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Investing in Real Estate

DNA of Property, Sep 5, 2017

This article is attributed to Ashish Jindal, Director – Real Estate, Sanctum Wealth Management

“Buy land, they’re not making it anymore” is a scholastic take on the indispensable nature of real estate by humourist, Mark Twain. Real estate has been the asset of choice for people since time immemorial. Land was the preferred commodity and historically, the only way to acquire land was to either buy it or grab it. We have come a long way since then though. As societies matured, hutments, townhouses and villas became tradable commodities. It then gave way to tenements, apartment blocks and towers. Over time, multiple asset classes emerged within real estate – retail shops to offices to industrial and commercial premises. Then came the structured way of investing in real estate.

Following is a guide on the different types of investment options available to investors within the real estate sector, and the risks associated with each.

• Buying raw land: Buying land can not only be an expensive affair but also requires buyers to be careful about the land title and various local authority permissions. Land in India falls under agricultural and non-agricultural domains, needing different degrees of approvals to acquire. Agricultural land broadly includes farming land and farm houses, and as per laws, only a farmer is allowed to own it. In addition, there are strict restrictions on converting a fertile piece of agricultural land into a residential or commercial one (including Land Ceiling Acts in a few states). Conversely, one may buy Non-Agricultural raw land directly from a local authority. Many states have eased obtaining ‘Non-Agriculture’ status for land under respective development plans. This as an asset class is the most liquid of all physical assets, can offer extremely high returns and yet it is the riskiest of all. Retail and casual investors should be extremely wary of getting into this.

• Residential properties: Land, plots with or without a constructed structure in townships, apartments and villas would feature in the category of residential real estate. The location of the property, quality of construction, together with good overall maintenance increases the value of such a property. However, in terms of return ranking, residential normally ranks lower when compared to other categories due to its limited income prospects. Having said this, it is one of the safer investments and one can look at this if their prime objective is capital protection.

• Commercial real estate: Consists of two broad categories – Office and Retail. Commercial office realty includes land, office buildings, floors and small offices and Retail includes shopping centers, retail malls and high street shops. Commercial real estate is generally a high cost acquisition and it requires the investor to have a medium to long term perspective. Investors looking at a steady monthly cash flow can look at this asset class. However, ideally they should look at structured products due to the higher level of complexity involved with commercial real estate.

• Industrial real estate: Again, this category is not for retail investors but is an extremely attractive option for HNIs, family offices and institutional buyers looking at a steady cash flow. Broadly consists of industrial complexes, industrial parks, factories and warehouses. With GST removing state boundaries, this asset class should see a lot of action. For the retail investors looking at this asset class, they should only look at structured products.

• Structured products: If you don’t want to deal with the hassles of physical realty, you can invest in structured real estate instruments, managed by professionals with the expectation of relatively stable cash flow. Most of these investments depend on interest in the form of rental income with capital appreciation as a bonus, and hence are meant for an investment horizon of at least three years or more. In India, individuals can invest in the following types of structured products under the real estate category.

i. Real Estate Investment Trusts (REITs), a recent introduction in India, are modelled after mutual funds, to provide investors diversification and long-term capital appreciation, using income from a professionally-managed portfolio of real estate properties.

ii. Infrastructure Investment Trusts (InvITs) are funds with a longer tenure or an open-ended structure. They help developers of infrastructure assets monetize their assets by pooling multiple projects under a single entity, using a trust structure.

iii. Alternate Investment Funds (AIFs) generally include venture capital funds, hedge funds, private equity funds, commodity funds, infrastructure and real estate funds among other collective investment schemes. AIFs are mostly used by institutional investors or HNIs due to the complex nature and limited regulations of the investment.

• Key risks Investors must be aware of: As an investor, one must be vigilant of the common risks involved with every real estate investment. These include the geography of the property and development, zoning or construction related approvals. Additionally, for properties that are being rented out or leased, investors could face long delays in finding the right tenant due to factors such as high pricing, poor demand in the area or credit worthiness. For under construction properties, one must remember that the delivery of the real estate asset depends on the experience and quality of the developer, and hence one should associate only with developers with a good track record of quality and delivery.

As the era of RERA comes in, more and more of these risks would get mitigated, thereby increasing investor confidence. Having burnt their fingers in earlier downturns, investors are also seeking ready-for possession units and pre-let investments rather than going for apartments, villas or unoccupied offices & retail units.

A rising economy normally lifts the value of real estate assets and improves rental yields. Industrial development could spawn new clusters of growth which would need residential and commercial real estate to be developed, and this is where opportunity lies for an investor. Every form of real estate – including the venerable land – would give substantial returns as long as the investment is made after a thorough market study.