When it comes to building assets, especially in India, real estate attracts a large section of investors. The reason is that, unlike a financial asset, it is something investors can see, touch and feel. That is why almost three-fourth of Indian household wealth is parked in real estate and only a small fraction in financial assets. "The average household holds 77 per cent of its total assets in real estate (which includes residential buildings, buildings for farm and non-farm activities, constructions such as recreational facilities, and rural and urban land) compared to 5 per cent in financial assets (such as deposits/savings accounts, publicly traded shares, mutual funds, life insurance and retirement accounts)," says a 2017 report by the Reserve Bank of India titled "Indian Household Finance Survey."
However, in the last few years, returns, especially from the residential segment, have been muted or even fallen. Many have even predicted the end of real estate as an investment, a view that gained further currency after the outbreak of Covid-19. However, as life slowly moves towards normalcy, there are enough signs that the sector cannot be written off as an investment. With interest rates on fixed income instruments falling and stock markets volatile, investors are seriously looking at segments such as commercial real estate, which has given decent returns over the past few years, and real estate investment trusts (REITs), whose early returns have been promising.
"Indian real estate consumers still remain positive about the economic scenario and income stability for the coming six months. Real estate (35 per cent) is still perceived as the preferred mode of investment, followed by gold (28 per cent), fixed deposits (22 per cent) and stocks (16 per cent)," says a recent report by Housing.com and National Real Estate Development Council.
Barring some periods in the short to medium term, real estate has given decent returns over long periods. However, before writing the cheque, one must understand that there are different segments within real estate, and risk, return and other factors differ in each case.
Why Real Estate
While it is true that almost everyone wants a piece of real estate, financial planners say one should invest in the sector only if it fits in one's portfolio. "Any investment decision regarding real estate ought to be made with an eye on overall allocation of finance and short-term liquidity requirements," says Lovaii Navlakhi, Managing Director and Chief Executive Officer, International Money Matters Pvt. Ltd, a financial planning firm. This makes even more sense during a period like this when household incomes have fallen. But the key questions are - Who all should invest? And in which segment?
"One should consider real estate only after building a sizeable liquid fund through financial assets such as mutual funds," says Varun Girilal, Executive Director, Mitraz Financial Services Pvt. Ltd.
Rohit Shah, Founder and CEO, Getting You Rich, a financial planning firm, says, "Real estate is considered a growth vehicle and can give decent returns in the long run. But concentrating all your money there is not a good idea. Check for asset allocation, liquidity, EMI ratio, rental yield and investment horizon."
Among the different segments, buying a house may not be a good idea at present, though most financial planners encourage purchase of a house at some stage in life, mainly for living. The market is conducive for the latter as prices have either corrected or remained stagnant over the last few years. Besides, due to huge inventory, developers are ready to negotiate prices. "Property rates are at their lowest. Many developers are offering further enticements such as attractive payment options and offers. Also, unlike in earlier years, buyers can get completely de-risked, ready-to-move-in homes at prices previously fetched by early-stage, under-construction properties," says Anuj Puri, Chairman, ANAROCK Property Consultants. However, it is not advisable to buy a house for investment at this stage. Market trends hint at tepid demand and severe stress on builders due to large unsold inventory.
What about commercial property? In contrast to residential real estate, commercial assets have been doing well in most major Indian cities. They are becoming popular among not just institutional investors and high net worth individuals but also retail investors. Commercial properties can yield 8-10 per cent in major markets depending upon location, demand-supply and quality of asset. Though the pandemic has dented growth and returns due to fall in demand for office spaces, experts believe it will rebound soon. "As a result of the pandemic, there has been a flight towards liquidity, which is impacting this asset class. Commercial real estate has been impacted more as many organisations are asking employees to work from home and downsizing. That said, at some point, the tide will turn, and prices will rise. However, one has to remember that real estate cycles last longer, five-seven years, and hence it could be a while before things start looking up," says Navlakhi.
Puri echoes this. "Undoubtedly, there was a dip in demand for commercial spaces, especially during the lockdown. But we are gradually seeing pick-up in demand in key cities. Google, for instance, is on an office leasing spree as a follow-up to its planned massive investment in India over the next five-seven years. The cities include Bengaluru, Hyderabad and Gurugram. The trend is likely to gather pace in the coming quarter where we will see more such announcements. So, it is an appropriate time for investors to get into Grade A commercial spaces that are future-ready and can align with the new normal now and in the future with ease."
Puri says office spaces near residential hubs have great potential. "Offices in a decent workplace hub or shops in residential areas make investment sense. Most retail investors may lack the bandwidth to participate in Grade A office buildings, which are the best bet, but they can still buy space in smaller office buildings that are well-connected and can draw workforce," he says.
However, even for that, you need deep pockets. You also have to carry out proper due diligence in terms of legal issues and future market outlook. That is why, for retail investors, Real Estate Investment Trusts (REITs) make perfect sense.
The REIT Bet
REITs address the challenges of ticket size and transparency. "REITs are good for investors who have small appetite for real estate - as small as Rs 50,000 - and yet want to invest in the otherwise highly cost-intensive commercial real estate market. They can take a small bite of the large commercial real estate pie with REITs," says Puri.
Sameer Kaul, MD and CEO, Trust Plutus Wealth Managers, says REITs should be the preferred vehicle for retail investors. "Investors should look to participate in real estate indirectly through more efficient structures such as REITs, which have better returns visibility, higher transparency and a certain degree of liquidity (higher than hard assets)," he says, adding, "REITs have been made available at an appropriate time given the volatility in debt and equity markets."
Girilal of Mitraz is also positive on REITs. "REITs have done well in developed markets such as the US and Europe, so one hopes that they grow in India with more options and transparency," he says. "Embassy and Mindspace REITs offer decent potential for returns. Returns through lease rentals and capital appreciation can range between 8 per cent and 12 per cent. One does not have to part with a large capital for REITs. They also come with the added benefit of liquidity and diversification of projects," he says.
The issue is that there are only two REITs in India so far. The first one was launched last year while the second one was launched last month. Therefore, one can study the past performance of only one REIT for reference.
"In the first year of our REIT, FY20, we delivered a 15 per cent YoY growth in NOI (net operating income), early delivery and healthy pre-commitments on our 1.4 msf on-campus development, culminating in strong distributions for our unit holders of Rs 1,882 crore," says Mike Holland, CEO, Embassy REIT. "We successfully navigated through the 1st quarter of FY21 despite the pandemic and maintained a healthy 92.2 per cent occupancy, collected a robust 98.9 per cent of rentals and distributed Rs 4,49.9 crore," he says.
Some financial planners suggest caution. "Like in case of any other asset class, you should focus on sustainability of returns, that is, ability of the asset to generate steady and growing returns. At present, the listed REITs in India have marquee commercial office assets and sticky Grade A tenants, offering clear visibility of sustainable returns. It is critical to assess the ability of the REIT manager to maintain the property and renegotiate rentals," says Kaul of Trust Plutus.
Some financial planners such as Suresh Sadagopan, Founder, Ladder7 Financial Advisories, doubt that REITs will be able to generate an average return of over 9 per cent year on year over a long period. Girilal suggests that in the current market, one can allocate 5-10 per cent of ones portfolio to REITs. "So, we would still recommend REITs as a satellite/non-core allocation only after one has adequately diversified across bonds, equity-based MFs and debt MFs."
If you are looking at investing in real estate, consider commercial real estate such as shop or office space at a good location which can fetch you decent returns. Go for REITs if you have budget constraints.
Ashwini Kumar Sharma is a Delhi-based Writer