I was recently discussing in a group of friends on the various opportunities available to an investor. Many asset classes were discussed and the associated risks were also discussed.
When it came to Real Estate as an investment option the perception of risk was very varied. A segment of participants perceived Real Estate Investment as Safe and on the contorary another segment perceived it to be a very risky option. From the discussion it was understood that the opinions were greatly based on the personal experiences or exposure to case studies discussed with close associates.
I thought this is a good forum to put forth some interesting points worth pondering upon. Lets take an asset class and understand how actual investment decisions are made. Lets understand this with the most common asset class Equity shares.
We first analyse the macro and micro economic environment, identify a few sectors that have relatively better prospects for growth. Then, we identify a few top performing companies and construct an investment portfolio of 12 to 15 stocks well diversified across sectors and across market capitalisation. In doing so we visualise an optimum portfolio return. There are other considerations like individual stock co-relation and so on. But, my idea here is not to get into efficient portfolio theory. So far this basic information on portfolio construction is sufficient to construct my thoughts around.
So now, why have we done this diversification? just to ensure that under-performance of one stock / sector will be off-set with the over-performance of another stock / sector and ensure that the overall investment return from the portfolio is optimal.
Now extending the same logic to Real Estate Investing we need to create a portfolio of Real Estate Investment. Yes I am refering to a Real Estate Portfolio to ensure investment risk reduction. How do we diversify Real Estate Investments? There are various class of Real Estate Investments. Some classifications can be as under :
- Residential, Commercial or Agricultural
- Commercial properties can be further sub classified as Office Space and Retail Space
- Rent Yielding or non – rent yielding
- Under construction, new fully constructed Property, old property
- Properties across geographical locations across Tier-1 /2 /3 Cities.
Each of these mentioned property types will have a different profile and investment prospects. So, one needs to carefully analyse each of these investments and include them to create a portfolio of Real Estate Investments. Now comes the major hurdle in real estate investing, the size of pocket. Hence by now it is pretty clear that a real, Real Estate Investor needs to have deep investment pockets and has to be prepared for long gestation periods. But, the irony is that a person purchases a piece or two of property here and there and claims to be a Real Estate Investor.Such investors find themselfs stuck in case of any unforeseen circumstances as is being faced by the Hyderabad property market. Exit becomes difficult leading to distressed sale and a loss in returns. Thus, defeating the very nature of Investing. So, How does one go about Real Estate Investing?
I know of investors who have, despite the current gloomy conditions have made 18+% returns in Real Estate Investing. How have they done it? They have taken the help of professional Real Estate Investment Houses like HDFC, ASK, Birla, to name a few. These Real Estate Investment Houses are setup as Trusts (REITs) or as simple Real Estate Portfolio Managers. They pool the money from a number of Real Estate Investors and construct a logical portfolio of Real Estate Investments across various classess and geographical locations. They sometimes also invest in regular return yielding properties. They ensure timely booking of profits and distribution of returns to investors. Thus, making property investments appear easy and simple. The best part of these investment is their ticket size. Most of them today offer investment options for Rs.20-25 lakhs. If one were to invest this amount directly in Real Estate will be able to investment in just 1 or 3 properties depending on the location and type of property. But will never be able to make a logical portfolio of Real Estate Investments. Thus killing the essence of Diversification.
India needs to travel a long way on the regulatory path, to ensure effective success of such Real Estate Fund Managers, and in taking this asset class to the smaller investors. But we hope a time comes fast when such investments are an integral part of smaller investors portfolio.