CRISIL Presentation

8/8/2019 CRISIL Presentation

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Real Estate Funds

- Unlocking Value in Real Estate Assets

Krishnan Sitaraman

Head FundServices and Fixed IncomeCRISIL

4th April, 2008

2.

Agenda

No Topic Slide

3 Real Estate Funds the Indian scenario 9

2 Real Estate Funds the meaning 5

Avenues for investing in Real Estate 21

4 Real Estate Funds are we prepared? 18

5 Conclusion 27


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3.

Avenues for investing in real estate

4.

Avenues for investing in real estate

Real Estate Investments

Direct Investment Indirect Investment

Non listedListed

Close end funds Open end funds REITs

Close ended funds may also be listed based on local regulations to provide

liquidity to investors

Mutual funds

MBS

Property stocks

MBS

Property stocks

Pa tne ships

Syndication

Pooled Funds

Joint Ventures

TIC Contracts

Fund of funds

REITs

Property Stocks


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5.

Real Estate Funds the meaning

6.

Real Estate funds

Real Estate Funds are generally available in two forms, depending on their

structure:

Real Estate Mutual Funds (REMFs)

Real Estate Investment Trusts (REITs)

Real Estate funds typically have an investment universe encompassing:

Real estate properties;

Mortgage (housing lease) backed securities;

Equity shares/ bonds/ debentures of listed/ unlisted companies which deal in properties and

also undertake property development; and in,

Other securities

In India, Securities and Exchange Board of India (SEBI) has recently come out

with its draft norms for launch of Real Estate Investment Trusts (REITs).

SEBI is also expected to shortly announce regulations for the launch of Real Estate Mutual

Funds (REMFs) by mutual funds in the country.

CRISIL FundServices (CFS) expects these funds to present investors with an

excellent avenue to capitalize on the potential gains from the property markets

and at the same time, help in bringing in greater transparency, liquidity and

institutionalization in these markets.


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7.

Key characteristics of Real Estate funds

Pooling of resources: Individual investments are small and are represented by

transferable units

Organisational Structure: Varies between companies and trusts depending on

local regulations and eligibility criteria

Funds may be both close ended and open ended

Property and Asset Management: Property management can be outsourced / in

house

Operating framework: Minimum percentage of assets that must be in the form

of real property or mortgages

Minimum proportion of the income that must be generated from such investments.

Minimum proportion of the income that has to be generated as dividends and distributed to

avail the tax benefits that these funds typically have.

Leveraging: Normally allowed to raise debt

Tax Advantages: Based on local regulations, may be exempt from corporate

taxes

Governance and disclosure: Local regulations with respect to the number of

independent directors and trustees.

8.

Benefits of Real Estate funds

Predictable revenue stream with regular incomes

High dividend yields

Good hedge against inflation

Diversification benefits

Low correlation with other asset classes

Higher risk adjusted returns supported by favorable taxes

Affordability and Liquidity

Professional asset management: REIT managers are skilled,

experienced real estate professionals

Oversight: Independent directors of the REIT, independent

analysts, independent auditors, and the business and financial

media monitor a public REIT's financial reporting on a regula

basis.

Disclosure obligations


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9.

Real Estate Funds the Indian scenario

10.

Real Estate funds the Indian scenario

Presently, in India, only venture funds have been offering real

estate funds

Presently available only to high net worth individuals and institutional

and global investors

Funds launched in this space include HDFC India Real Estate Fund,

India Advantage Fund from ICICI Venture Funds, Kotak India Real

Estate Fund, IL&FS Investment Managers, IndiaREIT Fund, Unitechs

CIG Realty Fund, etc

Draft regulations for REITs announced by SEBI in December

2007

Regulations for REMFs expected soon


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11.

Real Estate Mutual funds

REMFs refer to schemes of a mutual fund with an investment objective to

invest typically in real estate companies Governed by the provisions and guidelines under SEBI (Mutual Funds) regulations.

Launched by an Asset Management Company

Close ended structure with units listed on stock exchanges

In mid-2006, SEBI first came out with the basic guidelines for REMFs in India.

Areas such as valuation, related party transactions and taxation of these funds yet to be

addressed

Daily NAV disclosure after deducting administrative and management fees

Separate custodian responsible for custody of securities

Investment universe:

Mortgage (housing lease) backed securities;

Equity shares/ bonds/ debentures of listed/ unlisted companies which deal in

properties and also undertake property development; and in,

Other securities

Directly in real estate properties within India;

It is expected that REMFs would typically invest in debt or equity based

securities issued by entities in the real estate space.

12.

Real Estate Mutual funds

Indian mutual fund industry growing at a compounded annual growth

rate of about 35% over the last five years ended 2007

Equity fund AUM has risen to about 35% of the industry from 15%

levels two years back

This however is still lower than AUM of income-oriented schemes, including debt

and money market schemes

REMF offers an investment option that combines both reliable income

and strong growth prospects

A favorable alternative for domestic investors

Can potentially enable the mutual fund industry in growing more rapidly.


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13.

Real Estate Investment Trusts

Investment vehicles that invest in real estate directly, either through

properties or mortgages

Operate primarily with the objective of earning regular income and improving risk-

adjusted returns.

Globally enjoy a favorable tax treatment in many countries

May have significant restrictions on investment universe and distribution of income.

According to NAREIT (National Association of REITs), a REIT is a

company dedicated to owning and, in most cases, operating income-

producing real estate, such as apartments, shopping centers, offices

and warehouses. Some REITs also are engaged in financing real

estate.

REITs are generally of three types as given below:

Equity REITs

Mortgage REITs

Hybrid REITs

14.

Typical REIT structure

Distributions

Debt

Principal and

interest

Unitholders Lenders of

Debt

REIT

Investment in

REIT units

TrusteeAct on behalf ofunitholders

REIT

Manager

Property

Manager

Sub contract Ownership of assets Net Property income

Property management servicesProperty The global scenario


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15.


Draft norms on REITs from SEBI in 2007 Mandate an architecture comprising the Trustee and Real Estate

Investment Management Company model

Banks, public financial institutions, insurance companies and corporate

houses can be trustees of REITs

At least fifty per cent of the trustees and directors of the real estate

investment management company have to be independent directors

Close ended scheme structure with units listed on stock exchanges

Allowed to invest only up to 20% of total assets in incomplete and non-

income generating properties

Investment in vacant land is not allowed. Investment in securities or own

schemes not allowed unless specified

Concentration limits of upto 15% in any single real estate project upto 25%

of all the real estate projects developed, marketed, owned or financed by a

single group of companies.

16.


Mandatory valuations from a property valuer at least once a

year

Disclosure of NAVs as and when annual valuation is done

Mandatory rating of schemes by rating agencies

Leverage limits of upto over one-fifth of the assets

At least 90% of the post tax income to be distributed as

dividends every year SEBIs draft norms however do not mention anything on

taxation of REITs.

Globally, favourable tax treatments have enhanced the attractiveness of

these schemes to investors.


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17.

Key differences between REMFs and REITs

18.

Real Estate Funds are we prepared?


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19.

Real Estate Funds and Indias real estate sector

Key areas in which Real Estate Funds can positively impact Indias realestate sector:

Enhancing liquidity of the sector

Lack of liquidity impairs secondary market transactions

Real Estate Funds can provide liquidity through a more broad-based, and wider

participation of domestic retail investors

Institutionalization

Enhanced competition with institutional investors competing in a bigger way with the

unorganised sector for market dominance

Higher professionalisation

Greater acceptability for real estate as an investment asset class

Opportunities to retail investors to participate in the real estate sector

Asset diversification to corporate investors

Help build a vibrant, secondary real estate market

Improve sector transparency

20.

How big is the Indian Real Estate Funds opportunity?

Real estate stocks expected to grow around three fold to above USD

1400 billion by 2010.

Real Estate Funds expected to have the potential to hold at least a 5 per

cent share (more than USD 70 billion) of the total real estate market by

2010

India offers a greater opportunity for Real Estate Funds than any other

country in the world.

The yields on commercial real estate across metros in India are higher than

those prevalent in the global real estate markets.

Apart from the information technology (IT) and IT-enabled services (ITES)

sectors, retail, insurance, banking, healthcare, hospitality and consulting

businesses have also been growth segments in recent times driving the

demand for real estate.

A higher demand can be seen in the retail segment with an expected influx

of clothing and lifestyle stores, restaurants and beverage chains,

entertainment and leisure complexes.


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21.

Key issues that need to be addressed however

Limited availability of world-class realty:

Quality of the asset a key factor that determines its ability to

successfully survive economic downturns and maintain stable

rental rates and occupancy levels

Presently, there is a shortage of good assets in the real estate sector in

India in terms of scale and quality

Regulations such as the Urban Land Ceiling Regulation Act have played a

part in constraining the development of these assets.

As a result, a few good projects are being chased by all the large funds,

resulting, in turn, in fears of over valuation affecting investor confidence.

22.


The reasons for limited availability of quality developments are:

Unorganised, largely fragmented sector, characterised by small players

with a local presence

Limited number of professionally managed world-class companies with a

pan-India presence

Significant scope for improvements in terms of location, layout and

design, construction techniques, material quality, amenities offered tocreate long term value and face industry downturns

Absence of an enabling role by ensuring the supply of quality real estate

as in Hong Kong and Singapore

Limited number of property management companies, providing quality

services such as construction, development, repair and maintenance on

properties.


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23.


High transaction costs:

Current regulations in India involve high transaction costs, and

present problems in ensuring clear land titles, and prolonged

delays in obtaining clearances.

The sector also faces the following problems:

Lack of proper land records

Inadequate town and infrastructure planning for a sustained, planned

growth

Bankruptcy laws which have a lot of scope for improvement

Multiplicity of development laws and non-standardisation of laws acrossstates leading to delays and increasing costs

24.


Lack of transparency and information:

Lack of adequate disclosures on land/property transactions,

underreporting of taxable income and absence of uniform accounting

norms for revenue recognition.

As land/property transactions need to overcome regulatory constraints, avoid

stamp-charges on multiple transactions, and lack of clarity on titles, disclosures

are usually low.

Taxable income is under-reported in cash transactions.

The accounting norms allow both percentage completion and project completion

methods to be adopted, which results in non-uniform revenue recognition in the

industry.

There is also a near complete absence of a credible database on real

estate markets, in terms of property demand and supply, absorption

rates, geographic price data, occupancy rates, rentals, and

capitalisation rates for commercial, retail, and residential property

segments.


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25.


Illiquid secondary markets:

An efficient secondary real estate market facilitates a price discovery

process by enabling market demand-supply forces to arrive at the

efficient price.

In such a market, whenever the prices fall below their intrinsic value, the demand

would rise to the extent the price equilibrium is restored. Similarly, whenever the

prices rise above their intrinsic value, sellers would increase in the market to

ensure rationality in the market.

Currently, the lack of information and transparency and the high stamp

duty/registration charges constrain the development of the secondary

market.

26.


Valuation of properties is not standardised:

There are no standardised, accepted practices for property valuations

at present.

No meaningful benchmarks available among properties.

In the absence of standardised valuation techniques, it is difficult to identify

intrinsic valuations from the premium assigned by speculators.

The impact of extraneous variables such as interest rates and inflation

are also not factored in adequately into the valuations of properties.


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27.

Conclusion

28.

Conclusion

Multiple benefits through the launch of Real Estate Funds in India

Ease of access to realty markets for retail investors

Affordable to investors who in turn can own the good quality properties and have

access to expert management.

Provides investors with an efficient medium for diversification and asset

allocation.

Mortgage realty funds can provide a fillip to mortgage finance by creating asecondary market.

Medium to infuse large doses of capital into the realty sector.

Aids in making the sector more organized and transparent.

Offers developers and other companies, avenues to release property assets

from corporate balance sheets into professionally managed firms. Realty

sector can have access to funds at a cheaper cost, and thereby access to

better margins.


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29.

Conclusion

Real Estate Funds help meet two crucial ends

Stable, income oriented investment options for long term investors

Liquidity and depth for the secondary market

CRISIL believes that Real Estate Funds can be a potent tool in

institutionalising the real estate sector in India

There is however, a need for strict disclosures and other regulatory norms as

well as an enabling framework, before Real Estate Funds can be formally

introduced in the country.

Annexure


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31.

Correlation of real estate stocks to other asset classes

Canada

USA

Mexico

UKFinland

Netherlands

Germany

Belgium

France

Bulgaria

TurkeyIsrael

Singapore

Malaysia

Australia

New Zealand

Hong Kong

Taiwan

Japan

KoreaLuxembourg

Cash US Bonds

International

Bonds

US Large Cap

stocks

US Small cap

stocks

International

Stocks

Global Real Estate 0.05 0.18 0.25 0.51 0.51 0.71

Correlations of Real Estate stocks to other asset classes (1990 - 2006)

Source: Charles Schwab Investment Management Perspectives

32.

Category wise market capitalisation of US REITs

US REITs - Category wise market

capitalisation

Equity

93%

Mortgage

6%Hybrid

1%

Source: NAREIT


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33.

Increasing participation of countries across the globe in REITs

Canada

USA

Mexico

UKFinland

Netherlands

Germany

Belgium

France

Bulgaria

TurkeyIsrael

Singapore

Malaysia

Australia

New Zealand

Hong Kong

Taiwan

Japan

KoreaLuxembourg

Blue lines indicate countries that are close to finalizing REIT structures

IndiaItaly

Philippines

Pakistan

34.

Global REIT market by region

Canada

USA

Mexico

UKFinland

Netherlands

Germany

Belgium

France

Bulgaria

TurkeyIsrael

Singapore

Malaysia

Australia

New Zealand

Hong Kong

Taiwan

Japan

KoreaLuxembourgBreakdown of Global REIT market by region

Europe,

12.60%

Oceania,

13.20%UK, 8%Africa, 0.30%

North

America ,

56.40%

Far East ,

9.50%

Source: NAREIT


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35.

Global REIT market by number (February 2007)

Canada

USA

Mexico

UKFinland

Netherlands

Germany

Belgium

France

Bulgaria

TurkeyIsrael

Singapore

Malaysia

Australia

New Zealand

Hong Kong

Taiwan

Japan

KoreaLuxembourg

Source: AME Capital Global REIT Report - 2007

36.

Global REIT market by capitalisation (February 2007)

Canada

USA

Mexico

UKFinland

Netherlands

Germany

Belgium

France

Bulgaria

TurkeyIsrael

Singapore

Malaysia

Australia

New Zealand

Hong Kong

Taiwan

Japan

KoreaLuxembourg

Source: AME Capital Global REIT Report - 2007


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37.

Global REIT market by returns

Canada

USA

Mexico

UKFinland

Netherlands

Germany

Belgium

France

Bulgaria

TurkeyIsrael

Singapore

Malaysia

Australia

New Zealand

Hong Kong

Taiwan

Japan

KoreaLuxembourgGlobal REITS - Total rate of return - Three year to 30 June 2007 (%)

41.56

40.12

33.56

29.55

27.82

24.46

24.26

23.85

20.87

20.48

18.13

16.0914.49

10.66

8.51

0 5 10 15 20 25 30 35 40 45

South Africa

Turkey

Singapore

France

UK

Japan

South Korea

Canada

New Zealand

Netherlands

Australia

USBelgium

Hong Kong

Malaysia

Source: Ernst & Young Global REIT Report - 2007

38.

CRISIL Limited

www.crisil.com

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