By Sorabh Jain

Investor demand for real estate securities has reached global proportions. As more countries establish securitized real estate markets similar to U.S. REITs, greater attention is focused on those areas with either a non-existent or underdeveloped listed real estate industry. Naturally, when we are talking about a large country with enormous investment potential like India, interest is heightened.

India's combined commercial and residential real estate market is valued at $12 billion, which is around 2 percent of the country's GDP and 2 percent of total stock market capitalization. And it is only getting larger. The real estate market is growing at a rate of 30 percent per year and expected to reach $90 billion within the next 10 years. The market is even attracting the attention of U.S. real estate companies including Tishman Speyer, GE Commercial Finance Real Estate (NYSE: GE) and, most recently, Vornado Realty Trust (NYSE: VNO). In March, Vornado and India's Chatterjee Group announced plans to jointly float a $50 million real estate fund.

While the real estate market is booming, REITs are currently non-existent in India.

Following experiences from other Asian countries and the domestic growth appetite in India's real estate sector, it is expected that REITs hold enormous potential in the country. In absolute terms, it is reasonable to forecast the market's opportunity at more than $4 billion.

Establishing REITs in India

Several groups are actively working to improve the real estate investment options and establish a REIT industry in India. While REITs appear to be further off in the horizon, real estate-dedicated funds appear close to being established.

The Associated Chambers of Commerce and Industry of India (ASSOCHAM) has proposed creating REITs to ensure that India's property markets are suitably expanded with proper regulation. The Securities and Exchange Board of India (SEBI) Advisory Committee on Mutual Funds has considered the subject of mutual funds launching specialized real estate products (REMFs) on the lines of German open-end funds.

SEBI is working with various central and state government agencies including income tax authorities, representatives from the real estate industry and local governments on issues relating to stamp duties. Draft guidelines from SEBI were expected in February, but have been delayed until later this year. Once comments are received and issues are addressed it is expected that SEBI will announce its final guidelines to enable retail investors to participate in the real estate market via real estate-dedicated mutual funds. The new guidelines will enable mutual funds to invest in the real estate sector and thereby will also allow small investors to own property. The implementation of those guidelines is expected to be a smoother process than finalizing them as there is an existing regulated and governed mutual funds market to model.

The Association of Mutual Funds of India (AMFI) has constituted a committee for an in-depth study of relevant legal and operational aspects. AMFI's committee has put forward certain suggestions focused on two models: the collective investment scheme and the mutual fund structure. The legal framework for the collective investment scheme shall require a separate set of regulations and considerations in respect to stamp duty, registration charges, property taxes, etc. (which vary from state to state). Based on the current legal status, the mutual fund structure can be launched as part of the Mutual Funds Scheme subject to the Securities and Exchange Board of India (Mutual Fund) Regulations, 1996.

At present, 38 companies have been licensed to operate as mutual funds in India, including well-known international names like Alliance Capital, Deutsche Bank, Merrill Lynch, Fidelity, HSBC, Morgan Stanley, Quantum and ING. These firms have already floated more than 500 funds and could be in line to offer a real estate fund.

REIT Impact

The establishment of a REIT industry would provide a much-needed capital infusion to India's underdeveloped real estate market. There are numerous sources of capital that would welcome a REIT investment option. India's GDP is currently around $630 billion and is growing at an average rate of 7 percent to 8 percent. Additionally, household savings are growing at an estimated 15 percent, and this source of investable capital should reach $392 billion by 2010.

Also, pension funds are currently not allowed to invest in equity markets and real estate. As pension reform takes place it is expected that this long-term money will flow into the capital markets, making REITs or real estate-dedicated funds a desirable investment option.

Over the last decade, more than $70 billion of foreign capital has been invested in India, and with the growing popularity in owning global real estate assets, a viable listed real estate market would garner a sizable portion of that increasing foreign capital.

As mentioned before, the mutual fund industry in India is blossoming. Mutual fund assets have grown with an annual growth rate of 9 percent over the last five years. If mutual fund assets continue at this current growth rate, it is estimated they will double by 2010, but considering the growing appetite of retail investors for investments and the booming Indian economy, a bigger jump in assets under management is not out of the question. The bulk of the mutual fund assets are invested in income-oriented options, including debt and money market instruments. An investment option that combines both reliable income and strong growth, like a REIT, would be a favorable alternative for domestic investors.

All of these ready sources of capital are important to the eventual success of a new REIT industry. Real estate developers presently have limited means of financing, few developers have tapped capital markets for fund raising, and there is too much dependence on debt. Twenty real estate development companies at present are listed on the recognized stock exchange with a market capitalization of $1.5 billion, or 0.5 percent of the total stock market capitalization.

Further, most of these companies are focused on specific cities or regional markets and do not have the scale or size to operate in multiple cities across India. With the real estate market developing across the nation, real estate developers need to seize on opportunities arising in various locations that will require sources to raise large funds.

The introduction of REITs in India would provide a further boost to the real estate industry. This would result in increased rental housing generation and also raise cheaper funds for this sector.

REITs would also provide an opportunity for small investors to access commercial property returns (at present 9 percent to 10 percent per year) that are now unavailable without significant capital outlays. REITs could also foster improvement in investors' portfolios by diversifying the investment base and increasing the stability of income sources. Instruments like equity, mortgage and hybrid REITs can offer investors high yields as well as liquid methods of investing in real estate.

A REIT structure also offers a better chance for companies to release property assets from corporate balance sheets into professionally managed firms. They would also usher in a greater professionalism in the real estate sector and the association of dividend reinvestment plans, resulting in higher capital flow to the market.