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Business News/ Opinion / Mapping the risk-return profile of owning land
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Mapping the risk-return profile of owning land

Various parameters have to be met for land to be a profitable investment


A well-reasoned investment decision never undermines time, risk and return, the three essential constructs of money. Within the broader gambit of real estate, it is, therefore, essential to deconstruct the various stages in the life of real estate to correlate with this.

Land being the essential raw material for real estate offers the first and the most profitable avenue within the life cycle of a realty investment. But not only is it a naturally limited resource, for real estate development, it becomes more scarce as all construction has to be on areas that are not under agriculture, forests, mines, and others.

And since each city has well-defined boundaries, marked by local municipal government, land becomes a finite commodity. Further, every city is developed according to Development Control Regulations (DCR), which earmark land parcels for different users—residential, commercial or public utilities. With all these regulations governing land use, the available portfolio of land to invest for development purpose essentially trickles in rather than gush in. This makes investment in land a very profitable but high-risk alternative.

The biggest benefit of investment in land comes first from an economy of scale perspective. Typically, an astute investor in land would look at buying non-converted land on the peripheries of growth cities by aggregating it from farmers. While it is still being used for agriculture, its value is measured in terms of the returns on farm produce, which is not very high. Secondly, since such land does not have artificial restrictions on usage, it is in relative abundant supply, and sold in large tracks.

Mostly, the real value is unlocked when this land is amalgamated to the ever growing master plans of cities. So, the holding period of land investments tend to be higher—8-15 years. Once the land comes within city limits and within the purview of city development plans with clearly defined end use, its essential character changes. First, it becomes a finite asset as against the relatively large non-converted land. Second, it starts to get valued in terms of per sq. ft of development rather than acres. This unleashes the power of economy of scale by a factor of 50,000 or more depending on the floor space index (FSI) of the area and the proposed use. The returns on land, therefore, tend to resemble a “j" curve at the land stage and have surpassed returns from any other investment alternative.

But there are risks attached which should not be overlooked. To start with, the basic acquisition process of land is cumbersome and fraught with risks. In the absence of accurate reckoner rates, pricing can seldom be predicted, leading to large variations in pricing. Most land while still outside city limits is usually owned by many farmers on a fractional basis, and the woes are multiplied by subdivision within each family. A single acre can be owned by 2-4 families, with 3-4 subdivisions in each family. In the absence of title insurance in India, it is the prerogative of the buyer to ascertain the ownership flow by tracking at least a 60-year family tree of each seller to establish inheritance and authenticity of seller.

Aggregating land presents two clear challenges. First challenge pertains to contiguity of land. For a land to be eventually developable it needs to be contiguous. However since it needs to be purchased from multiple people it requires one to take a chance on buying what is available first rather than the adjacent parcel. Over time one may therefore end with an aggregation that does not speak to each other in parts. If the chasms in acquisition are large it may frustrate the entire effort and leave the acquisition valueless at the end of the day. Piecemeal acquisition also has challenges in terms of pricing. Over time the blocks of land left in between a large aggregation hold sufficient black mail value driving the prices higher than budgeted.

Access is another major hygiene factor to consider while buying land. This may be easier said than done as, often, the process of acquisition happens on the principle of “cheapest and largest land first". By the time the aggregation reaches the face of the road, either the prices become exorbitant or sellers vanish. The list of woes doesn’t end here. Since available land is likely to be off city limits and far away, maintenance and management poses another big challenge. One needs to provide for adequate fencing and security to ensure that no illegal occupation takes place. Possession is 70% ownership in India, and, hence, to ensure value retention in land, it is also important to hold vacant, peaceful and marketable titles or ownership.

The other risk to ownership comes in the shape of acquisition notices served by the government for social development purposes such as to build roads, industry, public amenities or even government housing projects.

Therefore, in keeping with the universal principle of risks defining returns, land may be a lucrative investment but carries commensurately high risk.

Jasmeet Chhabra is principal, Red Fort Capital Advisors.

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Published: 20 Jul 2014, 08:24 PM IST
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