NRI Corner

1.  Please share with us your views on the surge in real estate prices over the last couple of yeaRs Are domestic real estate prices on the higher side? When do you see a correction happening, if any?

Mr. Ramesh: Over the last few years property prices across the country have soared, ranging from 100% to 1,000%, e.g. apartments in Mumbai's Goregaon/Kandivli/Borivli area have more than doubled in the last three years, so is the case with South Mumbai/Bandra/Khar/Andheri.

Prices of commercial offices have gone up by 300% in locations like Parel/Lower Parel while those of residential apartments have tripled in the last three yeaRs

Similarly, Pune also has seen similar price rises. Magarpatta has moved to a rate of Rs 2,600 per square foot up from Rs 1,300 a few years ago. Viman Nagar last year was at Rs 1,300 today it has crossed Rs 2,500 per square foot. Aundh, Wakad, Baner, all these areas have seen more than doubling over the last two years. Ditto with Kolkata, Gurgaon, Noida, Jaipur, Hyderabad. Land prices have appreciated more than 500% in some locations over the last few years.

My view is that while some of this is genuine, some of this to me looks artificial. Genuine in the sense that the industry saw terrible years between 1996 and 2000, so in 2000/2001 prices were depressed beyond normal. The demand picked up in 2001 and with it the prices moved up gradually. Sometime in 2003, the country's overall sentiment changed to very positive (BRIC report, outsourcing, etc) and the huge actual user demand pushed prices of land and existing stock substantially. I believe that towards mid-2005/early-2006 speculators entered the market, as a result prices have moved up even further, and in quite a few locations, I believe they are now beyond the reach of the actual user.

I therefore feel that overall prices are on the higher side and that there should be a correction round the corner. Coupled with rising interest rates, demand could slacken, leading ultimately to a reduction in prices.

2.  How do domestic real estate prices compare with global prices?

Mr. Ramesh: Domestic Real Estate prices for office markets in India particularly in Mumbai and Delhi is amongst the 10 most expensive in the world. According to finding in CB Richard Ellis Research's semi-annual Global Market Rents survey, occupation cost for prime office space continues to rise in most global markets, particularly in Asia.

London's West End is the most expensive office location in the world at .60/sq. ft./per annum, the most expensive US location is now Midtown Manhattan at .04/sq. ft./per annum. Washington DC and Boston, the only other U.S. cities sited in the Top Fifty, ranked 27th and 29th respectively. Nariman Point in Mumbai, India at .06 sq. ft./per annum, it has broken into the top-10 list of the most expensive markets in the world. When Richard Ellis had conducted a similar survey 10 years ago, it had discovered that Mumbai was the most expensive city in the world for office rents. Rentals moving northwards is not restricted to Mumbai alone. There continues to be an upward swing of monthly rentals in Chennai, Pune, Bangalore and New Delhi with the demand created by banks, insurance companies, IT/ITES companies, multinational and big Indian corporates. Paste Global Prime Rate Excel worksheet

On the residential front, exclusive apartments in South Mumbai are going for a price of ,500/sq. ft., which when compared even to Manhattan looks expensive, considering the lack of infrastructure and cleanliness.

Estates of a few acres in New Delhi are going for Rs 1 bn (Rs 100 crores) upwards, which two years ago was barely Rs 25 crores. Am sure that with USD 22 m (Rs 100 crores), one can get more fabulous properties anywhere in the world.

3.  A real estate-linked investment avenue (real estate mutual fund) continues to elude the retail investor? In your view, what are the main hurdles?

Mr. Ramesh: Real Estate Mutual Funds are currently non-existent in India, however for a certain class of domestic investors real estate participation is allowed through Venture Capital.

SEBI, RBI and the Finance Ministry will bring forth a blueprint for REMF's in India. This requires a favourable legal, regulatory, accounting and tax system and environment.

Some of the issues that can come up are shown in the exhibit below

Some of the key hurdles/difficulties which will be faced relate to valuation, transparency and corporate governance.

4.  In the property funds that are proposed to be launched, how will the real estate be valued and at what frequency (SEBI has suggested daily valuations)?

Mr. Ramesh: Valuations still remain a critical question to be answered; unlike in the West we don't have any tested methodology for valuation of real estate assets. REIT analysts - perform regular (annual, and often quarterly) valuations of their company's property holdings. The value of a REIT's total assets, minus liabilities, divided by the number of its shares outstanding results in what is called the Net Asset Value (NAV) per share of the company.

Valuation of a property depends on a number of factors, for example, it depends on the age of the property, the quality of the property, the quality of the tenant, the tenure of the rental contract, the rental income, etc. In case of land or projects under development, valuation depends on the zoning of the land, stage of permits in hand, the level of construction or work in progress, etc.

We feel that valuation on a daily basis will be very difficult and is not even necessary considering real estate is a long-term play. However, a quarterly or a semi-annual valuation may be acceptable to investors and would also not be very inconvenient for the industry professionals.

5.  How will real estate funds be benchmarked? Is there an index in place?

Mr. Ramesh: REITs/REMFs in India may be benchmarked in following ways

1. Overseas Real Estate Indices
   
   
2. As in case of equity markets, comparisons are made with NASDAQ and the Dow, so will domestic real estate be compared with overseas real estate indices.
   
   
3. Domestic Real Estate Sensitivity Indices
   REITs/REMFs may also be benchmarked against domestic real estate index. It is likely that indices will be launched as the industry progresses. One such index has been launched by a Mumbai based real estate research and rating agency, Liases Foras. However its functionality is yet to be seen.
   
   
4. Comparison between real estate and other asset classes
   Investors will compare and benchmark the performance of real estate mutual funds with other asset classes such as gold, equities (sensex), fixed deposit returns, etc.
   
   
5. Fund to fund comparison
   REITs/REMFs can be valued by comparing funds of the same category. However the comparison should be between similar funds. For instance a REIT investing in residential properties in Mumbai cannot be compared to one investing in commercial space in another city.
   
   
6. Comparisons with market evidence
   Every investor has either a friend or a family member who will have his own anecdote of a direct real estate investment and its returns. So, a fund investor will also benchmark the fund performance with that of a direct property.
   
   
7. The fund's valuation statement could be benchmarked with `on the ground' experiences of rates.

6.  SEBI has allowed all mutual fund AMCs to set up real estate funds. Do you see a situation where even AMCs with little or no expertise in real estate jumping in the fray to launch realty funds, which could hurt the industry over the long term?

Mr. Ramesh: Yes, that scenario has a high likelihood of happening. My view is that a fund house which has the marketing strength and brand to raise the money will do so, in the belief that they will be able to put together a real estate team. It is to be seen how the team performs and whether their judgement is correct or not.

7.  On the same lines, existing mutual fund agents will be allowed to distribute real estate funds. Do you think this is an ideal scenario or there is a need to have a specialised/trained set of real estate fund distributors?

Mr. Ramesh: The mutual fund houses, I guess, would tap their existing marketing channels. What they would need to do, however, is to some extent train some of their persons in understanding at least the basics of real estate, so that at least the laymen's queries can be answered. For HNIs and sophisticated investors, they would need to have people who know more than just real estate basics.

AMFI may make some recommendations in this sphere.

8.  How are real estate funds in India expected to be different from those in developed markets?

Mr. Ramesh: REMFs/REITs are new to Indian markets and the concept is still in the nascent stage whereas the industry has matured in countries like USA and UK. Also these countries have specialised/customised products that invest in a particular category of real estate assets like Residential, Mortgage, Hospitality, Healthcare, Retail etc.

Initially the depth and breadth of the market will not be big as it is in the case of the US. There the total market capitalisation of the 197 Reits is USD 330 bn and total assets size is USD 400 bn.

REITs in US have following characteristics:

1. Listed entities
   
   

2. Own and actively manage income generating commercial real estate.
   
   

3. Required by law to distribute at least 90% of their taxable income as dividends
   
   

4. Reporting of Financial Statements as per GAAP
   
   

5. NAV Computation - quarterly and annually
   
   

6. Must have at least 100 shareholders
   
   

7. At least 75% of REIT assets must be real estate or loans secured by real estate.

As of now REMF's are still not permitted in India it is expected that they will be allowed soon.

SEBI has put forth following guidelines for REMFs in India.

• REITs to invest directly in real estate properties within India, in mortgage (housing lease) backed securities, equity shares/bonds/debentures of listed and unlisted companies which deal in properties and also undertake property development, as well as in other securities.
  
  

• The units of the REMFs shall be compulsorily listed on the stock exchanges
  
  

• Net asset value will have to be declared daily
  
  

• Structure of the REMFs initially, shall be close ended

The rules/structure in place today for mutual funds in general could be the starting point for the real estate mutual fund framework, with some modifications built in to adapt to the industry. So, it is likely that broadly the existing mutual fund framework will apply to even real estate funds. In that sense one should view real estate mutual funds as another sector fund.

9.  Is there real estate opportunity in the domestic segment for NRIs?

Mr. Ramesh: Yes, there is an opportunity for NRIs. They can look at investing in land or in properties for rent, either commercial or residential. Rental returns are in the ballpark of 5% per annum in case of residential and about 10% to 11% per annum for commercial properties. However, over and above the routine safeguards that they should be adopting, they also need to be careful about issues which they might have difficulty in handling because they don't live here, issues such as the security of the property, the maintenance of the property, the management of the property (paying bills, finding tenants at times of rollover, etc.) and timing of their exit.

Technically NRIs do not require any permission to acquire, transfer, lease, accept as gift, inherit any immovable property in India other than agricultural or plantation property or farm house. The RBI has prescribed guidelines for mode of making payment, repatriation of sales proceeds, operation of bank accounts for NRIs.

Any requests for acquisition of agricultural land/plantation/property/farm house by an NRI may be made to the RBI's Foreign Exchange Department.

10.  What is the best way for a retail NRI and high networth NRI to participate in the domestic real estate sector?

Mr. Ramesh: There are legal guidelines that the NRIs need to follow. Subject to those, the NRIs can directly buy properties as mentioned above.

They can also participate indirectly in the real estate story in the following manner -

• Investment in shares of listed company: NRI can participate indirectly by purchasing shares of the handful of real estate companies that are listed e.g. Unitech Limited, Mahindra Gesco, Bombay Dyeing, D. S. Kulkarni etc.
  
  

• Investment through overseas offerings: Some real estate companies are planning to raise money in overseas markets like the AIM, London or Singapore. NRIs can subscribe to those offerings e.g. K Raheja Corp, Mumbai and Embassy Group, Bangalore are in the news recently for such plans.
  
  

• Investment in overseas funds: Funds are being launched overseas to tap foreign money for the Indian real estate sector. NRIs can invest in such funds e.g. HDFC and ICICI, among others, have launched offshore funds in which NRIs can invest.
  
  

• Investment in Finance Companies: In a proxy manner, by buying into housing finance companies, banks, retail companies, NRIs can play the India real estate story.
  
  

• REIT's / REMF's: Discussed above

Based on the above scenarios, an aspiring NRI needs to select the most appropriate route given his risk appetite, size, strategy of being `more active ' or `passive', etc.

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