Valuation blues for realty funds

Lack of uniform valuation and disclosure standards could dampen the enthusiasm of investors in real state mutual funds (REMFs) once they are launched in the country.

Experts tracking the performance of Real Estate Investment Trusts (REITs), the equivalent of REMFs abroad, feel the lack of standards could put downward pressure on the scheme in the country.

"Worldover, REITs are being traded 5 to 10 per cent below their asset value due to improper valuation in some cases. In India, they could see additional discounts since there are some problems with valuation," said Graham F Chase, president of The Royal Institution of Chartered Surveyors (RICS).

Chase believes that accuracy of land valuation is the most critical element in the market performance of realty firms and REITs. "Do not assume that you will get market capitalisation above your asset value. Markets take a realistic picture of the assets and if they think that your valuation is bloated, the share prices will definitely be impacted," Chase said.

India could see the first REMF by the end of this year as the Sebi sub-committee is in the final stages of preparing detailed guidelines for the same.

REITs are basically set up to reduce tax burdens which otherwise have to be borne by individual entities. Corporate tax and capital gains tax are not levied on it since it acts as a trust.

In REITs, at least 90 per cent of the profits are distributed as profits through dividends and shareholders will then pay tax on dividends as if they were rental income.

REITs were first started in the US in the 1960s and since then REIT-type vehicles have become popular in countries such as the Netherlands, Luxembourg, Spain, the UK, Japan, South Korea, Singapore, Hong Kong, and Australia.

But experts believe that REMFs can bring more liquidity and transparency in India's real estate sector, which is largely unorganised.

Said Sourav Goswami, MD, Walton Street Capital: "The major challenge for the introduction of REMFs in India is the lack of yield-generating assets of institutional quality into which REMFs can invest. Also the methodology for valuation of REIT has not been decided yet. However, the good thing about REMFs is that they provide viable options for developers and funds to exit the projects and create additional funds."

John J Kriz, MD, real estate finance, Moody's, said "For emerging markets like India, REITs could help bring more liquidity, transparency and foreign investment in real estate. Since a significant part of wealth comes from property in India and the sector is capital hungry, REITs can help increase the extent to which public equity is raised."

He added: "Most of the real estate firms focus more on housing development and less on long term investment. REITs are famous for long-term goals"

The net asset value (NAV) of REITs is calculated in different ways in different countries. Various factors taken into consideration which include valuation of property, individual assets they own, cash-flow measures, occupancy and rentals achievable, interest rates and so on. Those with mortgaged properties are valued less compared to those which do not have mortgaged properties.

In the US, where nearly 200 REITs are operational, NAVs are calculated on the historical value of the asset. In countries such as the UK and Hong Kong, external valuation is done once in 4 years and internal valuation in between. Then markets decide whether they would be traded at at premium or deficit to the NAV.