Real Estate Investment Opportunities In the mid-nineties, the Indian real estate was booming. Projects were being launched (and sold) across all cities and price points. It turned out that most of the frenzied buying was being done by investors – both local and overseas. Towards the end of 1996–97, the party wound up. A bloodbath followed, investors pulled out and projects were left incomplete. Property prices halved and in some cases even reached one-third levels vis-à-vis their peaks.
From then on it was a very slow and painful recovery, leaving only the best men standing, a `going back to the roots’ scenario. A turnaround was witnessed in 2000 when markets started strengthening; the middle class consumption (driven by low rates of interest) increased dramatically. Also the off take by the IT sector has been huge, prices have moved upwards, in some cases too sharply for comfort. There are opportunities available today for investment across all types of real estate and across all budgets. Let us begin by discussing the opportunities arising in the commercial office space sector. Nowadays, office spaces are mostly taken on a ‘leave and license’ basis and not purchased outright by the user/occupant. The licensee enters into long-term contracts for periods ranging from five to ten years. Typically, the yields are between 10%-11% pa along with built-in escalations of approximately 5% pa. Assuming such a property is purchased by an investor, he can then borrow against the property (and against future rentals) amounts upto 50% of the property price albeit it can stretch upto 70%-80% of the property price in some cases. And the cost of borrowing locally is with in the 8%-8.5% pa range; if borrowed internationally, the cost of borrowing is much lower. This financial engineering/arbitrage results in an additional yield of about 3% to the investor. Assuming a modest annual appreciation of 3%-5%, the total returns work out to a handsome 17%-18% pa. And all this with relatively less risk since the property is still in ownership of the investor, the client is a well reputed corporate, the laws provide for speedy recovery of the premises among others. Sounds good, doesn’t it, but remember that there is nothing like a free lunch. With every opportunity, there are risks. Risks of the occupant leaving and the premises remaining vacant, risk of the market falling, risk of the building not being maintained well enough thereby reducing the property values, risk of a higher running or maintenance costs than anticipated. In spite of the risks, this is an opportunity worth considering. The next category could be a property suited mainly for the IT sector. Here the property sizes are usually much larger with a minimum floor size being upwards of 30,000 sq ft. These properties are usually located at city suburbs and rented out by IT companies, the ITES sector and BPO companies. These properties tend to be very price sensitive and hence a windfall rise in prices is not usually expected. Reason being that the IT companies need space within a very tight price band, if the properties cost a lot more, they simply move to a lower cost destination. The infrastructure and planning is specifically designed for the IT/ITES sector, and is such that can hardly be used by a non IT company. But, the positive is that once an IT company uses a space, it usually does not leave it for a very long time, and that too only if it really has to. So, predictability of rental flows is high. Secondly, the growth in IT is so huge that there is today a larger demand than supply for such properties. It is estimated that over the next five years, the IT sector will require 75 million sq ft of space. Some of the regions where such opportunities can be found are Gurgaon, Chandigarh, Pune, Kolkata, Chennai and Hyderabad. The yields are more or less the same as in the case of commercial properties discussed above. Another opportunity could be in the retail segment. Retail, so far has largely been unorganised. Recently, mall developments have taken place across the country. Presently, only 3% of all retail is in the organised sector, so really there is a long way to go. Here, an investor could buy space in a mall and rent it out to a multinational like MacDonalds, KFC, Nike or a local company like Barista, Provogue. An investor can opt for a pure rental model or a revenue sharing model where his rentals are linked to the sales or revenues of the store by a pre-fixed formula. This way, he gets to ride the retail story and participate in the upside / growth of the retail business. Lot of investors are in this sector already, but the scope is huge, so there is still enough space for new entrants. The thing to worry about here is the oversupply of malls in certain pockets as well as the dynamic nature of the business. A mall planned for today can become obsolete very soon, as new formats evolve with lightning speed.
A fourth category of investments could be housing. With an estimated shortfall of 22 million housing units, the potential is huge. With reduced interest rates and tax benefits given to borrowers (the effective rate of interest is 5.5% pa) and with simultaneous increase in salary levels, the average affordability has gone down from a high of 15 years in 1995 to 4.5 years today. This basically means that an employed youth can buy a house with 4.5 years income. Thus, the demand for housing is huge. An investor can come into a project at the construction stage, buy a block of apartments from the developer and then sell them to the actual user upon the building being ready for possession. By riding the construction period, he basically finances the developer to some extent and exits when the user is ready to move in the apartment. Investment holding period could range from 1-3 years depending on the project size. Returns can be good, in the 15%-18% pa range. However, there are risks. Risk of the market holding out, risk of the project getting completed in time, and up to expected specifications, risk of finding a buyer at the expected price. Such opportunities should be explored only in situations where one is comfortable with the builder and is confident of the market in that location. Otherwise there can be huge disappointment. Another way to participate in the housing growth story is by investing in apartments for their rentals and capital appreciation. In this model, rentals can give a yield of about 6% pa and one can expect some capital appreciation over the medium to long term, if the property is well located, in a region where the demand is good. However in most cases the rental contracts are not very long-term in nature, so borrowing against such properties can be quite tricky. As you can see, the opportunities are immense, the themes are plenty and varied. It really depends on the investor as to how he wants to play the game. By knowing your bite size, risk appetite, staying power, comfort levels, you can select which is the optimal way for you to participate in the great Indian real estate story. Hopefully, this time round, you will do better than the last. This article is contributed by Mr. Ashwin Ramesh, Director of Primary Real Estate Advisors Pvt. Ltd.
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