Real Estate Mutual Funds spared of paying any income tax

The Economic Times news paper today reported that the uncertainty over the tax-treatment of real estate mutual funds is set to end soon. The government will exempt from tax the income generated by mutual funds which float schemes which aim to invest mainly in the stocks of realty firms.

According to a senior revenue department official, real estate MFs and other MFs that invest in shares of realty companies will be spared of paying tax on all income. The dividend income of unit holders who buy these products to reap the gains of a realty boom will also be tax-free.

Securities market regulator Sebi had approved the launch of real estate mutual funds almost two years ago. But the operational guidelines or norms are yet to be unveiled. Now, with greater clarity on valuation norms and the calculation of net asset value (NAV), the regulator may soon prepare the ground for the launch of real estate MFs, an official said.

Real estate MFs are expected to be close-ended, and the units of these funds will be listed on the exchanges. Such funds invest in both listed and unlisted securities of realty firms. They offer an opportunity to investors to take an exposure to a sector which offers reasonably attractive capital gains and steady dividend income.

However, the Reserve Bank of India (RBI) has not been comfortable with more investment flowing into realty given the dangers of an asset price bubble.

While real estate mutual funds will stand to gain due to favourable tax treatment, Real Estate Investment Trusts (REITs) that directly buy and sell property including apartments and shopping malls could be denied such benefits.

REITs are investment vehicles registered under the Indian Trusts Act. They are managed by professional real estate investment management companies and invest in properties. They also own and manage properties. An investor can buy units in an REIT just as he does in a mutual fund and earn a dividend income on the unit or shares of an REIT.

Ahead of this year’s budget, the capital market regulator had told the government to consider granting tax benefits to REITs on the lines of local mutual funds to encourage wider investor participation. But the revenue department, it appears, has turned down the proposal. Read More about REIT at Investing in Real Estate Part 2

The income-tax law now provides for a pass-through status for mf’s and all income earned by the fund is tax free. But any income distributed by the mutual fund attracts a dividend distribution tax, depending on the nature of the fund. The maximum rate of dividend distribution tax is 25%. But unit holders do not have to pay any tax on their dividend income.

SEBI to clear launch of Real Estate Investment Products

Yesterday, the SEBI Chairman, Mr M. Damodaran has mentioened that the decks have been cleared for the launch of the real estate investment products in the market.

The last hurdle had been cleared with the Association of Mutual Fund Industry and the Institute of Chartered Accountants of India having firmed up the valuation norms for these products.

Explaining the process, he said that these two bodies looked at whether it was possible at all to accord a valuation and the frequency with which one needed to do it. Valuation, almost on a continuing basis, is needed as people enter and exit schemes on a regular basis.

The above means that Real estate fund that were privy only to the High networth individuals will start being available to the common man. Also, the high frequency of price disclosure means that one will be able to get in and get out of the fund just like any other Mutual Fund unlike the current Real estate fund which have long term commitment and lock in.


Learn more about Real estate funds in the links given below

1. Investing in Real Estate Part - I

2. Investing Real Estate Part - II

Some more 'Interest'ing news

Here is an extract from various sources on interest related news this morning. Read these news in relation to my previously submitted blog dated 29th June Inflation at 4.28%, Hits 14-month low

1. An 'Interest'ing climb down ahead - Indications are that interest rates will climb down

2. Inflation expected to rise to 4.32% - Will the actual interest rates climb down if inflation does not come down

3. Corporation Bank cuts interest rate on home loans - It does not matter, the bank has decided to cut the interest rate on home loans

4. China's GDP zooms at 11.5% - Will the chinese authority increase the interest rate and cause a flutter in the market.

There is defintely an expectataion in the fall of interest rates possibly leading to the following

1. Depreciation of the rupee
2. Increase in Bond values and hence increase in NAV of Bond Funds
3. Some interest back to real estate sector - See related news at Kotak Realty raises $400 million in 6 months

Investing in Real Estate - Part 2

In my previous blog, I explained the benefits of investing in Real estate even though the returns when compared in isolation is not the highest when compared with other asset classes such as Equity.
In this blog, I will explain the concept of realty mutual funds and the advantages/disadvantages of the same as a means to invest in Real Estate indirectly.

How do they work ?
Realty Mutual funds function almost in the same manner as the typical equity mutual funds work where money is collected from various investors for the sole purpose of investment in real estate over long periods of time. These are typically close ended (cannot be bought and sold on a daily basis) where the period of investment varies between 5 and 7 years if not more. These mutual funds are started by AMCs along with participation from realty developers. The modus operandi is fairly simple and straight forward. The money collected by the fund house (over a period of time) is invested in the various real estate properties that the real estate developer identifies and develops it for future sale to the potential buyers. The funds could invest specifically in retail, commercial, hospitality sectors or any of them. It really depends on the theme of the fund. They could also deploy the money in buying real estate and then generate revenue by renting/leasing them to the final users.

Advantages
1. Helps in achieving the diversification of wealth by investing in the real estate asset
2. Mitigates risk of volatility of real estate prices across the country by investing in real estate across multiple projects in the country and multiple categories of asset such as retail, commercial etc.
3. The funds are handled by professionals who have expertise in understanding the dynamics of the real estate business. Leave it to them to identify the assets to invest.
4. No need to register the property etc thus reducing the hassles in owing an real estate.

Disadvantages
1. Banks do not give loans for participating in the investment of such realty mutual funds
2. Not very liquid (Though there is a published price for every quarter, it is not easy to exit the fund as the seller has to find his own buyer) even thought it is marketed as a Mutual Fund.

Limitations
1. The entry barriers to invest in such funds are fairly high even today. It was close to Rs 1 crore to begin with but has reduced to Rs 20 Lakhs now.

I believe that these funds will become more and more affordable for a common man to participate in the near future. Just like Mutual Fund SIPs where the entry barrier was Rs 500 p.m has now reduced to Rs 5 p.m, I assume that the entry barrier for such products will also come down.

Investing in Real Estate - Part 1

It has always been a dream for all of us to own our homes however small it might be. Some of the reasons for owning a home is to give a sense of satisfaction of having one's own roof, some sort of an investment which is long term, availability of loans by banks and financial institutions to fund the purchase and Tax breaks that one gets.

While the above points make sense for the home that one will stay, is it prudent to invest into the second property as a form of investment especially when one is seeing a booming stock market ?

Before i get into the justification, let me start of with an interesting view with some facts.

Over long periods of time, the stock market tends to give anywhere between 15% to 20% p.a returns. The real estate market tends to give anywhere between 5% to 10% p.a over long periods of time. However, there will be cyclical boom and bust in both the asset classes that will average the returns over long periods of time.

Now, given the above data if i ask where you will invest Rs 10 Lakhs (Rs 1 million), the logical answer will be the equity/stock market given that the returns that it generates is higher than of the real estate market. However, the fact that banks are willing to give loans to purchase property (ofcourse one will need to eligible and capable to repay the loans) makes a big difference to the above equation and let me illustrate with an example.

Let us take a 2 year period for our comparison. If one invested Rs 10 lakhs, it will be worth Rs 14.4 lakhs at the end of 2 years giving a return of Rs 4.4 lakhs on an investment of Rs 10 lakhs.

However, assuming that one bought a property worth Rs 1 crore by borrowing Rs 90 Lakhs 9banks tend to give 90% of the value of the proerty as a loan) and contributing Rs 10 lakhs from one's pocket (ofcourse one will need to eligible and get the loan as well as be capable to repay the loan). Thus if the property grew at 10% p.a., the value of the property at the end of 2 years will be Rs 1.21 crores and assuming that one borrowed the Rs 90 Lakhs at 10% p.a, one would need to repay interest only on the amount of money that one borrowed over this period of 2 years (say Rs 60 lakhs) which works out to Rs 12.6 lakhs on the higher end. Thus after considering the repayment of the interest, the capital gains works out Rs 8.4 lakhs. Thus an initial investment of Rs 10 lakhs yields a return of Rs 8.4 lakhs as against a gain of Rs 4.4 Lakhs in the case of equity/stock markets. Even if we consider payment of tax for the capital gain in case of the gains in real estate, it still will beat the returns when we compared it with equity. Thus, we get the benefit of leveraging in the case of real estate which is not so easily available in the case of equity.

If we consider a longer period of 3 years then the capital gains exemption in real estate will also kick in.

However for the above to happen, one would need to consider the following

1. Capability to be able to borrow the large sum of money from the bank.
2. Interest rate movements will impact the returns (Please note that, this will also impact stock markets)
3. Appreciation as per expectations.
4. Ability to sell the real estate easily.


In the next part of this series, i will explain how one can invest in real estate but not by directly investing in property.