High returns in rentals

Jan 19 2013, 09:07 IST
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SummaryEven as PE investments in realty have sagged, rental yield funds combine the certainty of a regular rental income and potential for attractive capital appreciation

The private equity (PE) story for real estate in India has had a chequered past. Private equity real estate (PERE) investments in India stood at $6.7 billion in 2007 and $3.31 billion in 2008. It declined to $0.84 billion and has remained sluggish since then. It stood at around $0.85 billion in 2011.

In the financial year 2011-12, PERE investments stood at $700 million, during the first to the third quarter. This is around 15 per cent lower than the same period the previous year. The main reason for this slowdown has been difficulty in raising funds focused on real estate sector in India. After the global financial crisis of 2008, few realty funds have been able to raise the intended fund corpus and their fund raising timelines were substantially delayed.

PERE in India has suffered mainly because of the following reasons:

Returns from PE funds in general have not been very encouraging. Perhaps expectations were not managed properly. Investors also believe that they can make more money investing in real estate than going through the PE fund route.

The funds are close-ended and typical tenures are 6-7 years. There is therefore a long lock-in and liquidity for such investments is moderate or low.

Investors’ communication has been lacking and investors perceive lack of customer centricity in PERE sector in India. Investors have often expressed concerns about lack of adequate disclosures and communication from PE funds.

The fee structure charged by the funds has not found favour with the investors.

Recently, market regulator Securities and Exchange Board of India has raised the minimum investment in PE funds to Rs 1 crore (from Rs 5 lakhs under venture capital funding regulations) under the Alternative Investment Funds (AIF) guidelines, which has significantly reduced the investor base for fund raising.

On the downstream part, lacking transparency in the sector and developers’ lacklustre effort in improving operational efficiency in the sector has not helped in institutionalising real estate financing. Some of the private equity investments have suffered due to information asymmetry prevalent in the real estate sector in India. This has reduced PE interest in the sector despite its huge long term growth potential.

These factors outlined above coupled with an increase in risk aversion among investors in the post global financial crisis era has shifted the focus from “opportunistic funds” to “value added” or “core plus” funds. Such funds offer moderate returns with low risks.

One such product is the rental yield fund, that offers an excellent opportunity for investors to get a fairly attractive rate of return with low risk. This is so on account of the following reasons:

The rental yield fund does not involve any development/ execution/ approval/ title risks.

A significant part of the overall returns are known at the time of acquisition in terms of net entry yield. Investors also get recurring income stream by way of distribution of rental income.

Investors realise that the yield fund holds title to the property hence there is a tangible asset backing the investment.

The newly laid AIF guidelines have alluded to listing of the units after final closing and hence investors see liquidity option that is available to them unlike the long lock-in of 6-7 years in a close-ended fund.

Fund managers now devise a competitive fee structure, which is appreciated by investors. Investors do not mind sharing upside with fund managers as long as they make a decent return.

Commercial real estate market across cities in India has stabilised and most of the precincts are expected to witness robust absorption, rent escalation and yield compression in the coming years. In this perspective, since the current valuations of commercial properties are fairly attractive as rentals are bottoming out, the overall returns can be reasonably attractive.

Given that interest rates have peaked and are expected to decline and risk premium for commercial real estate sector is expected to decline in the coming years, yield compression expected on investments in commercial properties can be robust. As such, this is the right time to invest in commercial properties and hence yield fund.

The yield fund combines the certainty of a regular rental income and potential for attractive capital appreciation.

In sum, while fund raising is never easy, a rental product addresses investor requirements and concerns in a holistic manner and hence is finding favour with them.

—The author is CEO and MD, Azure Capital Advisors

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