Real Estate MF's & NCD's - Should you go for them?


We are currently seeing strange times in the real estate market nowadays. Banks are vary of funding real estate developers because of their over-leveraged capital structure, mezzanine financers have increased their financing rates and no investor is willing to or capable of shelling out the amount of money real estate developers require. These developers have now turned their attention to the following instruments to fulfill their cash needs – Real Estate Secured Non-Convertible Debentures and Real Estate Private Equity Funds.


NCDs and REPE are primarily for HNIs because the ticket size is no less than Rs. 10 lacs and the rates range from about 13% to as high as 22% with a tenure ranging from 2-5 years in case of NCDs. In some cases the payments are in different tranches which a normal investor is incapable of handling. The factors determining the rates are the security cover provided by the developer, the completion stage of the project of the developer, the rating of the developer, the tenure and also the amount intended to be raised.

So what basically happens is a Real Estate Developer faces a cash crunch around 70% completion stage of a project, as he exhausts the initial funding he gets from banks or from self-funding and requires working capital to move towards completion.

Since banks are not interested in lending any further, these developers approach Portfolio Management Services (PMS – SEBI registered) who does the ground work with respect to developing the structure of NCDs or REPE (if not already in place). In case of NCDs what is required are Debenture Trustees (who are the custodians of the debentures and SEBI approved) and the Chartered Accountants (for valuations of the underlying securities the developer offers). When the documentation is done at the back end, the product is rolled out to the HNIs of the PMS and they start investing in it.

Such investments can be very lucrative and very fruitful as the security generally offered is 2 to 3 times the raised amount, so the invested money is going nowhere. The interest starts coming about 6 months from investment. Principal amount in paid out in installments a year from investment as well.

In case the developers default on payments you have the Debenture Trustees working in your favor to make sure your money is in safe hands. They liquidate the securities in case of defaults by first appointing a Nominee Director who takes care of further proceedings. This is to ensure that your money is safe. PMS's like Karvy, Reliance, etc have been rolling out such instruments for Real Estate Developers for sometime now.

Another source is the REPE. The investor money pooled into such funds invests in projects of private developers. REPE is not suitable for small retail investors, since the minimum ticket size in most funds is Rs 25 lacs.

REPE funds usually have a five to seven year life span. The period includes a two-year investment period where properties are acquired, followed by a 3-5 year holding period where active asset management is carried out. At the end of the whole period, the investors make an exit when the acquired properties are sold. The typical expenses for such investor include annual management fees, one-time setup fees, and a performance-based fee (also known as carried interest).

The fund's manager will seek to achieve returns through several means, including capital appreciation on land holdings, net operating income on real estate projects, capital gains from disposal of real estate projects, income and capital gains on equity stakes in real estate development companies, rental yields, and proceeds from financing activities with the overall goal being to achieve a gross IRR in excess of 25%. Currently, the leading players in the domestic REPE industry are Kotak, ICICI, HDFC, Indiareit, ILFS, ASK, Aditya Birla, UIOF, AnandRathi and Milestone.

As the Real Estate Sector has grown over the years it remains a safe haven for most investors (mainly HNIs) to seek diversification in their portfolio. The reason why the emphasis on only HNI's is because they alone will have the financial backing & risk appetite to invest in fund structures and NCDs. A normal investor with Rs. 10 lacs portfolio can't invest in PMS products as the minimum investment per product of a PMS is Rs. 25 lacs (a per new SEBI guidelines). Investors who have the financial strength to enter such a market and who have no exposure to Real Estate in their portfolio can consider these instruments for venturing into this sector. For rich NRI's this can serve as a highly attractive investment.

This article has been contributed by Pankul Kohli.

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