New age of property investments in India
Real estate as an investment option is falling out of favour. While a few factors such as the black money bill may be cited as a reason for the cyclical downturn, fundamentally property as an asset class is maturing in the country. From being a opaque system with many inefficiencies, the industry has been changing in the last decade as institutional capital is bringing more professionalism and transparency.
In the past, homes were built for consumption only and not as an investment. Homes were also self-constructed and there were no large scale projects. With real estate industry picking up, there was a need for capital. Property developers looked to investors to raise money, as traditional funding sources such as banks and NBFCs were not always willing to lend to, especially during the early stages of a project.
As an alternative to money lenders, larger developers went with real estate private equity funds. They were all the rage in the mid 2000s and many foreign and local funds were launched. They offered funding in two models – equity and debt. Equity oriented funds provide money in the early stage and when the property is sold, get their returns by way of price appreciation. Debt oriented funds offer loans in any stage to be repaid with interest (ranging from 18 to 25 per cent annually) after a certain period. There are also hybrid funds where the developer pays an assured minimum return plus a share of the price appreciation.
While it was a good deal for developers, many foreign funds and those that invested in commercial property such as office buildings, malls and retail space were stuck as they could not sell their stake. There was a shake up and many funds shut shop – the number of funds is now down to about 10, from 50 in the go-go days of 2007.
Among those left standing are local funds with a focus on residential real estate. Their strengths include offering thorough diligence on the builder and the project. They also monitor progress, put in systems to ensure quality and on-time delivery – all to ensure they can earn their return. Home buyers and developers also benefit in this bargain.
These methods have worked and the funds have been able to earn healthy returns even when the market was beaten down. The case in point is ASK Investment, a real estate private equity fund. They had at least four exits from the residential segment investments at multiples of 2.25 to 2.5 times in about four years. These work out to annual returns of 20 to 25 per cent – not a bad deal for any investment.
So while investors who bought physical property were stuck with low returns and inability to exit, wealthy investors who took the financial ownership route through real estate PE funds were laughing on their way to the bank. Real estate PE funds also offer diversification benefits as they invest in different geographies. Based on the risks assessed for the project and developer, the returns are set and systems are put in place to reduce issues.
The main disadvantage of the PE funds however is that they need a large corpus – the minimum investment is Rs 1 crore, as per SEBI regulations. Money flow to these funds increased over 20 per cent in 2015, after doubling in 2014.
In many developed countries, there are more avenues available for smaller investors to also benefit from economic ownership of property, rather than physical ownership. These include real estate investment trusts (REITs) which are entities that can invest in under-construction and completed properties – both commercial and residential.
REITs in India are however limited to income generating commercial properties. And worse, there has not been a single REIT announced, nearly 18 months* after the rules were clarified for launch.
Financial instruments backed by physical assets such as property offer retail investors a way to invest in property while eliminating the hassles with physical ownership. The cost of capital for developers is also reduced thanks to the additional funding source; this in turn could make homes more affordable for the end user. Making the residential property market more institutionalised – with more economic ownership choices for investors big and small – will only help the system further.