Tuesday, January 01, 2008

New year, New avenues

I flipped the calendar... It's love all...
SEBI presents us with a new investment avenue this new year... Real Estate Investment Trusts (REIT) – specialized mutual funds that invest only in real estate - are here. How well they suit the Indian market? How appealing will they be to our investors?

The way it is structured by SEBI, I think it will appeal to those who prefer bank fixed deposits than equity investors. Let’s look at the up and downsides –

a) Compulsory distribution of 90% of its income to investors. That means higher dividend yield and low scope for capital appreciation. This suits fixed deposit mindsets better;

b) An opportunity for small investors to capture the fortunes of commercial real estate market – something they can never dream of owning;

c) A new diversified avenue for investment in times of recession in equity markets; Right time to buy REIT units will be when the economy is slowly coming out of recession when its NAV will be low. That’s when businesses choose to expand and new businesses sprout up in new locations driving RE demand up; Ride the wave and capture the upside.

d) When interest rates are down, dividend yields from REIT units will be higher. Businesses shall borrow more and expand at new locations. Move your FD investments to REIT units.

e) Benefits of professional RE management.

f) Liquidity is assured since REIT units shall be listed at stock exchanges.

Now let’s look at its downsides –

a) Cyclical nature of its income stream. The investors ROI is dependent on the performance of RE market. That makes it risky especially if investors buy REIT units when RE sector is at its peak and will be victims of a bubble burst.

b) Being a close ended fund, REIT units cannot be safely held till maturity. It could be possible that the fund is closed out and units compulsorily redeemed when RE market it not exactly on an uptrend. Does not suit passive “buy and hold” type investors.

c) REIT funds provide a safe exit for early stage PE investors in a RE project. PE funds normally value their projects after discounting their earning on a forward basis. Therefore the investors in a REIT fund will not be left with much on the table when they bite in. That will expose them to the vagaries of RE market.

d) Bloated valuations commanded by early investors (including PE firms, developers) would drive up RE market to unsustainable levels. REIT investors will have to put up with poor dividend yield since they would be buying units at a high NAV.

I have not touched upon the tax issue since CBDT notification on tax treatments has not yet been finalized. I shall revert when it gets done.

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