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How to build a real estate fortune
Anuj Puri | December 30, 2006
Money invested in real estate, for income and capital growth, provides stable and predictable returns � similar to bonds � offering a regular return on investment, if the property is rented, as well as capital appreciation.
Of course, like all other investment options, real estate too has certain risks attached to it, and they are quite different from the ones involved in other investment avenues. Real estate investment opportunities can broadly be categorised into the residential, commercial office space and retail sectors.
In analysing real estate as an investment avenue, a realistic assessment of the risks to future cashflow, resulting from lease expiry, has become essential today. And, as such the compensation for such risks is now more closely linked to income performance.
The projections of market players and industry analysts in this respect are worth noting. They now consider A-grade commercial office and the retail segment of realty, with a projected yield of 11-12 per cent a year, a more lucrative option than residential properties, with an estimated return of 5-7 per cent a year.
Watch out for...
The projections of market players and industry analysts in this respect are worth noting. They now consider A-grade commercial office and the retail segment of realty, with a projected yield of 11-12 per cent a year, a more lucrative option than residential properties, with an estimated return of 5-7 per se cannot sell some units or a certain part of one's property (as one can do in the case of equities, debts or even mutual funds) in case of an urgent need of funds.
Further, the maturity period of a realty investment is uncertain. Apart from all this, the investor has to verify the property title, particularly if the investment is made in India. Industry experts believe that only persons with deeper pockets and a long-term investment horizon should invest in properties. They say from a long-term financial return perspective, it is advisable to invest in higher-grade commercial properties.
Returns from the property market are comparable with that of certain equity and index funds in the long term. Any investor looking for balancing his portfolio can now look at the real estate sector as a secure means of investment with a certain degree of volatility and risk. A right tenant, location, segmental categories of real estate and individual risk preferences will henceforth prove to be the key indicators in achieving the target yields from realty investments.
The proposed introduction of REMF (real estate mutual fund) and REIT (real estate investment trust) are likely to boost realty investments among small investors. This will also allow small investors to enter the real estate market with contribution as low as Rs 10,000.
There is also a demand by - as well as need for - different market players in the sector to gradually relax norms for foreign direct investment in it. Higher foreign investments mean higher standards/ quality of infrastructure and, hence, a marked change in the entire market scenario in terms of competition and professionalism of market participants.
The investor profile
The two most active investor segments are HNIs and financial institutions. And both these segments are particularly active in commercial real estate. While institutions such as HDFC and ICICI show preference to investments in commercial properties, HNIs evince interest in parking their money in residential as well as commercial properties.
The third category of investors - non-resident Indians - has a clear bias towards investing in residential properties rather than commercial properties.
This can be attributed to emotional attachment or/and the tendency to guarantee future security. As the formalities and the necessary documentation for purchasing immovable properties other than agricultural and plantation properties are quite simple and the rental income is freely repatriable outside the country, NRIs are increasing their exposure to real estate.
FDIs in realty form a small portion of the total investments as there are restrictions such as a minimum lock-in period of three years, a minimum of 25 acres of property to be developed and conditional exit.
Besides these conditions, foreign investors have to deal with a number of government departments and interpret many complex laws/ bylaws. All said and done, the government's decision to allow FDI in the real estate sector is a step in the right direction.
REIT is close to being introduced in India. But what is important is that, like most other novel financial instruments, this new concept too needs to be accepted without too many problems, except those expected to be encountered in the teething time.
REIT will be structured as a company dedicated to owning and, in most cases, operating income-producing real estate, such as apartments, shopping centres, offices and warehouses. Thus, a REIT will be a company that buys, develops, manages and sells real estate assets and allows participants to invest in a professionally managed portfolio of properties. Some will also be engaged in financing realty.
Further, REITs are pass-through entities or companies that are able to distribute the majority of income cashflows to investors, without taxation, at the corporate level. Its main purpose will be to pass the profits to the investor in as intact manner as possible. Hence, initially, the REIT business activities will be restricted to generation of the rental income.
The investor's role is the key in situations where the interests of the seller and those of the buyer do not match. For example, if the seller is keen to sell the property and the identified occupier intends to lease the property, between them, the deal will never be fructified. However, an investor can have competitive yields by buying the property and leasing it out to the occupier. `
The writer is managing director, Trammell Crow Meghraj.