Opinion | Investing in real estate funds can help diversify risk
Managed real estate funds can invest in multiple projects across geographies
Residential real estate which was reeling under pressure due to demand-supply mismatch since 2013 underwent a slew of transformational reforms in 2016 and 2017 which postponed the sector’s recovery further. While demand revival is inevitable considering India’s growth prospects, pent up demand and job creation, this cyclical recovery will be driven by end-user demand.
Investor demand, on the other hand, will see a gradual revival. Earning speculative returns in a short span of time is not feasible because of structural reforms, increasing supply due to RERA and removal of tax sops.
Those still looking to invest in real estate also have the option to go through a managed fund, which can invest in multiple projects across geographies. Here, risks can be diversified vis-à-vis investing in a single property. You will need to evaluate and select funds which is easier said than done.
There are many parameters like credentials of the promoters of the fund (sponsor), management, strategy, performance track record, a fund’s ability to manage risks associated with the sector, ensuring project completion at optimum cost and so on, which you will have to consider before locking into a real estate fund. Typically, these funds are structured as alternate investment funds, with a minimum investment of ₹1 crore and a lock-in period of between five and seven years.
High commitment and stability of the team is important in such products. Next comes experience in managing and mitigating risks in projects evaluated as investments, the ability to raise funds, investing and exiting investments at a reasonable return. You can gauge this from the fund’s performance track record and exit values of previously held investments.
The structure of the fund itself holds importance. Will the fund invest as an equity investor or structured debt investor? Not only is the risk associated with both different, the choice of developer is key to the success of investments in such managed funds.
In the current environment, a suitable target segment for making investments is perhaps the affordable mid segment. In real estate investment, bought through a fund or directly, sub location within a larger location like a city matters greatly to the output and the price change. Many PE funds are grappling with providing exits to investors due to investment in projects in satellite towns of metros or tier II or tier III cities.
These investments have been due to assumptions based on investor demand, expected unhindered growth but without regard to lack of social and physical infrastructure or lack of job creation in those micro markets. Here is where the risk lies.
One way to understand the fund manager’s track record is checking existing investments. If these are stuck for a long period due to investments in long gestation projects like townships or are seeing delays due to land related issues, it brings up a red flag. These factors can help in determining the gap between the fund manager’s promise and competence.
Because experience can be so diverse, funds should have a stringent partner selection criteria encompassing factors like management experience, track record of delivery and quality, focus on customer, financial soundness, corporate governance, brand and so on. There have been many instances where funds have undergone challenges in providing exits due to partnering with non-prudent/over-leveraged developers.
One way to have better control is for the fund manager to have a say in decision-making in critical aspects of project execution, cost and sales rather than just a board representation. Also, check if they have a controlling or minority interest in the project? Controlling interest through active participation in project execution is imperative for ensuring timely delivery at optimum cost.
Let us understand that in real estate, cost is a reality and sales are a hypothesis. Thus, a focused risk management framework through controlled investments and active asset management can ensure timely execution, liquidity and alignment with expected returns.
Amit Bhagat is CEO and managing director of ASK Property Investment Advisors