A Guide to Investments in Indian Real Estate

Real estate has traditionally been an avenue for considerable investment per se and investment opportunity for high-net-worth individuals, Financial institutions, and individuals looking at viable alternatives for investing money among stocks, bullion, property, and other avenues.

A Guide to Investments in Indian Real Estate 1

Money invested in property for its income and capital growth provides stable and predictable income returns, similar to bonds, offering a regular return on investment if the property is rented and the possibility of capital appreciation. Like all other investment options, real estate investment has certain risks attached to it, which is quite different from other investments. The available investment opportunities can broadly be categorized into residential, commercial office space, and retail sectors.

Investment scenario in real estate

Before considering real estate investments, any investor should consider the risk involved in it. This investment option demands a high entry price and suffers from a lack of liquidity and an uncertain gestation period. To be illiquid, one cannot sell some units of his property (as one could have done by selling some units of equities, debts, or even mutual funds) in case of urgent need.

The maturity period of property investment is uncertain. The investor must also check the clear property title, especially for investments in India. In this regard, industry experts claim that people should make property investments with deeper pockets and a longer-term view of their investments. From a long-term financial returns perspective, investing in higher-grade commercial properties is advisable.

The property market returns are comparable to that of certain equities and index funds in the longer term. Any investor looking to balance his portfolio can now see the real estate sector as a secure investment with a certain degree of volatility and risk. The right tenant, location, segmental categories of the Indian property market, and individual risk preferences will be key indicators in achieving the target investment yields.

The proposed introduction of REMF (Real Estate Mutual Funds) and REIT (Real Estate Investment Trust) will boost these real estate investments from the small investors’ perspective. This will also allow small investors to enter the real estate market with a contribution of as little as INR 10,000.

There is also a demand and need from different market players in the property segment to gradually relax certain FDI norms in this sector. These foreign investments would then mean higher standards of quality infrastructure and would change the entire market scenario in terms of competition and professionalism of market players.

Overall, real estate is expected to offer a good investment alternative to stocks and bonds over the coming years. Real estate investment attractiveness would be further enhanced based on favorable inflation and a low-interest rate regime.

Looking forward, the progress towards the potential opening up of the real estate mutual funds industry and the participation of financial institutions in the property investment business may pave the way for more organized investment real estate in India, which would be an apt way for investors to get an alternative to invest in property portfolios at a marginal level.

Investor’s Profile

High Net Worth Individuals (HNIs) and Financial Institutions are the two most active investor segments. While the institutions traditionally prefer commercial investment, high-net-worth individuals are interested in investing in residential and commercial properties.

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Apart from these is the third category of Non-Resident Indians (NRIs). There is a clear bias towards investing in residential properties rather than commercial properties by the NRIs; the fact could be reasoned as emotional attachment and future security sought by the NRIs. As the necessary formalities and documentation for purchasing immovable properties other than agricultural and plantation properties are quite simple, and the rental income is freely repatriable outside India, NRIs have increased their role as investors in real estate.

Foreign direct investments (FDIs) in real estate form a small portion of the total assets. There are restrictions such as a minimum lock-in period of three years, a minimum property size to be developed, and conditional exit. Besides the conditions, the foreign investor must deal with several government departments and interpret complex laws/bylaws.

Real Estate Investment Trust (REIT) is on the verge of introduction in India. But like most other novel financial instruments, there will be problems for this new concept to be accepted.

Real Estate Investment Trust (REIT) would be structured as a company dedicated to owning and, in most cases, operating income-producing real estate, such as apartments, shopping centers, offices, and warehouses. A REIT is a company that buys, develops, manages, and sells real estate assets and allows participants to invest in a professionally managed portfolio of properties.

Some REITs also are engaged in financing real estate. REITs are pass-through entities or companies that can distribute most income cash flows to investors, without taxation, at the corporate level. REITs’ main purpose is to pass the profits to the investors in as intact a manner as possible. Hence, the REIT’s business activities would generally be restricted to generating property rental income.

The investor’s role is instrumental in scenarios where the interests of the seller and the buyer do not match. For example, if the seller is keen to sell the property and the identified occupier intends to lease it, the deal will never be fructified; however, an investor can have competitive yields by buying the property and leasing it out to the occupier.

The rationale for real estate investment schemes

Real estate activity includes a wide range of activities such as developing and constructing townships, housing, commercial properties, maintenance of existing properties, etc.

The construction sector is one of the highest employment sectors of the economy and directly or indirectly affects many other sectors’ fortunes. It employs a large workforce, including a substantial proportion of unskilled labor. However, this sector does not have smooth access to institutional finance for many reasons. This is perceived as one of the reasons for the sector not performing to its potential.

By channeling small savings into property, investments would greatly increase access to organized institutional finance. Improved activity in the property sector also improves the revenue flows to the State exchequer through increased sales tax, octroi, and other collections.

Real estate is an important asset class, which is, under conventional circumstances, not a viable route for investors in India at present, except using direct ownership of properties. For many investors, the time is ripe for introducing products to enable diversification by allocating some of their investment portfolios to real estate investment products. This can be effectively achieved through real estate funds.

Property investment products provide opportunities for capital gains and regular periodic incomes. The capital gains may arise from properties developed for sale to users or direct investors. The income stream arises out of rentals, income from deposits, and service charges for property maintenance.

Advantages of investment in real estate

The following are the advantages of investing in Real Estate Investment Schemes.

As an asset class, the property differs from the other investment avenues available to small and large investors. Unlike conventional investments, property investment has its methodology, advantages, and risk factors. A completely different set of factors, including capital formation, economic performance, and supply considerations, influence the realty market, leading to a low correlation in price behavior vis-à-vis other asset classes.

Historically, over a longer term, real estate provides returns comparable with returns on equities. However, the volatility in realty prices is lower than equities, leading to better risk management to return trade-off for the investment.

Real estate returns also show a high correlation with inflation. Therefore, real estate investments made over long periods provide an inflation hedge and yield real returns.