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Investors need to understand the nature of real estate funds and the suitability

 

WANT to be a part of the real estate growth story? But don't have enough dough to buy a property or just don't want to take risks associated with investing directly in realty? Relax. You can still invest through real estate funds.


   A real estate fund, in fact, is a professionally-managed portfolio of diversified real estate holdings and is basically meant for high net worth investors. But, thankfully, not-so-rich investors can also get a slice of the real estate pie by investing in real estate funds, which give them an opportunity to participate in specific asset classes such as residential, commercial, hospitality etc in a more concentrated manner. When you invest in such funds, you essentially make investments in the schemes of concerned firms, which in turn invest the money in upcoming or ongoing real estate projects. The returns from building and selling or leasing the projects are the gains that investors receive from the investment.


   It is a known fact that unlike earlier, there are various modes of investing in real estate these days, one such mode being investing directly in a property. One is often tempted to invest directly as this usually gives very good returns. For instance, one could always look at buying apartment units from reputed developers in upcoming areas wherein one can expect 15-18 percent indicative returns, with rentals and capital appreciation over a long-term investment horizon. On the flip side, however, such investments need big money and also have their own risks.


   "One can invest directly in real estate, say, in flats, bungalows, office buildings or a piece of land. Most of these investments are concentrated in a particular location and/or with a developer. Most of the time one buys these assets in a place one's family stays or works. These assets, however, can only give returns in a rising property market or through leveraging," says Sunil Rohokale, executive director of ASK Investment Holdings.


   Direct investing in real estate also involves upfront costs in the form of stamp duty, registration, service tax, transfer charges, brokerage and taxes. It also entails concentration risk of location and developers along with project execution, as controls are virtually missing. But in a situation like rising interest rate, more supply and less demand, poor execution and very low visibility of property prices to go up in a hurry, the question remains—how does one make risk-adjusted return at the cost of illiquidity?


   Another mode is through investing in listed real estate companies. However, since this investment is in a company, the investor has less information and control over the utilisation of funds. Besides, real estate companies' valuation is a tricky subject and there is no established/proven method in the Indian market. The current prices of most real estate companies are at a steep discount (50-60 percent) to their initial offerings, indicating the unrealistic valuations assigned to these companies. Though one has liquidity in this option, but the downward risk is the highest due to volatility of the stock market. This is, in fact, the most risky investment option in real estate investment.


   One can also invest in a piece of land. However, though investment in land yields the maximum returns, it is prone to a high level of risk right from identification of the right growth corridors to title risk and possession risk. Hence, unless in the business of real estate or plotted developments of reputed developers, such investments should be avoided,.


   Real estate funds, on the other hand, offer the option of investing in close-ended funds with a tenure of five to seven years, and target returns in the range of 20-25 percent. These funds are managed by experienced professionals, have a defined investment policy, risk and asset management systems and entry-exit policy to ensure superior risk adjusted returns. As these funds are closed ended, they suffer from liquidity. Therefore, in markets where property prices see resistance to move northward, real estate funds seem to be the best option. Also, investors access developer's margin over price increase and have control on operations, mitigating delay in execution and spreading the investment across growth corridors, reducing concentration risk of locations and a developer.


   Real estate investment growth is dependent on multiple macro economic factors and the risks associated are micro in nature, such as title risk and execution risk, among others. Given this, it is always appropriate for an investor to depend on experts. Real estate funds are theoretically the best investment mode, given that these funds are run by experts who ensure risk mitigation
while ensuring returns.


   Also, the real estate fund business at this juncture has enough data on track records of most funds and fund managers, and hence one is in a position to pick and choose, unlike five years ago. Real estate funds are more safe as they are registered with SEBI as Portfolio Management Services (PMS) or Domestic Venture Capital Fund (DVCF). These funds are closed-ended funds with five to seven year tenure, with an option to extend the tenure by one or two years. The investments are drawn in two to three years, depending on the identification of investment opportunities. Most funds charge a management fee of two percent and entry load of two percent. Besides, there is normally a profit sharing beyond a certain threshold of return to the investor known as 'carry', which can go up to 20 percent.


   During the subscription, 20 percent of the committed amount is normally required while the rest has to be paid over two to three years. Most of the real estate funds offer a hurdle rate of 10-11 percent with targeted returns of 20-25 percent. Fund managers are also eligible for performance fees. There are some funds which also focus on fixed income yielding assets like office/IT or retail properties and offer returns of 10-12 percent per annum.


   There are various domestic funds wherein one can invest in the new or follow-on offerings. The funds available in the domestic space are either backed by financial institutions such as HDFC, ICICI or financial services organisations such as Kotak, AV Birla Financial Services or are standalone funds such as ASK Real Estate Special Opportunities Fund and India REIT, among others. Each fund has a unique objective and returns can go up to 20-25 percent, depending on the investment quality.


   The risks and returns, however, are very specific to the investment. Also, the investor has the opportunity to participate in project upsides that may be made by unlisted development companies as well. The investor also gets specific project-related information, resulting in better tracking of the investment.


   Investing in real estate funds requires lesser amount also. For instance, if an investor wants to buy a property directly, he might end up looking at investment sizes running into several lakhs and even crores of rupees, depending on project location. On the other hand, one can start one's journey with real estate funds with a sum as little as 10-15 lakh only, although there are many funds in the market today which require 25 lakh to 1 crore as the minimum investment amount. This effectively means that an investor can get exposure to the sector for smaller amounts, rather than having to provide for large asset costs.


   All this, however, doesn't mean that real estate funds are entirely safe. To be on the safer side, therefore, one needs to necessarily look at the track record and reputation of the entity backing the fund, experience and track record of the fund manager, investment objective, asset class and the structure in order to optimise tax savings and maximise returns.


   Also, while the hassle-free nature of investing in these funds may seem attractive, investors need to understand the nature of these funds and the suitability of such investments in their portfolio. Real estate funds, for instance, can't be a substitute for buying one's dream home!

 

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