There are a lot of people out there who want alternatives to stock market investments that are comparatively assured on returns and moderate in risk. More specifically, some investors look for investing in a tangible product like real estate without having to own them. Which means, these investors don’t want to buy or own a residential, commercial or industrial property, but want their investments to deliver high returns in the real estate sector.
The questions we are addressing in this article are: is it possible to invest significant amount of money (for instance, upwards of Rupees thirty lakhs) in the real estate sector and get handsome returns? If yes, how do we go about? Do we buy real estate shares or invest with builders? If yes, what kind of ‘risk-assessment’ or ‘due diligence’ exercise do we undertake to make sure we do not lose our peace of mind?
The answer to the above question is: ‘YES’, we can invest in real estate either through instruments like REITs and InvITs (explained below) which are traded in stock exchange, or ‘invest directly with builders and get returns in the range of 15% to 20% annually’. This is, however, subject to the capital being solicited as a ‘business opportunity’ for sleeping or active partners, where the investor can park the funds with a builder post getting into a business agreement with the builder.
What are REITs and InvITs?
While big businesses invest via Foreign Direct Investment (FDIs) in India, the individual investors in India now have the option to invest through ‘Real Estate Investment Trusts’ (REITs) and ‘Infrastructure Investment Trusts’ (InvITs). REITs like Embassy Office Parks, Mindspace Business Parks give returns of about 7.5% to 8% annually. InvITs like IndiGrid, IRB are similar to Mutual Funds, where an individual investor can invest in real estate without owning them.
More about REITs and InvITs:
Both REITs and InvITs are traded in the BSE/NSE, they offer liquidity to an asset which is normally considered illiquid. Both REITs and InvITs are recent entrants in the Indian investment scenario, although in the US, UK, Japan, Korea etc. these instruments are very popular.
These innovative instruments are indicative of the emerging trends of investments in real estate sectors where the developers are able to monetize their revenue generating real estate or infrastructure, and the investor can invest in these without owning them. Plus, these generate fixed income for those with surplus cash, and also allow them to enter or exit the real estate sector easily.
Investing in real estate through ‘REITs and InvITs’ Vs. ‘Investing directly with a builder’
The REITs and InvITs present a flip side: the rates or returns an investor realizes are subject to the trading prices and sentiment at the stock exchange. Some investors do not want that, and prefer something tangible like a real estate project which is a more resilient option compared to investing in the constantly fluctuating stock markets or mutual funds.
This article is meant for those who are not satisfied with Mutual Funds and Fixed Deposits, and are seeking a mid-term investment by parking their funds with a builder for a certain assured amount of returns with low to moderate risk.
Exploring direct investment with a real estate builder
While we can invest directly with a builder, it is subject to the builder seeking funds, and offering you a good deal (returns), plus, keeping your principle amount safe! Investors who are not keen on the fluctuating stock market prices of the REITs and InvITs, can invest directly with a small to medium-sized real estate builder of repute for assured returns. One can invest directly with these builders for a certain ‘stake’ in the project or for a certain amount of ‘return on investment’ in the range of 15% to 20% annually.
Time duration required for staying invested in a direct investment with a builder
For healthy return to materialize by investing with a builder, the investor must be willing to stay invested as a sleeping partner from medium to long term duration i.e. anything between 18 months to 48 months, depending upon the size of the project, time taken for construction, the speed with which the project sells-out, the construction-linked payouts by the individual home buyers resulting in the much needed cash-flow, and the risk-appetite of the investor.
While a well thought-out and executed project in the range of Rupees 5 to 20 Crores can be completed and sold within a year or so, the larger projects can take up to three to four years to complete and sell. Unsold projects result in an inventory over-hang (unsold inventory), a risk that is governed by the market conditions, marketing efforts, and overall customer specific requirements. Hence, the business acumen of the builder in being able to provide a ‘valuable market offering’ is critical to getting healthy and timely returns on investment with a builder.
A prelude to the due-diligence process for investing in a real estate venture
The question for an individual investor willing to invest between Rs 30 lakhs to Rs 2 Crores is, how to make sure we find a builder who:
- conceptualizes the project very well
- completes the project on time
- sells it on time
- is a good and efficient builder with high moral fabric and business ethics
- is keen on offering a good returns, and
- pays back as per the promised schedule
The answer is to first find out builders who make such an offer, and then going all out with a thorough due-diligence exercise prior to investing. Before we begin due-diligence exercise, it is important to understand some facts related to the what, when, why of investing with the builder.
8 Important Facts about Investing Directly with a Builder
- Expected Returns: Direct investment with a builder presents a viable investment option to such investors with high returns on investment in the range of 15% to 20% annually
- Extent of Risk: This option allows you to let your money earn for you, and give you high returns with a low to moderate risk. Before you do so, you need to know how to go about ensuring your money is safe
- Importance of real estate Knowledge: Investors who have a penchant for real estate are able to appreciate the pros and cons of real estate better, particularly, the factors involved like the ‘time taken to sell the apartments’, the ‘inflow of payments from the buyers’, ‘cash flow requirements’ of construction, the ‘demand and supply factors’, ‘home buyer preferences’, the overall ‘competitive landscape’ and much more
- Key Activities of builders: A Builder takes-up a project, residential or commercial, and strives to complete it as per the stipulated timeline. The builder goes all out to manage both the ‘construction’ and the ‘marketing & sales’ side of the project
- Importance of cash flows in construction: For construction, the builder needs constant inflow of cash, and that comes-in only when the units of the project are sold within the targeted timeframe, and the projected inflow of funds flows in. Construction business is all about cash-flows at different stages of the construction, and not all payments flow-in from the home buyers
- Importance of Investors to ease cash-flow needs: Lack of cash-flow is why the need for an investor arises, and an investment opportunity opens up for the individual investor. Builders normally have funding requirements for milestones like purchase of land, working capital needs etc.
- Type of investment opportunities offered by builders: Builders may offer investment opportunities either for a ‘stake’ in the project, or offer a ‘range/fixed percentage of returns’ with a repayment schedule comprising interest-rates, due dates, frequency of payment etc. Sleeping partners give the funds to such cash-flow dependent businesses, and do not actively engage in the builder’s operational functioning
- Extent of Investor’s engagement: The investor’s engagement in the construction and marketing process is usually ‘passive’ or ‘hands off’. The builder uses the money invested, and delivers on returns to the investor, both interest and principle amount, on a yearly/half-yearly basis or as per the agreed terms and conditions
With a sound due diligence exercise, the investor can make the right decision, and make the surplus funds work to give you handsome returns.
To understand the due-diligence process in greater detail, please read the article titled “7 guidance points on due-diligence process: DO’s and DONT’s for a real estate investor”
Investing your funds with a real estate builder is a viable option provided the background, reputation and credentials of the builder are credible. This is an alternative to investing with REITs and InvITs, both of which are still at a fledgling stage in India. Besides, not everyone is comfortable with the bulls and bears of stock market shaking the stock holdings on a daily basis, and prefer stable (assured) returns with low to moderate risk by investing directly with a builder.
What it takes for an investor is to find a builder who understands the target segment, is focusses on quality, believes in a good value proposition, is high on business ethics and integrity, has a good marketing set-up, and understands the importance of extraneous factors like right location for construction, buyer preferences etc.
Simply put, a good due diligence exercise is called for before parking our funds with a builder!
For a sound investment, one needs to choose the right builder offering an investment opportunity to earn 15% to 20% returns annually.
A builder with a strong business model, effective business strategies and a proven track record gives an investor the assurance of the required acumen of a builder to deliver the desired returns safely!