In April this year, the capital market regulator, Securities and Exchange Board of India (Sebi), asked a company named Viswas Real Estates and Infrastructures India Ltd to abstain from continuing its business activity. Working on a complaint, Sebi observed that the company was collecting money from various investors and offering properties against it with assured returns.
The scheme was identified as a collective investment scheme (CIS), which needs Sebi approval to operate. But the company did not have any such approval. Therefore, Sebi passed the order against the company and its directors and asked them not to collect any money from investors or launch or carry out any CIS, including the existing one. In the order it was highlighted that the company was offering assured return of 12% per annum.
This is not the only company offering assured returns on real estate projects (these mostly apply to commercial properties). In a similar scheme, Cosmic Structures Ltd, a Noida-based real estate developer, offered assured returns to investors on many of its projects. One investor, Vikas Punj, told Mint that he had invested Rs.4.7 lakh in one of the projects, Corporate Park One, in August 2012. He, and many other investors, including Sanjay Kumar Srivastava (invested Rs.7 lakh), and Tannu Mihani (invested Rs.9.7 lakh), were assured a return of 11-12.5% per annum till getting the letter of completion, and 9% per annum as first lease once the property was ready and let out. They have invested in different projects by the same builder, but all located in Noida, mostly to be able to get fixed regular returns from their money, and the property at the end of it.
Further, the scheme stated that if the developer was able to let out the property at a rate higher than 9%, the excess rental income would be shared equally between the investor and the company. And in case of a shortfall, the company would pay the difference.
However, the investors received assured returns only till March 2015. They claim that none of the projects are near completion.
In fact, in a letter to investors, dated 17 August and signed by the company’s managing director, the company admitted that it was facing financial difficulties and that it will resume paying assured returns from October 2015.
However, in a meeting, held on 12 October, the company’s senior management verbally informed investors that they were not in a position to pay the returns, and instead offered extra space to investors. Mint has the related documents.
It is not only this company; there are many complaints around non-payment of assured returns on http://www.complaintboard.in/ (an online consumer forum) against other developers.
Shekar Muttreja, managing director, Cosmic Structures, said that the company is facing financial constraints, but that is because the entire real estate sector is going through a tough time. “We are giving two options to our customers—either they take extra space of the value of the outstanding assured return or wait and take the assured return amount along with interest at the same rate,” he said. But the investors are not keen on this choice as they doubt the company’s ability to complete any project.
Muttreja told this reporter, “The company is in talks with banks to fund construction. We are expecting funds within a month. This fund will be used to speed-up the construction process, and we will start offering letters of possession within 12 months from now.”
Birth of ‘assured’ returns
The global financial recession left many sectors reeling, including real estate. The situation worsened in India when the Reserve Bank of India (RBI) issued strict restrictions on lending to developers.
So, in order to get funds, various types of ‘schemes’ were started, such as 80:20 plans and interest subvention plans (no equated monthly instalment till a point) in residential real estate, and assured returns in commercial realty, which turned up during 2010-11 and gathered pace during 2011-12. Even now many developers offer such schemes.
How it works is that the developer promises a fixed percentage of return on investment, typically in double digits, and which is higher than what any other fixed return instrument offers. Even with having to give higher returns, this type of money is cheaper than, say, borrowing from banks and other lending institutions.
“Typically, returns promised are 9-12%, which is lower than the cost of debt for construction. Higher returns may be a sign of the need for capital, and is sometimes a red flag for the investor,” said Amit Oberoi, head of valuation and advisory services at Colliers International India, a global real estate consultant.
To borrow from a bank or private equity investor for a particular project, a developer will have to pay interest of 15-18% per annum, or more.
When offering an assured return scheme, the developer does not have to provide collateral security, which it would have to do if it had approached a lending institution.
By investing in an under-construction project, especially in commercial properties, you not only undertake construction risk but also market risk.
“Investors should be aware that it is often impossible to offer guarantees on rents at the marketing stage,” said Anuj Puri, chairman and country head, JLL India. “They should be guided purely by facts and not assurances,” added Puri.
Typically, projects that offer assured returns are priced higher than similar commercial properties in the area. For instance, if a project costs Rs.5,000 per sq. ft, a similar project offering assured returns may cost Rs.5,500-5,750 per sq.ft.
Also, in such schemes, the investor has to make the entire investment, or a large part of it, upfront. Developers do not offer construction-linked payment plans in such schemes. Moreover, banks and other lenders do not offer loans to individual investors to invest in the commercial space. Therefore, not only do you have to pay a large amount upfront for space that’s more expensive than others in the area, you also won’t get any loan for it, so, you will have to pay everything yourself.
An even bigger risk than the ones mentioned above is the fact that if the developer fails to give you the assured return, there is not much you can do. “These kinds of schemes are not governed by any regulators. So, recourse available is generally to approach the civil court, which is a time consuming process,” said Oberoi.
You will also take an income-tax hit. Assured return schemes offered by developers are considered income under the head ‘income from other sources’. So, you cannot claim the standard deduction of 30% on it, which you could have claimed for rental income from a tenant.
Also, in most cases, the investors do not have a role in choosing the tenants; that decision is mostly taken entirely by the developer. Therefore, it’s a losing proposition for an investor.
Mint Money take
Basic things to look at while investing in any avenue are—risk, returns, time horizon, and the exit route. Though such schemes offer high returns, but at the same time, risk is higher, investment tenor is longer and exit is also difficult. Moreover, an exit may mean paying a heavy penalty.
Real estate has always been an integral part of investment portfolios, but to benefit from it, one needs to be careful. Given the current market conditions, it is advisable to invest in completed projects, be it commercial or residential. And if a builder promises assured returns, ignore the offer.