When it comes to investment options, real estate is always a safe bet. Even when not used for personal use, a property is sure to provide capital appreciation as well as a steady means of income from rent.

The opportunity

The real estate boom in the last two years has seen property prices escalating, giving returns that can rival even the stock markets’.

The security offered by investments in real estate as well as their low volatility have attracted investors in droves. However, the biggest hurdle to investing directly in real estate is the huge money required for property purchases. Hence, real estate has been the forte of high net worth investors.

Worldwide, public investment in realty is done through real estate investment trusts (REITs), or through portfolio management services (PMS), which are structured like venture capital funds.

Real estate PMS products launched by HDFC, the Piramals and ICICI have been around for a few years, but they have been mostly restricted to high net worth investors.

Realty mutual funds, however, enable even a small investor to have access to a diversified portfolio. Sebi has come out with Real Estate Investment Trusts Regulations, 2008, to prepare the ground for the launch of realty mutual funds.

Global scenario

Let us see how REITs work globally. A REIT is a professionally managed entity, which can buy, develop, manage and sell real estate assets to provide rental income as well as capital appreciation to investors.

The structure of a REIT is similar to a mutual fund. The management comprises an independent trustee and a manager. Most REITs are pass-through entities — they do not pay tax on investors’ gains but distribute it to their unit holders, who pay tax on these gains at their own marginal rates.

To ensure good governance, strict restrictions are placed on avenues and quality of investments. Adequate and timely disclosures are also mandatory. To qualify as a pass-through entity, a REIT must be structured as a corporation or a trust, which is managed by a board of directors/ trustees. Its shares/units must be fully transferable, with a minimum number of participants, to ensure broadbased holding. It should distribute at least 90 per cent of its income. At least 75 per cent of the investment assets must be in real estate and it should derive at least 75 per cent of the gross income from rents or property mortgage interest.

Types of REITs

REITs can be of three types. Equity REITs can invest in or own real estate.

Mortgage REITs can lend to other property owners and developers against mortgage of such properties, or invest in mortgage backed securities such as securitised rent receivables. Hybrid REITs are a mix of equity and mortgage.

Sebi rules

According to Sebi regulations, REITs should be structured in the form of trusts and appoint a real estate management company for the fund. Both these entities have to get themselves registered with Sebi. To ensure transparency, all schemes to be launched shall be evaluated by an independent appraisal agency and rated by a credit rating firm. The fund will also have to appoint an independent valuer who will value the purchases, sales and existing real estate investments of the scheme.

The fund cannot invest more than 20 per cent of its corpus in incomplete or non-income generating properties. It cannot invest in vacant land or take part in property development activities. Moreover, it cannot have more than 15 per cent of its assets in a single project and not more than 25 per cent exposure to a single promoter group.

The fund can leverage up to 20 per cent of its assets to make further investments. It must distribute at least 90 per cent of its net profits to unit holders. To provide liquidity to investors, the schemes will be listed on bourses within six weeks of the closure of the offer.

Rishi Nathany is a certified financial planner. He can be contacted at rishi@touchstonewealth.com