Real estate mutual fund schemes

Most ways of buying property through a fund buy shares in property companies. A real estate mutual fund scheme buys the buildings.

That changes the regulatory problem completely. A share can be valued on a screen and sold in a day; a building cannot. So the rules do two things at once — they force the scheme to hold enough real property to justify the name, and they define "real estate asset" so narrowly that the scheme cannot hold anything speculative, disputed or unfinished.

What counts as a real estate asset. An identifiable immovable property that is:

• located in India, in a city specified by SEBI or in a special economic zone;
• complete and usable — construction finished;
• evidenced by valid title documents;
• legally transferable;
• free from all encumbrances; and
• not the subject matter of any litigation.

It expressly does not include a project under construction, vacant land, deserted property, land specified for agricultural use, or property reserved or attached by any government or authority or under court orders, or whose acquisition is otherwise prohibited by law.

The two floors. Every real estate mutual fund scheme must invest at least 35% of net assets directly in real estate assets. Subject to that, it must invest at least 75% of net assets in real estate assets, mortgage backed securities (but not directly in mortgages), and equity shares or debentures of companies dealing in real estate assets or undertaking real estate development projects, listed or not. The balance goes into other securities.

The diversification ceilings. Unless otherwise disclosed in the offer document, no mutual fund may — across all its real estate schemes — invest more than:

• 30% of net assets in a single city;
• 15% of net assets in the real estate assets of any single project;
• 25% of the total issued capital of any unlisted company; or
• 15% of the net assets of any of its real estate schemes in the equity shares or debentures of any unlisted company.

The related-party wall. No such scheme may invest in any unlisted security of the sponsor, its associate or group company, or in any listed security issued to them by preferential allotment, or in listed securities of the sponsor group beyond 25% of net assets. No mutual fund may transfer real estate assets among its own schemes, or invest in any real estate asset owned by the sponsor, the AMC or their associates during the last five years, or in which any of them holds tenancy or lease rights.

Prithvi Real Estate Mutual Fund Scheme has net assets of Rs 1,200 crore.

Direct real estate = 300 + 190 = Rs 490 crore = 40.8%. Clears the 35% floor. The 75% basket = 490 + 250 + 200 = Rs 940 crore = 78.3%. Clears.

Now three proposals land on the investment committee.

1. A second Hyderabad tower for Rs 90 crore. Hyderabad exposure would become Rs 390 crore = 32.5% of net assets, above the 30% single-city cap. Rejected unless the offer document disclosed a higher limit.
2. A single Bengaluru project for Rs 200 crore. That is 16.7% against a 15% single-project cap — Rs 20 crore too large.
3. A completed warehouse offered by the sponsor's group company, which owned it until it was sold to a third party three years ago. Barred outright: the scheme may not invest in a real estate asset owned by the sponsor, the AMC or their associates during the last five years. Three years is inside the window, and the intervening sale does not reset it.

A fourth idea — moving the Pune podium into a sister scheme of the same fund house at an agreed valuation — is also barred. No mutual fund may transfer real estate assets amongst its schemes.

Chapter 14, section 14.5.1 (Real Estate Mutual Fund Schemes). The section is almost entirely numbers, which is exactly why it is examined.

The reliable questions are the two floors — 35% directly and 75% in the wider basket — and the four ceilings: 30% single city, 15% single project, 25% of the issued capital of an unlisted company, 15% of net assets in one unlisted company's equity or debentures. The definition of "real estate asset" is also tested by exclusion: candidates are asked which of a list — a project under construction, vacant land, agricultural land — qualifies. None of them do.

• 35% is direct; 75% is the wider basket. The 75% includes the 35%; they are not additive.
• Mortgage backed securities count toward the 75%, but the scheme may not invest directly in mortgages. The distinction is in the text and is examined.
• A project under construction is not a real estate asset. Nor is vacant land, agricultural land or a disputed property. "Complete and usable" is a definitional requirement, not a preference.
• The city and project ceilings apply across all the fund house's real estate schemes, not scheme by scheme — and they can be relaxed only if the offer document disclosed otherwise.
• The five-year sponsor look-back covers past ownership, not just present ownership, and tenancy or lease rights are caught as well as title.
• Inter-scheme transfer of real estate assets is prohibited outright. There is no approval route, unlike several other related-party limits in the same chapter.