Realty Funds are Better Vehicles to Invest in Real Estate

The current standoff in Real Estate markets due to global uncertainty, high interest scenario and flagging demand has put the investor in a fix. Apart from the macro economic issues, there are number of issues associated with the developer where the investor can exercise control.

The developer risk emerges from its financial perspective due to its overleveraged positions and undertaking of several projects beyond its execution capabilities. This further impacts the ability to complete projects in the given time period with promised quality standards.

In addition to this, direct investments brings with itself higher percentage of transaction cost through stamp duty / registration thus the product price has to appreciate to cover for these costs before any return is earned. For instance, an investment of Rs 5,000 per sq ft should become Rs 10,500 per sq ft to absorb stamp duty/registration cost of Rs Rs 500 per sq ft and balance Rs 5,000 per sq ft will offer 26 per cent IRR (Internal rate of return) over three year period provided entire payment has been made upfront.

Ideally an investor is prone to invest into a city where he resides. This concentration of all investments in one market also gives rise to a risk. For instance, this risk is being more appreciated by investors in Hyderabad due to current sociopolitical crisis prevailing in the state.

These risks that are mostly associated with direct investments in Real Estate can be mitigated, if these investments are routed through the Domestic Real Estate Private Equity Fund. Domestic Real Estate private equity (REPE) funds are pooled vehicles registered with SEBI. Duration of these funds is typically five to seven years. Commitment period of these funds denote time duration during which the money is drawn from the investors and invested in phases. Since the commitment period of these funds are two to three years, it offers staggered investment opportunity thereby also reducing the risk of investing the entire money during peak of the cycle.

In addition to these funds on account of being pooled funds provide compounding opportunity due to size and scale of investment. The fund size also enables the investor to invest across cities and thereby mitigate concentration risk provided prudent limits are set for investment in multiple cities.

The Asset Management Professionals manning the REPE funds are in the better position to select the right development partner based on objective selection criteria. The Asset Management Professionals carry hard core construction experience to monitor day-to-day progress of projects invested; which ensures the timely completion of projects with requisite standards.

Returns in Real estate can be optimised if an investment is made at project development stage. REPE being equity partners share the profit margins of the developer unlike the direct investor who is solely dependent on the end product price appreciation. To illustrate: Rs 5,000/ sq ft can be end-product pricing for retail customer but developer and private equity fund may have invested approx 1/3rd of the price as land /FSI cost, the other 1/3rd which is construction cost is financed by retail customer and the balance 1/3rd is the profit margin of the developer and REPE. Hence, the appreciation is not the target by REPE. Direct investment necessitates appreciation as the only means of making decent returns at the cost of not managing any risk.

REPE funds are managed by dedicated professionals who are Real estate experts. These experts manage the risk of diversion of money which mitigates the completion risk. The track record of REPE funds to invest in quality projects and deliver returns is the final criteria to invest in such funds.

"Joined the group from ICICI Home Finance where he was the Head of Property Services business, which consisted of Home Search (buying / selling of residential units) in the Retail segment, Commercial and Retail agency (leasing) business on the corporate side and advisory / investment banking in the structured finance business. In the advisory segment, he was responsible for placement of private equity in Real estate in various project specific investments across India. He has played an instrumental role in developing a PAN India network for transactions and advisory business focusing on 20 major cities." Amit Bhagat, MD and CEO, ASK Property Investment Advisors