Why AIFs are more attractive than real estate

In 2017, mumbai-based businessman Rakesh Shah bought a house in Alibaug, a coastal town in the Konkan region of Maharashtra just a ferry ride away from India’s financial capital. Shah wanted it to be a place for his family to spend fun weekends and earn him a tidy profit over time.

Things didn’t quite pan out the way he imagined they would.

“It just wasn’t adding up financially,” Shah, 47, says. The house was rarely used, rental demand was weak, and its upkeep was expensive, he says.

In 2023, he sold the property and chose to invest the proceeds in an alternative investment fund (AIF), typically a pooled investment vehicle that invests in non-traditional assets like private equity and hedge funds. They have a minimum investment of Rs 1 crore.

Sure, the decision may seem contrarian for a wealthy investor, to whom it may make better sense to invest in a holiday home or a second house. However, Shah is so far pleased with the switch.

“It’s managed by professionals, there’s no maintenance hassle, and the returns feel more stable,” Shah explains.

Some high net-worth individuals (HNIs) like him are being drawn to AIFs by the promise of diversification, simplicity and higher risk-adjusted returns. Securities and Exchange Board of India (Sebi) data show that domestic institutional investors are seeing record inflows; AIF commitments reached Rs 13.49 lakh crore by March 2025.

The traditional attraction of a second home as a symbol of legacy and status, it would appear, is being challenged by the compelling math of AIFs. Let us take a look at some reasons behind this.

Numbers

For India’s affluent, second homes have long represented more than investments—they embody generational wealth, social status and tangible security.

“However, the stark numerical reality presents a different narrative. While luxury properties generate rental yields of 2-5%, AIFs aspire to provide 15-25% annual returns on average, with 110 out of 123 monitored AIF strategies showing gains in April alone,” says Tanvi Kanchan, Head of NRI Business & Strategy at Anand Rathi Shares and Stock Brokers.

A stable macroeconomic backdrop supported buying sentiment in the first half of 2025, but it failed to translate into real growth—overall housing sales dipped 2% year-on-year to 0.17 million units.

In both tier-I and II cities, investor demand has weakened because of plateauing rental yields and exorbitant property price increases.

Category I and II AIFs, which invest in assets like venture capital or private equity, are also illiquid like real estate, but are professionally managed to deliver better returns. And Category III AIFs offer a definite opportunity.

“Over a five-to-10-year period, these funds, which invest in the markets using sophisticated strategies, have the potential to deliver returns above the Nifty, often in the 12-20% per annum range. So, from a pure wealth-compounding perspective, the math often favours a well-managed AIF,” says Prabhakar Kudva, Director and Principal Officer, Portfolio Management Service at Samvitti Capital.

AIFs provide exclusive access to the most exciting growth stories in India, like the start-up ecosystem and private credit, inaccessible through traditional routes.

This, combined with the disillusionment from stagnant residential property returns and management hassles, makes the shift more compelling.

Tax Nuances

The tax efficiency advantages are equally compelling. “While second homes face capital gains complications, stamp duty burdens, and maintenance cost non-deductibility, AIFs offer pass-through taxation benefits and professional management fee deductibility,” says Kanchan of Anand Rathi.

The tax landscape being quite nuanced, the best choice depends on an investor’s goal. For a second home, the tax structure is familiar: rental income gets added to your personal income and is taxed at your slab rate, while long-term capital gains on sale are taxed at a lower rate with the benefit of indexation, as applicable.

AIFs operate differently. The key advantage, especially for Category III AIFs, is tax simplicity for the investor. The fund pays the taxes at the fund level. For instance, income from derivatives trading is taxed at the highest rate (around 42.7%) within the fund, but the returns you receive as an investor are post-tax and don’t complicate your personal tax filing.

“This is a huge benefit for busy HNIs who are already in the highest tax bracket. The disadvantage is that the tax rate on certain types of income within the fund can be high, and you lose that direct indexation benefit you get with property,” says Kudva.

Beyond Location

Diversification becomes critical in examining second-home investments. A luxury property worth Rs 5 crore represents not just a single asset-class exposure, but also geographic concentration, regulatory risk, and liquidity constraints.

“AIFs enable diversification across private equity (capturing India’s entrepreneurial growth), debt instruments (benefiting from monetary policy transmission with 60% floating rate loans linked to Reserve Bank of India, or RBI, benchmarks), and infrastructure (participating in the government’s massive Capex spending),” says Kanchan.

Recent data indicates that while foreign institutional investor (FII) outflows impacted equity markets, domestic demand continues driving consumption sectors. AIFs positioned in these sectors offer HNIs exposure to India’s structural transformation beyond traditional real estate cycles.

Simplifying Inheritance

Transferring a physical property to the next generation can be a nightmare. It’s an indivisible asset—how do you fairly split a house between three children? AIFs solve this problem. They are financial securities, just like shares.

This means they are perfectly divisible. “You can bequeath exactly 1,357 units to one heir and 2,468 to another with mathematical precision and fairness. The transfer process is simple, and the valuation is transparent, based on the net asset value (NAV),” says Kudva.

Most importantly, wealth remains under professional management, ensuring continuity without burdening the next generation with managing a complex asset. For seamless multi-generational wealth transfers, AIFs are a far more modern and efficient tool.

In fact, modern estate planning demands sophistication that second homes simply cannot match. AIFs offer HNIs unprecedented flexibility in structuring cross-generational wealth transfers.

Unlike immovable property, which faces challenges in equitable distribution among heirs, AIF units can be structured with varying rights and preferences. “For instance, a family patriarch can allocate growth-oriented Category II AIF units to younger generations while retaining income-generating debt fund units for immediate family needs,” says Kanchan.

Private Markets

HNIs choose AIFs because they fill a unique and critical gap in a sophisticated portfolio. Compared to real estate, the advantages are clear: potential for higher returns, professional management, better liquidity and far simpler wealth transfers.

The comparison can extend to public markets like mutual funds or portfolio management services. “While MFs are great for gaining market-linked returns, or beta, AIFs are designed to deliver something more. Category III funds, for example, can use tools like derivatives and short-selling to generate alpha, or returns that are independent of the market’s direction. Furthermore, Category I and II AIFs are the only gateway to invest in private markets—start-ups, infrastructure and private credit,” says Kudva.

These assets have a low correlation to the stock market, which provides powerful diversification and reduces overall portfolio risk.

Having said that, the comparison between AIFs and second homes has become central because both serve similar emotional and financial goals, namely legacy, wealth preservation and perceived stability.

“Also, through AIFs, one can also invest in commercial and retail properties, completed versus under-construction properties, warehousing and SEZ (special economic zone) projects, etc,” says Nishant Agarwal, Senior Managing Partner, ASK Private Wealth. In fact, according to ANAROCK Research, real estate dominates AIF net investments with Rs 73,903 crore of infusions in the first nine months of FY25.

Says Bamasish Paul, Co-founder, Managing Partner & CEO of Etonhurst Capital Partners, a Category II AIF with a real estate fund, “Our current fund focuses on private credit type deals as we identify and fund society redevelopment projects in MMR (Mumbai Metropolitan Region). As Mumbai is undergoing a transformational change never seen before, older buildings in great locations desire to upgrade into newer and modern buildings.”

Regulatory Reset

As of December 2024, Sebi had scrutinised nearly Rs 1 lakh crore—around 20% of the total Rs 4.5 lakh crore invested AIFs—for potentially being used to bypass regulations like non-performing asset (NPA) norms, Foreign Exchange Management Act (FEMA), and foreign portfolio investment (FPI) rules. In response, the regulator has continued to strengthen the regulation and transparency of AIFs with several key measures.

Fund tenure must now start from the first close rather than the final close, preventing funds from prolonging their life by taking multiple years to raise capital. Extensions are limited to a maximum of two years and require approval from limited partners, who provide capital to a partnership without participating in its active management.

“Additionally, AIF units must be dematerialised, placement memorandums need regular updates, and compliance reports must be submitted to Sebi. These steps collectively enhance governance and reporting standards, significantly boosting investor confidence in AIFs,” says Alekh Yadav, Head of Investment Products at Sanctum Wealth.

Sebi’s tightening of AIF regulations has significantly reshaped investor confidence.

“Schemes with over 50% contribution from a single group of investors must undergo enhanced due diligence as per SFA standards—ensuring accountability in fund structuring and deployment. Independent valuation protocols, now extended to Category III AIFs, along with board-level oversight on conflicts and valuation changes, further reinforce trust,” says Samir Satyam, Fund Manager at PL Capital Performing Credit Fund.

SFA is short for Standard Setting Forum for AIFs.

Recently, RBI tightened norms for banks and non-banking financial companies (NBFCs) investing in AIFs. From January 1, 2026, no single regulated entity can invest more than 10% in an AIF. The combined investment from all lenders is capped at 20%.

And if an AIF invests over 5% in a borrower’s debt, the lender must make full provisions for that exposure. This aims to ensure better credit discipline.

AIFs Offer Clarity

“To sum up, AIFs are better for investors who look for professional management and diversification, want less operational involvement and are comfortable with a higher minimum investment and less illiquidity, and aim to diversify their portfolio beyond traditional assets without the hassles of property management,” says Madhupam Krishna, a Sebi-registered investment advisor and chief planner at WealthWisher Financial Planners and Advisors.

Second homes suit those who value tangible things, personally usable assets, and potential regular rental income and don’t mind active management or can outsource it. Plus, they should be prepared for operational and maintenance work and understand real estate markets.

AIFs are like hiring a financial manager—high skills, hands-off, and (hopefully) high reward. Second homes? They’re your personal fortress with potential rental returns. Both require patience and capital, but the choice comes down to whether you prefer the elegance of financial engineering or the warmth of holding the keys to your own investment.