Mutual funds in a tizzy on realty investment norms

Najaf Ishrati

June 17, 2006
ET Mumbai

WITH guidelines for investment in real estate by mutual funds (MFs) expected in a week, there is a considerable speculation as to what exactly these guidelines may contain. MF players say that investing in real estate is a different ball game altogether, with a few similarities to investment in equity.
The major difference that there is no exchange’ where real estate can be traded is obvious enough. However, the absence of an exchange throws up many issues. Speaking recently in Mumbai, Milind Barve, managing director, HDFC Mutual Fund, explained, “Without an exchange, suppliers are not regulated. There is no regulator who looks at the buyers interest. Also, what will be the time taken for settlement? Will it be T+2, or T+12 months?”. According to him, without the exchange, the issues of price discovery, settlement and liquidity become paramount. Real estate being an illiquid asset, the funds may have to be close-ended in nature.
The next issue is that with real estate, there are no `securities’. It becomes a physical asset, it can’t be safely left at the hands of a custodian. The pertinent question in this case is, ‘who is the custodian?’. Further, as against taking shares in the demat form, here the MF will have to take delivery of the title deed and other documents. This leads to a further issue, which is how good is the ‘quality of title?’.
With MF investment going into real estate, even valuation poses a new problem. With equity funds, AMCs have to supply NAVs of each of their schemes by 8pm everyday. Such valuations will not be possible with realty investments. Analysts say that there are some overseas funds, which publish their valuations just once in a year. In this case, it is learnt that AMFI has suggested a valuation of once every three months. But even this quarterly valuation will pose challenges. Here, there are no shares whose numbers have to be multiplied by their closing price to derive the NAV. Mr Barve, also the chairman on AMFI’s committee on valuation, has suggested that funds be allowed to have a panel of pre-approved valuers, who will do the valuation for them, and that disclosures are made on the method that has been chosen for the valuation.
The last issue that Mr Barve highlighted was that of risk management.
The risk of loss through concentration in one area had to be mitigated by diversification. He suggested diversification on three parameters, namely by location, project and developer or supplier. Further issues that crop up here are those of related party transactions.