Investment opportunities in the real estate sector

By Amitabh Chaturvedi and Ekta Sukhramani, Mine & Young
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Real estate is an asset class that can deliver handsome returns on a long-term basis. With the real estate sector flourishing, the pace of investment in the sector has increased tremendously. The expansion in real estate investment can be attributed to various factors such as significant inflow of foreign funds, liberalized legislative framework, constantly increasing purchasing power, growth of customer friendly banks and other financial institutions, and tax reform measures.

Amitabh Chaturvedi
Amitabh Chaturvedi

Some investment opportunities previously restricted to Indian residents are now also open non-resident Indians (NRIs). Developers, builders and investors are exploring opportunities to invest in various segments of the real estate sector, including residential property, plots of land for residential, commercial and office space, retail outlets, and industrial and hospitality properties. However, the major real estate developments in India are mainly townships, residential units, shopping malls, offices, retail stores and commercial complexes. The latest entrants in the sector are information technology spaces such as IT parks and integrated townships in such IT parks.

Avenues for investment

Lucrative areas of investment are basic rental properties where the landlord is responsible for paying the mortgage, taxes and costs of maintaining the property and the tenant is charged enough rent to cover all of these costs, in exchange for being in possession and making use of the property.

Then, there are real estate investment groups in which a company buys or builds apartment blocks or condominiums and then allow investors to buy them through a company, thus joining the group. A single investor can own one or multiple units of self-contained living space, but the company operating the investment group collectively manages all the units, taking care of maintenance, advertising vacant units and interviewing tenants. In exchange for this management, the company takes a percentage of the monthly rent. The lease is in the investor’s name and all of the units pool a portion of the rent to guard against occasional vacancies, so an investor will receive enough to pay the mortgage even if the unit is empty.

Real estate trading occurs where traders buy properties with the intention of holding them for a short period, often no more than three to four months, after which they hope to sell them for a profit. This technique is also called flipping properties and is based on buying properties that are either significantly undervalued or are very hot in market.

Ekta Sukhramani
Ekta Sukhramani

Lately, NRIs have been permitted to invest up to 100% in housing sector ventures, and with the opening up of foreign direct investment and foreign institutional investment, foreign investors can now purchase commercial development projects, as well equity stakes in unlisted real estate companies. Further, foreign venture capital investors may invest in real estate assets, within the framework of the Securities and Exchange Board of India (SEBI), paving the way for capital infusion into the real estate market. Venture capital funds associated with developers form a prospective client base interested to invest in the real estate sector.

Other funding schemes include real estate mutual funds (REMFs), which invest directly or indirectly in real estate and offer returns in the form of an increase in the market price of the REMF units. The true potential of REMFs will be realized only after the setting up of real estate investment trusts (REITs), which will make it more convenient for the public to invest in the realty sector by enabling small individual investors to invest in real estate assets.

Drawbacks

However, investment in the real estate sector has certain drawbacks. There is no fixed maturity since the owner purchases a property, uses it and then disposes of it whenever appropriate. The price varies among regions due to regional differences in the property market. This has an impact on returns and needs to be considered carefully when making an investment. Liquidity is lower in the sector as there is a substantial lag between the time one decides to sell a property and the time when it’s actually sold. Transactional costs are high due to high purchase and sale costs, which cover commissions, development and other costs related to the project, which in turn increase the purchase price of property.

Changes resulting from the Real Estate Regulation Bill, the Land Acquisition and Rehabilitation and Resettlement Bill and the introduction of REITs are expected to improve investment in the sector. Further, the government has liberalized finance for the sector, allowing external commercial borrowings (ECBs) for integrated townships development and dispensing with the requirement of all-in-cost ceilings limits for ECBs, which is expected to increase borrowings and in turn boost the sector. Also, with SEBI allowing REMFs in India, equity investors have an exit option available coupled with the liberalization of finance for the sector. All of this not only makes the Indian real estate market more organized and structured but also provides better investment opportunities to both domestic and foreign investors.

Amitabh Chaturvedi is the managing partner of Mine & Young, where Ekta Sukhramani is an associate.

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