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Why real estate funds are a better investment vehicle Date: Apr 21 2012

A look at various implications in terms of the risks and benefits that it entails


In hindsight, real estate has been a common sense way of prudent investing. Any investment made during 2001-2007 has shown healthy positive returns over medium and long term horizon of 3-7 year.

Come 2008 and the returns on this asset class has not been a one way journey. Investments made in 2007-2008 may not have yielded any positive return. 2009 was another good period for direct real estate investment due to correction in prices. 
However the same cannot be said true for 2011. With global uncertainty, inflation and high interest rate the investors are compelled to ponder at direct investment strategy.

The key risk being undertaken by a direct investor in under construction project is developer risk and completion risk. Developer risk is more on account of overleveraging and over commitment.

Completion risk is on account of quality and committed time duration. Another unforeseen risk in case of direct investment is that of concentration risk since a typical investor will have an understanding of one city where he resides.

This risk is being more appreciated by investors in Hyderabad due to current socio-political crisis prevailing in the state. It is rightly said "Do not put all eggs in one basket".

In case of direct investment the end product price has to appreciate after netting off stamp duty and registration cost to make decent returns. 

For instance, Rs 5000 per sq ft should become Rs 10,500 per sq ft to absorb stamp duty/registration cost of Rs 500 per sq ft and balance Rs 5000 per sq ft will offer a 26% IRR (Internal rate of return) over a 3 year period provided entire payment has been made upfront.

Real Estate private equity (REPE) funds are pooled vehicles registered with SEBI. Duration of these funds is typically 5-7 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 2-3 years, it offers staggered investment opportunity thereby also reducing the risk of investing the entire money during peak of the cycle.

Since these vehicles are pooled vehicles they provide compounding opportunity due to size and scale of investment. Due to investment in multi cities, concentration risk is also mitigated.

Active asset management also reduces the completion and risk associated with quality. Private equity funds are manned by Asset Management professionals with hardcore construction experience to monitor day to day progress of projects invested.

Last but not the least these funds target returns at prevailing end product prices since they are targeting the profit margins of the developer and not the price appreciation.

To illustrate, Rs 5000 per sq ft can be end product pricing for retail customer but developer and private equity fund may have invested approximately one-third of the price as land cost, the other one-third, which is construction cost is financed by retail customer and the balance is the profit margin of the developer and REPE.

Hence the appreciation is not the target by REPE whereas direct investor is looking for appreciation as the only means and not managing any risk being addressed by REPE.

These funds are managed by professionals who are real estate experts and they also manage the risk of diversion of money which mitigates the completion risk.

It is pertinent to mention that the experience of the fund management team and track record of quality investments with returns is the final barometer for selection of a private equity fund.

The writer is CEO and MD, 

ASK Property Investment Advisory



(DNA Property Page 3 Dated 21.04.2012)