Updated: Oct 2, 2019
Real estate investments are extremely beneficial for an investor's portfolio if done properly and without excessive exposure. This asset class not only provides capital appreciation over long term but also generates rental income for investors, combine these benefits with relative stability (low volatility) of this asset class and you get a potent investment vehicle.
The question however arises that if this asset class is so good then why common investors do not own it in their portfolios? The reason for that is the entry barriers in this asset classes, these entry barriers stabilise this asset class as well by driving away short term traders from this asset class.
The entry barriers we are talking about are:
Investment is capital intensive: Owning a single real estate unit can cost an investor from 40-60 Lacs for a residential property (or small shop) and in the range of 20+ crores for commercial buildings in business parks. In a country where an average portfolio size itself is significantly below 20 Lacs it is impossible for investors to hold real estate as one of the assets in their portfolios. Thus if an investor invests in real estate most likely he/she won't have any money left to invest anywhere else. This exposes investors to concentration risks (learn about advantages of portfolio diversification here) and if this asset doesn't perform well, their portfolio is already dead. Combine this with mortgage investors would generally take to raise this sum and you see the personal financial crisis an investor is heading towards.
Lack of liquidity: Realising good profits from this asset needs patience for years and even after that you may have problems in immediately selling it off. The reason for that is again capital intensive nature of this asset, your buyer needs to raise that capital as well before buying this asset from you. Also, the market size is small, because how many people in market will actually have that capital and want that asset in that city/locality.
Legal liabilities: Any real estate investment requires significant paperwork for purchase, registration and rental agreements to name the most common ones. This additional burden on investors contributes towards reduced investor participation in this asset class.
Risk of encroachment: Given real estate is fixed in terms of location and an individual's job can take him/her around the globe anywhere, this asset comes with a risk of encroachment/illegal occupation. By the time investor fights a legal battle to get back in control (conditional) years would have past, thus making your asset your worst nightmare.
Manual rent collection: For individual real estate holders tracking of rental income in itself is a financial overhead which they would surely want to avoid.
After cribbing about all the hassles in real estate investments and understanding the nuances of this asset class let us put back our investor hats and find solutions. Below are the ways an investor can participate in real estate asset class directly/indirectly without all the complexities mentioned above:
REITs: REIT, short form of Real Estate Investments Trust is a very new concept in India and is getting exceptional response from market. It lowers the financial entry barrier by providing entry lot size which can be bought @ 2 Lacs. On top of that it invests in completed commercial properties with close to 100% occupancy thus generating sustainable rental income. For transparency sake I want to disclose that our reference point for REIT is the only publicly traded REIT in India i.e. Embassy office REIT.
InvITs: These are Infrastructure Investment trusts which invests in infrastructure projects in early stages and then generate income for investors in the from of rental/toll income. InvITs are required to: Invest 80% of their capital in income generating infrastructure projects (remaining 20% can be put in under-construction projects) and distribute 90% of their net cash flow to investors. Now this might seem to generate higher profits as investors are getting rental income plus capital appreciation on under-construction projects, but till now none of the listed InvITs have been profitable in India. This attributes to lack of visibility into future earning potential of a project and also the quality of infrastructure projects put in the basket of current INVITs. Also, the minimum investment size in IRB InvIT (one of the most popular one) has been 10 Lacs which again puts restriction on common investor to put their money into it.
Private equity based property shares: Similar to REIT, this is an emerging alternative investment vehicle backed by private equity ventures in India. At the time of writing this article I am still in the enquiry phase of this investment model and will update this article further as I personally explore. That being said, I am listening positive feedback about propertyshare.in from my peer group which provides PE backed property shares.
Infrastructure bonds and Non-convertible debentures backed by real estate properties: These bonds and debentures are used by infrastructure developers to generate capital from common investors, which in turn is used for construction/building of infrastructure. Such bonds and debentures generally offer a higher rate of interest than fixed deposits and do indirectly contribute towards real estate sector debt based investments.
Stocks of real estate companies: Although this doesn't at all account by any means that you own a real estate, also it doesn't provide you with the stability of investments in real estate asset, but then for people having constraints with respect to capital requirements, real estate stocks is the next big thing to benefit from real estate sector. This exposure in your portfolio can also be brought through a real estate/infrastructure focused mutual fund which invests in a basket of such stocks (thus optimising exposure risks to a single stock).
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