After delaying for several years, SEBI has just approved the draft regulations for Real Estate Investment Trusts (REITs). There has been some hype of expectancy around this product and the market has been eagerly awaiting it. So have the HNI's (High Net Worth Individuals). Such products appeal to the HNI's since they seem to be an avenue to invest in high-yielding real estate without actually getting their hands dirty by going and actually purchasing some real estate. And HNI's, especially of the salaried variety, don't want to get their hands dirty. They want to get high returns while ensconced in their offices, trusting the money managers who, they are assured, are there just for that purpose – to ensure that they get good returns while being inured from all the hardships such investments entail. And therein lies the rub. We think that since it is a structure that works fine in the developed western economies it will work fine here too.
But first the structure. SEBI has mandated that all these funds should be closed-ended, with an initial asset size for each fund of at least Rs.500 crores. Each unit in the initial issue will be at a minimum of Rs. 2 lakhs; follow-on issues at a unit size of minimum one lakh, thus ensuring that only the wealthy invest in it. In other words, it is risky, so don't blame us if it turns sour – you wealthy can afford to lose money! There are no great entry barriers for becoming a sponsor, and the sponsor can of course appoint his own "manager" who manages the fund. The trustees, needless to say, will be appointed by the sponsors, thus ensuring that there is no real "independence". But so far, it is no different from any Mutual Fund. These funds have to be compulsorily listed, but mere listing does not ensure liquidity as we all know. The manager has to invest at least 80 percent in completed and revenue generating properties. The balance can be invested in under-construction properties, or mortgage backed securities, or debt or equity of real estate companies. This whole bucket of the balance of upto 20 percent looks scary. This money will basically be invested directly with the builders and we know how honest and transparent they are reputed to be in India.
I see several problems with this structure.
1. How independent are the managers, trustees and sponsors going to be? Who will be setting up these funds, and who are the entities that will control them?
2. When you invest in real estate directly, even if in an under-construction property, you have more skin in the game. What kind of oversight and control over the builder will be exercised by the money managers? They are more into managing money; are they going to manage all the problems that come with being a landlord? They will leave it to the builders to manage, and send them periodic reports, preferably already in ppt form, so that they can present it to their bosses and investors.
3. The primary problem in my view, is that this is a highly unregulated, opaque, non-transparent, not very honest, black-money prone, unstructured industry in India. Things, especially with regard to valuations and cash flows, are never as they seem to be. There is a great incentive for the money manager to cut side-deals with the builder. And the investors will never know.
4. SEBI has not mandated that any building regulations should be followed or checked for the investment properties. There is nothing in the guidelines pertaining to real estate; SEBI is treating this like any other mutual fund. The money managers who enter this game may not be experienced in the real estate industry, and the builders, as we know, are very experienced. The managers will be like new fish entering into a pool full of sharks.
5. Valuation for NAV calculations will be an issue. In equity mutual funds there is a ready liquid market with daily quotes. Here the fund will appoint "experts" to determine the value. Since the assets are illiquid, and the valuations depend on assumptions, they can be manipulated to show a steady increase in NAV. Or a sudden drop as a prelude to some insider purchases. Or very aggressive valuations not providing for long-term repairs and renewal. The potential to play around with the numbers is enormous, and we as investors, are going to be investing at these NAVs.
6. The upto 20 percent that can be invested in "under construction" projects is actually another conduit to lend money to the real estate industry. Anyone who knows the Indian real estate industry will be worried.
7. Exits from investments, both for the funds for their investments in projects, as well as for investors, is not going to be without cost. There will be a heavy illiquidity premium built into the price.
So where does that leave us? To invest or not to invest? Those of you who are not "HNI's" don't have to bother, this product is not for you, even as per SEBI's definitions. Those of you who are HNI's, remember all those PMS schemes you put your money into? The odds are you didn't make too much on it – as to the problems with PMS, I shall reserve that for some other time. You are going to trust your money to someone who may not know much about real estate, to invest it with builders who are not known for their honesty and fair dealings, in a market that is illiquid and full of "cash" transactions, in expectation of a higher return.
I would advise caution. At the very least, invest only if the sponsor is HDFC or something.