Monday, July 21, 2014

Best investment options in the real estate sector

This article was first published in the business section of on July 18, 2014; Co-Author: Pooja Bajaj

This rise in urbanisation and economic affluence supported with significant infrastructure developments, government initiatives and demand-supply gap has triggered development across real estate spectrum says Pooja Bajaj and Nupur Pavan Bang.

India, the world’s fourth largest economy with 1.2 billion people, has steadily emerged as one of the most preferred destinations for global business. 

Consequently, this has fuelled demand for real estate across verticals viz residential, commercial and hospitality.

On account of globalisation, favourable socio-economic profile, natural features, demographics and government initiatives, the Indian realty sector is being viewed as one of the most favourable destinations for investors and developers globally. 

Increase in the natural and migrant populace in cities in search of jobs and business opportunity who are keen to invest in real estate, coupled with rising per capita income, have given a major demand boost in the sector. 

According to the United Nations estimates, India leads in the rate of change of urban population amongst all the BRIC nations (Brazil, Russia, India and China). 

It is estimated that 843 million people will reside in cities by 2050 in India, which is equal to combined population of the US, Brazil, Russia, Japan and Germany. 

Favourable government reforms and policies such as repealing of Urban Land Ceiling Act, altering FSI rules, allowing 100 per cent FDI in the construction development through automatic route, approving the recent Real Estate (Regulation and Development) Bill, 2013, have further strengthened confidence of investors in the sector. 

This rise in urbanisation and economic affluence supported with significant infrastructure developments, government initiatives and demand-supply gap has triggered development across real estate spectrum. 

Apart from residential, commercial and hospitality, development of educational and healthcare institutions has further widened the scope of opportunities for the sector. This development is now not restricted only to metropolitan cities but is quickly gaining momentum even in Tier II and III cities as well.

As per an IBEF report on the sector, “the second largest employment generation sector after agriculture, real estate contributes about 6.3 per cent to India's gross domestic product (GDP). The real estate sector of India is projected to post annual revenues of $180 billion by 2020 against $66.8 billion in 2010-11, a compound annual growth rate (CAGR) of 11.6 per cent.  The foreign direct investment (FDI) in the sector is expected to touch $25 billion in the next 10 years from its current $4 billion”. 

The construction development sector, including townships, housing and built-up infrastructure garnered total FDI worth $22,671.95 million in the period April 2000-August 2013. Construction (infrastructure) activities during the period received FDI worth $2,280.95 million, according to the Department of Industrial Policy and Promotion (DIPP).

The real estate prices over the past decade has increased manifold across cities. During the period Q2-2009 to Q3 -2013, India has witnessed an increase in residential apartment prices by over 50% on an average.

As per Knight Frank Research, since 2009, IT/ITeS driven markets of Bengaluru, Pune and Chennai have witnessed a minimum of 38 per cent increase in weighted average price.

However, currently it’s mainly the affluent investors who are able to reap the benefits of high return in the sector. 

Despite the desire to invest in realty, the mid-income-segment populace of the country is not getting the right opportunities primarily on account of large ticket size, transaction costs coupled with high home loan interest rates.

For example, the overall ticket size of an apartment may vary from about Rs 3.6-3.8 mn (considering an average 2 Bedroom, Hall and Kitchen apartment of 1200 sq.ft.) in business districts such as Madhapur, Kondapur and Gachibowli situated at a distance of about 8-12 kms from prime residential areas in Hyderabad.

From investment perspective, an amount of about Rs 4 mn for direct purchase of property is not only a large ticket size for a small investor, but this option involves several risks related to title of the property and furthermore benefits of diversification are also not available. 

While housing loans are available, the high interest rate regime in India, makes taking loans against property a less attractive option. 

Investment Vehicles
Real Estate Fund is a vehicle that can bridge the gap between properties and investors.

A real estate fund is a professionally managed portfolio of diversified real estate holdings which invests pooled funds in residential, commercial, corporate or rental properties. 

Globally, in the recent years, different types of fund vehicles available to, and chosen by, sponsors and managers of real estate funds have proliferated. 

HDFC, Birla Sun Life, Kotak, ICICI Prudential, ASK, Piramal Group, Milestone etc have introduced real estate funds through the Portfolio Management Services (PMS) route or the Venture Capital route or the Private Equity route which primarily raise funds from Indian HNIs. 

However, most of these funds came into existence before the Alternate Investment Fund (AIF) guidelines were implemented by Securities and Exchange Board of India (SEBI).

AIF, notified by SEBI in May 2012 in India, allows pooling of funds from Indian and foreign investors for investments in areas like real estate, private equity and hedge funds.  

As per the guidelines, AIFs shall be close-ended funds and have tenure of atleast three years with a maximum number of 1000 investors. Further, the minimum investment to be accepted by AIFs from a single investor is Rs 1 crore (Rs 10 million), thereby differentiating retail investors and long-term high-net-worth individual (HNI) investors.

Another popular vehicle for investment is Real Estate Investment Trust (REIT). To enable real estate investors reach capital markets, in 2008, SEBI had issued certain draft regulations for introducing REITs and later in October 2013, SEBI announced the draft consultation paper on REIT Regulations. 

As per the regulations, REITs in India would issue securities, which would be listed on stock exchanges and will invest 90 per cent of the net asset value in completed rent generating properties in India and remaining in developmental properties, listed/unlisted debt of companies, mortgage backed securities etc.

They may raise funds from any investors, resident or foreign. It is proposed that initially the units of the REITs may be offered only to HNIs/institutions and therefore, the minimum subscription size shall be Rs 2 lakh.

REIT shall provide investors a real estate investment vehicle which has characteristics similar to mutual fund and Exchange Traded Fund structures for stocks, bonds and other securities. 

REITs offer several benefits as they will be listed, will provide regular and stable source of income for investors with least project execution risk. However, the proposed initial investment requirement of INR 2 lakhs may be high for some retail investors, though they are much lower than the minimum required investments in AIFs.

In 2008, SEBI issued guidelines for Real Estate Mutual Fund (REMF) in India. Similar to a Mutual Fund, a REMF is a scheme of a trust fund set up to manage pooled money of unit holders by investing in real estate projects, mortgage-backed securities as well as equity/debt/debentures of real estate companies.

These funds are close-ended and listed on stock exchanges. In addition to earning returns from properties by way of rents and capital appreciation, these funds also get interests, dividends and share price appreciation from securities of real estate companies.

Issues related to valuation, lack of clarity and uncertainties have deterred players from launching REMFs till now in India. However, with strong fundamentals and improving transparency in property market, REMFs are expected to make it easier for an average investor to invest in real estate. 

With such funds, even by investing an amount of say INR 10,000 - 20,000, investors may be able to own a small portion in a high value property.

It will also provide significant benefits of diversification as investors may be able to invest in different types of properties across different cities without getting into cumbersome paperwork.

There are certain critical differences between a REIT and REMF. REITs have to invest 90 per cent of the net asset value in finished real estate projects and not more than 10 per cent in developmental properties.

However, REMFs have to invest at least 35 per cent in finished projects and at least 75 per cent of the corpus in real estate or related securities, and therefore they can invest in under-development properties to a large extent. 

While REITs offer investors a regular income, REMFs gives capital appreciation too on account of investment in under-construction projects.

Indian real estate is one of the most sought after investment destinations for both HNI investors and retail/small investors. 

However, currently most of the investment vehicles – direct purchase or AIF available are primarily targeting or can attract only HNIs on account of huge ticket size for investment. 

REITs have also been proposed to target HNIs initially. For an average investor, investments can be routed through REMF or Real Estate ETF. Both these options are currently either not available or not successful.

The government should consider the need of these investors who wants to participate in the sector. This will provide further impetus to the sector by supplying additional source of capital via retail investors' money.

This might also reduce black money in the sector significantly by making operations of various stakeholders involved more transparent and accountable.
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