How realty funds burnt a hole in investors’ pockets
7 min read.Updated: 08 Sep 2019, 09:33 PM ISTNeil Borate
Slowdown in the sector and poor selection of projects seem to have hit them hard
Apart from physically buying a flat or land, you can invest in the real estate asset through NCDs, AIFs or REITs
It all begins with a smooth pitch delivered either at your home or in an expensive café. You are reminded about the high returns that real estate has given over the years, then you are told that you can invest in the asset through funds, which will give you the advantage of accessing a diversified basket of properties and the fund manager expertise. Finally, the deal is clinched by dangling returns, usually around 12-15% annualized and sometimes higher. However, in most cases, the investors ended up with a loss.
Real estate funds
The Aditya Birla Real Estate Fund I, which was launched in 2010, raised ₹1,055 crore in 2010 and returned a total of ₹969 crore over its lifetime, which ended on 31 August 2019. This translates to a loss of 8%. However, the money was raised in stages from 2010 to 2015 and it also paid back in stages with the first payments starting in 2010 itself; as a result, its internal rate of return comes to about -2.5%.The ticket size for investors at the time of launch was ₹25 lakh. The Securities and Exchange Board of India (Sebi) has since raised the minimum ticket size for alternative investment funds (AIFs), another instrument that allows you to invest in real estate, to ₹1 crore but this is no guarantee that such a performance will not be repeated. Wealthier investors are not necessarily adept at evaluating complex investment proposals. “I was approached by Aditya Birla Money in 2010. I’m not sure how they got my contact details. They pitched me this product saying I would get access to real estate at a low ticket size. I wanted to invest to buy a house and I thought I would get ₹50 lakh (from a ₹25 lakh investment) after the six-year term of the fund," said Dinesh Sharma, 40, a shipping industry executive who invested in the fund. “However, the fund managers kept changing and they kept extending the life of the fund. Now, I will be thankful if I get back anything at all," he added.
Something similar happened with Unitech CIG Realty Fund II, a fund managed by Unitech Advisors (India) Pvt. Ltd. Launched in 2007, its original tenure was seven years. However, it extended its tenure to nine years and then to 12 years as it became difficult for it to exit projects it had invested in. As the extended deadline approached, it set out an almost desperate letter to investors on 16 July 2019 with two options. The first was that investors could opt for immediate liquidation which would be a distress sale. The second was to opt for “in-specie" distribution of assets which would be the equity and debt of private limited or closely held companies involved in projects. In effect, investors could either take on the loss from the sale of projects the fund had invested in or be straddled with debt and equity investments in companies of the projects, with no visibility on returns. This would give investors a minuscule stake in non-listed entities with no board seats or special rights, the letter pointed out.
Similarly, Piramal Indiareit V, which was launched in 2013 and was set to expire in 2019, extended its term to 31 August 2020. A letter from the fund to investors announced that it was unable to exit six out of the 10 projects it had invested in. The letter cited reasons ranging from delay in government approvals and land acquisition, to drop in land prices and slowdown in the sector (read). “My bank’s relationship manager sold me this scheme in 2013, saying I would get 13% returns. I had to invest ₹25 lakh. The fund had a six-year term which could be extended by two years. So far they’ve returned 55% of my money," said an investor, who is a retired individual and declined to be named.
Yet another fund, IDFC Real Estate Yield Fund, is unable to exit two out of the eight projects it invested in and has extended its term to 2021.
Mint reached out to each of the real estate funds mentioned above on email but got no response from three of them. The fourth, Investcorp issued the following statement through their spokesperson,"In a tough market environment, we have already exited most of the portfolio and distributed around 1x back to the investors. For the two remaining investments as well, we are in the process of closing transactions with incoming developers to take over those projects. On account of market conditions and to ensure value maximization for investors, we decided to extend the fund life till May 2021. As always, protecting the interests of our investors is paramount." While we have picked out four real estate funds that are in trouble, there may be others that may be facing similar problems.
These funds seem to have selected poor projects and underestimated the impact of factors such as delay in government approvals, lack of transparency and poor accountability of developers. Evaluating these factors was the expertise that the investors were expecting fund managers to bring to the table. This was compounded by the slowdown in the real estate sector as it dealt with the effects of demonetization and liquidity conditions and the disruption caused by regulatory reforms such as the Real Estate (Regulation and Development) Act, 2016 and the goods and services tax (GST).
Sajeev Chandiramani, national director - capital markets at Knight Frank India, a real estate consultant firm, said the real estate funds in distress invested in the years before RERA Act was passed, at a time when there were challenges pertaining to transparency, governance and financial discipline among developers.
How else to invest
Apart from physically buying a flat or land which comes with its own problems, you can invest in the asset through non-convertible debentures (NCDs), AIFs or real estate investment trusts (REITs).
NCDs: They provide very low-ticket sizes at high interest rates, but are extremely risky and undiversified.
AIFs: They are more diversified but they have a minimum ticket size of ₹1 crore and can differ widely based on the quality of the fund manager. “Sebi has stipulated a minimum ticket size of ₹1 crore in AIFs but has not put in sufficient regulations on diversification and transparency," said Amol Joshi, founder, Plan Rupee Financial Services. “People with large incomes and the ability to invest aren’t necessarily financially savvy. There is nothing to stop such debacles from occurring again," he added.
However, some wealth managers continue to be bullish on AIFs. “The rental yields in some real estate segments like commercial and co-living are quite attractive," said Prateek Pant, co-founder and head products at Sanctum Wealth Management. “We recommend REITS and AIFs after looking at the yield and pedigree of the asset manager—the ability of the institution to manage the fund well. A tenor of five to seven years for such a fund is suitable," he said.
Sajeev Chandiramani identified co-living and student housing projects as attractive areas for investment. “A high net-worth investor (HNI) looking at such a real estate fund should look at the background and sponsor of the fund, corporate governance, diversification between residential and commercial real estate and delivery. He should also look at the overall financial health of the developer, rather than just the project being funded. Greenfield projects should be avoided for now," he said.
REITs: These are the most regulated of the three options. They have to invest at least 80% of their assets in completed commercial properties and are mandated to distribute 90% of their cash flows. In April, Sebi lowered the minimum ticket size for investing in them from ₹2 lakh to ₹50,000.
However, they suffer a tax disadvantage. Since they are pass-through vehicles, the rent and interest rate earned by them is taxed in the hands of the investors. Only one REIT has listed so far giving you very little choice in terms of products. You should ideally wait for more REITs to be listed and the industry to mature. That said, if you really wish to invest in real estate, a REIT is the least risky option among the alternatives you have.
Regardless of the product you are shown, ask a few basic questions: What type of projects or properties will the fund be investing in? Is it taking any measures to reduce risk? What is the fee or commission the distributor and the fund manager will earn? Above all, remember that a return figure mentioned orally has no value.