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Real estate PE funds not for retail investors

Real estate PE funds not for retail investors
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First Published: Mon, Jul 11 2011. 09 12 PM IST

Illustrations by Shyamal Banerjee/Mint
Illustrations by Shyamal Banerjee/Mint
Updated: Mon, Jul 11 2011. 09 12 PM IST
If you had invested in one of builder projects in Greater Noida that are in a jeopardy after the Supreme Court judgement establishing the farmers’ rights on the disputed land, your entire money may be at risk. Real estate funds are vehicles that give you exposure to the sector without the risk of one property going bad.
Also See | Building Blocks (PDF)
In the absence of real estate investment trusts (Reits) or real estate mutual funds (REMF), what we have in this space is privately sold products, known as real estate private equity (PE) funds, that are not listed on any exchange.
Illustrations by Shyamal Banerjee/Mint
But in the absence of a physical property, will you be comfortable investing in these? While the price of your property may increase the next year itself, investments in a private equity fund may not give any returns in the first two years. And that’s why these are not meant for everybody. These are meant for high networth individuals (HNIs) who want to enter the real estate market but are not willing to go through the regular buying-selling process.
We tell you what these funds are and given the absence of data and regulation in the sector, whether it makes sense to invest in them.
What are these
To start with, let’s differentiate these funds with Reits and REMFs. Reits, a popular form of investment in developed markets, are listed on stock exchanges and are governed by transparent norms. REMFs, on the other hand, own commercial properties and make gains by renting our or selling their holdings; they work like mutual funds and share profits with investors. Both are not available in India at present.
Real estate PE funds are different. These funds invest in real estate projects by tying up with the developer, wherein the developer sells a portion of the project to the fund. Some funds tie up with companies also.
Most funds operating in India have a lock-in period of three to seven years. At the end of this period, the fund exits the holding by selling it in the secondary market. If the investment is in a commercial property, the fund may rent it out within the lock-in period and exit later.
Most funds invest in residential projects and those commercial projects that are nearing completion. While residential projects move faster in the market, there is a rental yield attached to commercial projects. Says Sanjeev Dasgupta, president (real estate), ICICI Venture Funds Management Co. Ltd, “Because of the improved demand for housing and low capital requirement, these funds are now focusing on residential and income-generating commercial projects.” A few funds invest in projects that are still in the initial stages of construction, based on saleability and track record.
Options in the market: There are enough options available. According to data from VCCEdge, the financial research platform of VCCircle, the Indian market has 44 domestic real estate PE funds in total having a collective size of $11,226.8 million (Rs 49,813 crore). Since June 2010, these funds have invested around $717.95 million across the country.
Recently, ICICI Venture Funds Management Co. Ltd, a subsidiary of the ICICI Group, announced that it will raise up to Rs 1,000 crore to launch its second real estate focused fund in the country.
Whom they are meant for
As mentioned earlier, these are primarily meant for HNIs. Though the ticket size has come down a bit, it’s still not for the retail investor. You should have at least Rs 10 lakh to enter this product.
“Buoyed by high returns for earlier exits in the past, fund houses have started offering smaller minimum capital limit for retail investors and not just HNIs,” says Ujwala Rao, head (West India capital markets), Jones Lang LaSalle India (JLL India), a property consultant firm. For example, the minimum investment in a new fund managed by Milestone Capital Advisors Pvt. Ltd is Rs 10 lakh. The fund house has invested in projects in Mumbai, Chennai and Noida, among others.
The returns
It is difficult to put a clear number on the returns since real estate PE funds are non-transparent. There is no data to fall back on and returns are not guaranteed.
Says Sanjeev Dasgupta, president (real estate), ICICI Venture Funds Management Co. Ltd, “Regular returns from an early stage and lower downside risk has enabled yield-based funds (real estate PE funds) to generate interest among HNIs. Most funds promise a return between 23% and 25%.”
At the time of investing, the manager will give you an estimated return figure, but that may not be exactly what you get at the end of the lock-in.
The costs
In the absence of clear regulation, there is no fixed fee that all funds charge. Usually, there is a one-time entry fee of 2% of the investment amount. “In some funds there is an entry fee or the set-up fee. For some others there are no such charges. However, there is an annual maintenance fee of 2%. In rare cases this is slightly higher than 2%,” says Rao. For example, the entry fee for the fund from Milestone Capital is around 2.5% of the total investment. But some funds give certain discounts depending on the investment size. In some large-ticket deals of at least Rs 1 crore, the fund house may waive off the set-up fee or reduce the annual charges.
Then there is a performance fee that you have to pay by sharing your profit with the manager; this is usually a predetermined number. This is linked to the fund’s hurdle rate, which is usually 10-12%. Only if your money gives a return higher than the hurdle rate, the manager would share the profit.
The performance
In the recent past, some domestic funds have given annualized returns of 20-25%, according to JLL India. According to data available with them, Kotak Realty Fund and Indiareit Fund have exited some of the projects. Exit would mean the fund made gains; these gains get transferred to the investor. Currently, Indiareit has four funds in the country and Kotak has three.
HDFC Property Ventures, the real estate fund of India’s largest mortgage finance company, has also started exiting a part of its investment portfolio, says JLL India. South-based real estate firm Nitesh Estates has bought back the fund’s stake in a retail project in Bangalore. “Compared with international (real estate PE) funds that are operating in India, domestic funds have done well because they were not bound by the rule meant for foreign direct investment (FDI). So they had the advantage of investing in projects of different scales with different completion time,” says Rao. Those bound with FDI policy cannot invest in projects that have area less than 50,000 sq. ft and also need an Indian partner.
The risks
Though domestic real estate PE funds in India are registered with the Securities and Exchange Board of India, there is no clear regulation on the disclosures. So the manager may promise you return but can’t make a commitment. “Because of the absence of any definition on the operation of the real estate fund and its structure in India most do not commit or guarantee any fixed returns. Some may give you a lump sum at the end of your lock-in-period; some others may give you annualized return,” says Om Chaudhary, chief executive officer, FIRE Capital Fund Pvt. Ltd, an India-focused real estate fund.
Then there aren’t any regular returns as such. Until the fund sells its holdings, there is no gain to be passed on. “You will generally not get any return in the first year of the investment because it takes two-three years to complete a real estate project,” says Chaudhary.
While you can sell your property next year, selling your share of investment in a fund may not be that easy. “You can only sell your papers in the secondary market to another person,” says a sales head of a well-known real estate fund on condition of anonymity. The firm closed its first fund in 2009.
Graphic by Paras Jain/Mint
devesh@livemint.com
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First Published: Mon, Jul 11 2011. 09 12 PM IST