Real Estate Funds being HNI products are not tightly regulated like retail investment products.  The costs could hence vary from fund to fund. These funds normally have an entry fee (set-up fee) which ranges between 2% - 2.5%; apart from this there is an annual maintenance charge which is typically equivalent or slightly lower than the entry fee. There is also a performance linked fee which is payable if the fund posts returns in excess of the hurdle rate. 

Hurdle rates are typically around 8% - 10%. Some funds also have slabs for the performance linked fees. Such investments do not have any past trend one could fall back on; hence it becomes tough to predict the returns. Incase of commercial property, where rental yields are involved,  there is a minimum threshold of rental yields that are promised and which could range between 7% - 10% (pre-tax), in addition to this one stands to gain from the capital appreciation (if any). Most funds typically target about 20% - 30% pre expenses. After expenses and taxes, these could end up with returns of 15-22% post expenses and taxes.

Taxation

Real Estate Funds’ taxation depends on the structure they choose.  Most funds would have a combination of interest (taxed at normal rates), unlisted equity (could result in profits which is taxed at normal tax rate or capital gains which is taxed at 20% after indexation for inflation) and capital gains on debentures (taxed at 20% after indexation for inflation). Some funds may also provide rental income (30% deduction on rent).  Some structures of funds could have double taxation and hence one needs to understand the taxation structure before you invest. 

Hope this bit helps you understand this alternate investment avenue better and evaluate whether it is complementary to your overall portfolio.

Bottomline:

• These are HNI products best suited for investors wanting to diversify beyond traditional investment avenues. 

• Provides the benefits of real estate with the ease of a financial product

• Ideally restrict your investment to a maximum of 15% of over your all portfolio

• Expected to provide returns of 15-22% post expenses and taxes.  Taxation could differ from fund to fund.

• Fees structures can be higher than most retail products

• Risks mainly relate to title of properties that the funds invest into

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e-mail: Anil Rego

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