This article is meant for those who are looking at concerted steps to be taken before investing their surplus funds with builders for returns higher than mutual funds or fixed deposits. The seven pointers detailed below are the steps to be undertaken, and the precautions to be exercised before investing directly with a builder.
With a well thought-out approach and filtration criteria, an investor can select the right builder to invest with, and reap healthy returns to the tune of 15% to 20% over a period of 18 months to 48 months.
‘Investor profile’ of an investor wanting to invest directly with a builder
The real estate investors here could be the ones who:
- want their funds to earn them high returns,
- do not wish to own the real estate unit, but only invests an amount (let us say, upwards of Rupees thirty lakhs) with a small or medium sized builder that undertakes a project below Rs 50 Crores,
- are willing to stay invested anything between 18 to 48 months, and
- are comfortable with a return of 15% to 20% annually
Before we proceed, it is important to know that parking funds with the builder as a ‘sleeping partner’ is good only for people who have their basic needs covered, and have surplus cash available to make such medium to long term investments. Once an individual is comfortable on this front, only then the rest of the due diligence process should follow, not otherwise.
7 pointers of the due diligence exercise explored
Before the money is handed over to the builder, a proper due diligence exercise must be undertaken by the investor. The builder highlights their business and the potential value it carries, and it is upon the investor to ensure that these are well understood, and thoroughly evaluated. An investor must analyze the risk of their investment as suggested below:
- Gain construction-related basic knowledge: The very first step is to first equip yourself with the right knowledge. Gain knowledge about the basics of construction including legal and construction related intricacies. It does not take long to build knowledge of understanding real estate, and how to evaluate a project on its merits and demerits. One needs to know all the factors that make a good project saleable. A good project sells, and if it sells, your returns are assured
- Evaluate the terms and conditions of the investment offer: The construction companies seeking investment needs to make an offer, and specify the details of the deal, especially about the returns, and the associated terms & conditions. The builder also needs to provide their credentials like the company profile, ROC verification, PAN details, details of market offerings and segment catered to, details of project to be undertaken. Get to understand the Terms and conditions of the deal to you as an investor, and the type of agreement that will be signed. Information about the recourse or penalties upon defaults and/or delays in making payments to you as an investor. See if this fits your risk appetite, the time frame and all your expectations
- Gather builder specific information: Once the offer is made, you must initiate the information gathering exercise. While evaluating a developer of builder seeking funding, the first step is to gather information about the party involved. Seek information related to the past project. Some other details you must check or gather are:
- Historical experience in building and selling projects, business model and projections about the project under question, vision, mission, and the customer segment being targeted
- Information about the company’s indebtedness, and registration documents of the builder’s firms, the structure of ownership, the authorized signatories, the control mechanisms
- Details about the project team of the project you are investing in including structural engineers, architects, marketing and operations
- Licenses and permits required for the project under consideration, especially RERA registration and civic body permissions. Regulatory and compliance related process and evidence into past projects required by the civic bodies; Special focus to be given on RERA and GHMC permit (civic body in Hyderabad)
- Details of completed projects starting from inception to closing, including ‘actual time to deliver’ versus ‘promised’
- Get to understand the Marketing and Sales set-up, and the plans to market the project
- Customer information (buyers) of previously completed projects
- Information about contracts with vendors and suppliers
- Technology being used to control processes related to construction, marketing, sales, and stakeholder management
- Reputation related information about the company, the management team, and the overall organizational culture
- Go back to the builder for any information doubts you may have
- Analyze the builder’s Risk profile, and conduct SWOT analysis: Once the information is in place, get on with the risk analysis exercise, alongside conducting a SWOT analysis [Strength, Weaknesses, Opportunities and Threats] of the company basis the credentials and information gathered. SWOT should consider the ‘Internal’ factors like the Strengths and Weaknesses of the company. Also, consider the ‘external’ factors like the General Economic environment, location and market-segment specific Threats and Opportunities.
- Look for loopholes and gaps during this risk analysis exercise
- Verify the claims made by the builder against actual data provided. Do not develop a favourable disposition basis the first impression, conversation skills, or the positive feelings being conveyed by the builder
- Check and verify the credentials of the developer by actually visiting the historical sites and properties developed
- Check the background of the builders through multiple sources. Look out for people who have known the builder for a reasonable period of time, preferably beyond 10 years, and who can shed light on their intent, integrity and their character in conducting business
- Check how much of their own money is being invested to know the extent to which they have their skin in the game. There needs to be complete transparency in terms of the amount of ‘own money versus debt’ being utilized by the builder
- Understand the financials of the project in which you are investing. Understand the contingency plans due to roadblocks like slow pace of sale of units due to factors beyond control
- Go back to the builder to gather more details if required
- Initiate negotiation process only if basics in place: Once the SWOT analysis by the investor gives the right indicators, and basics are in order, then get on to the negotiation table to further dwell upon the terms and conditions. Again, do not be in a hurry to lend the money for want of returns; The deal offered by the builder for your investment should be reasonable and realistic returns, and NOT be unbelievably high for a sleeping partner. Make sure your interests are protected, and not highly in favour of the builder by leaving you high and dry. Professional help at this stage is in order
- Engage with the builder in person: Never ever take a decision unless you meet the builder and people involved face to face. Ensure you are able to establish the identity of the key people who are shareholders of the company concerned. Once all the information is in place, it is prudent to avail professional help (Chartered Accountant and/or Lawyer) before getting on the negotiation table, and bring-up 3 scenarios: viz. ‘best-case scenario’, ‘average-scenario’, and ‘worst-case-scenario’ on the returns
- Do not deliver a decision or get on the bargaining table in the first meeting. Do not be in a hurry to close the deal
- Understand the offer, and first ensure that the principle amount is safe. Do not skip to the step of negotiating unless the basics about the credibility of the party is established
- Take the final decision to invest post thorough discussions and assessments: The final decision of a ‘go’ or ‘no–go’ is internal to the investor, and must be taken basis the information, possible scenarios, the nature of the deal and the risk-appetite. Evaluation and assessment must be undertaken as follows:
- Basis the evaluations, evidences, and factors considered, develop a yardstick of ‘accept’ or ‘reject’. This criteria must be in line with the investor’s ‘risk appetite’
- Let there be multiple iterations before the decision is made to go ahead. Make a list of your ‘ask’ while getting on the discussion table
- Discuss the facts, apprehensions, and possibilities threadbare. Again, judge the offer, and the builder basis the response; Ask for a provision for investors meet, and a forum to address investor’s grievances, if any
- The lender must remain protected on the terms and conditions of the tenure and returns, with recourse to penalties in case of defaults or delays
- In the eventuality of a litigation, the agreement must be enforceable in the court of law. The agreement must be signed only once the terms and conditions are clearly understood alike mutually by both parties
- Go ahead and sign the agreement if the management team, the project, and the returns as well as the other factors of due-diligence exercise are favourable
The returns on the investments are subject to market conditions, and the investor needs to be prepared for some delays, so far as the returns are assured. If the property is and the builder team is good, it will eventually sell.
Investor also must be aware that the money once given cannot be taken back abruptly before the expiry of the term, hence, not to invest more than what your personal finances permit. Avoid investing an amount (threshold) beyond which there could be a possibility of a distressed financial situation! The builder may not be able to give back the principle amount in case of an emergency at the investor’s end. Financial prudence is something every investor must exercise, and not stretch beyond reasonable means.
The most important factor to consider before parking your funds with a real estate builder remains their background, reputation and credentials. A real estate project with the right target segment, the right quality, the right value, and the right location sells fast!
An investor needs to engage well on the ground to make this assessment, and choose to invest in the right project with the right builder!
A builder who has a strong sense of business, integrity, and know-how to get the ingredients of the value proposition right is able to deliver and sell the inventory with ease. This in turn is the surefire recipe to high assured returns in the range of 15% to 20% annually for a real estate individual investor.
Thankfully, real estate investments have now become safer with the presence of regulatory bodies like RERA, and civic bodies like GHMC (in Hyderabad), which keep a close watch on the builders to construct and deliver the units of a project in a professional and timely manner. This has made the entire real estate sector well regulated, and by default safer to invest in. The safety cover available to the home buyer benefits the real estate investors as well, since the business opportunities also become safer when they fall under the purview of regulatory bodies.
For a safe, worry-free and pleasurable investment experience, one needs to choose the right people offering the real estate business opportunity. Eventually, it’s all about the people you are dealing with!
Please read on the article titled ‘Investing in Real Estate projects: exploring investment opportunities for a healthy return’ to delve further on the basics of investing directly in real estate