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Indian Real Estate MFs to Draw in More Foreign Money
Wednesday, May 21, 2008

Some things make the Reserve Bank of India (RBI) paranoid. The invasion of foreign money in the Indian property market has always been a familiar theme that rang alarm bells on Mint Street - the central bank's headquarters.

Whenever it sensed an alarm, the regulator moved in to clamp down on such money flows. Even foreign venture capital funds opening shops here are asked by RBI to give an undertaking that the money they raise will not go into real estate.

In the past two years, the regulator had persuaded New Delhi to tighten investment rules that would make it difficult for foreign money to chase Indian properties. Not that it has helped significantly, with smart money managers operating from offshore tax havens finding new ways to side-step the curbs.

But in its battle against "asset price bubbles", RBI will now face a challenge from an unlikely quarter. A month ago, the Securities and Exchange Board of India (Sebi) had paved the way for foreign funds to take a new route to enter the local property market. This would be through real estate mutual funds (REMFs).

There is nothing that can now stop a foreign institutional investor (FII) registered with Sebi or NRIs to buy units of mutual fund schemes which have invested in real estate assets. Under the new rules, which are carved out of the regular mutual fund guidelines of SEBI, an REMF can invest the entire money that it mops up "directly in real estate assets".

This could be ready commercial properties earning rental income. In a way, it would help investors as well as developers overcome the present rule that says foreign entities can put money only for construction and development and not in ready properties.

The Sebi notification issued on April 25, '08 says that at least 35% of the new assets of the scheme should be invested directly in real estate assets while the balance may be invested in mortgage-backed securities, securities of companies engaged in dealing with real estate assets - a slice of these securities can also be unlisted shares, bonds and hybrid instruments. In other words, an REMF is free to invest as much as 100% of its money in ready properties.

This is a curious situation, where one arm of the government has changed rules to restrict foreign direct investment (FDI), while another regulator has found ways to let fresh money flow into properties. What RBI had done was to push changes in FDI regulations, but now foreign money can come in through the portfolio route, with the government clarifying that FIIs are not subjected to the conditions under Press Note 2 that lay down the norms for foreign investment in real estate.

This, perhaps, was inevitable. Banks are almost barred from giving loans to builders who have turned to foreign investors. The latter found the India property story irresistible, with prices having multiplied in the past few years, and higher interest rates in India compared with overseas markets helped them make a killing on such investments. If REMFs lower the fund cost for builders, it would benefit the industry in the long run.

The downside is new money could further fan property prices. Already some of the fund houses are planning to float REMFs. But these players are looking for some changes that could help REMFs take off. For instance, they want REMFs to be exempted from income distribution tax like equity-oriented MFs, where more than 65% of the assets are equity.

Second, REMFs can invest in real estate assets which are free of litigation. While this is only fair as far as investors are concerned, it could limit the scope for the scheme's investment.



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