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Realty Funds: MYTH & REALITY

Ever since the Foreign Direct Investment (FDI) norms were relaxed for investments into the real estate sector, the Indian real estate market has been drawing the attention of foreign realty funds (i.e venture capital funds with a focus on investments in the real estate sector). These realty funds are essentially pooling vehicles that raise capital from a number of investors with a profit sharing model on returns.



The Indian real estate sector continues to be one of the most appealing investment avenues, despite issues such as land title, lack of rationalized stamp duty legislation and absence of specific tax incentives for realty funds. The government currently permits 100 percent foreign investment in companies engaged in the development of townships, housing, built-up infrastructure and construction development projects. However, such investment is subject to conditions contained in Press Note 2 (2005) which include conditions such as minimum built up space, minimum capitalization, lock-in period of three years, etc. There also exists a lot of ambiguity around some of the conditions contained in the said press note. Separately, under the existing exchange control regulations, no Indian company is permitted to raise debt from non-residents to be utilized for real estate activities.



Given the above constraints, realty funds which make investments into real estate companies in India invest only by way of equity or other instruments which are compulsorily convertible into equity, such as compulsorily convertible debentures or preference shares (as these are treated as FDI as per the existing policy). Under the existing regulations, pure play debt funds and mezzanine debt funds are not permitted to directly invest in real estate companies.



Another area of perceived disadvantage to the realty funds invested or wanting to invest in India is the absence of specific tax incentives for realty funds. Currently, venture capital funds investing in certain specific sectors including software, information technology, bio-technology, etc are eligible for tax relief on their income by way of dividends and long term capital gains. However, realty funds are not entitled to any such tax relief and therefore, invest either as normal investors and take benefit under the provisions of the tax treaties with Mauritius and other countries or have to rely on the normal provisions of tax laws to ensure single stage taxation.



Hitherto, the Indian real estate sector was not known to be an organized sector with good corporate governance and strict disclosure requirements. Real estate funds are good for the industry as they help in bringing organized money in this fragmented market and require the real estate companies to adhere to corporate governance and disclosure requirements.



Realty funds also provide real estate developers better access to competitively priced capital, particularly since banks are generally reluctant to lend to developers and in particular smaller and emerging players. Given the fact that a significant portion of the urban development in India is being undertaken by the private players, the presence of realty funds would boost the real estate sector in particular and the Indian economy at large. India, should take a leaf out of the book of some of the south Asian economies whose economies achieved sustainable high growth rates due to the real estate sector.

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