In India, real estate has remained largely outside the purview of formal economic activity. The activity of real estate includes a wide range of activities such as development and construction of townships, housing and commercial properties, maintenance of existing properties etc.
The construction sector is one the highest employment sector of the economy and directly or indirectly affects the fortunes of many other sectors.
It provides employment to a large work force including a substantial proportion of unskilled labour. However for many reasons this sector does not have smooth access to institutional finance.
This is perceived as one of the reasons for the sector not performing to its potential. By channelising small savings into real estate, investments would greatly increase access to organised institutional finance.
Real estate is an important asset class, which is generally not available to investors at present in India, except through direct ownership of properties.
For many investors the time is ripe for introducing product to enable diversification by allocating some part of their investment portfolio to real estate investment products.
The following are the advantages for investing in Real Estate Investment Schemes
- Real estate as an asset class is distinct from the other investment avenues available to a small as well as large investor.
- Historically, over a longer term, real estate provides returns that are comparable with returns on equities.
- Real estate returns also show a high correlation with inflation.
Risk factors
The risks involved in investing in real estate are primarily to do with future rental depreciation or general property market risk, liquidity, tenancy risk and property depreciation.
Location
The location of a building is crucially important and a significant factor in determining its market value.
Physical characteristics: The type and utility of the building will affect its value, i.e. an office or a shop. Utility refers to the benefits an occupier gets from using the building. The risk factor is depreciation.
Tenant credit risk: The value of a building is a function of the rental income that you can expect to receive from owning it. If the tenant defaults then the owner loses the rental income.
Lease length: If a building is let to a good quality tenant for a long period then the rental income is assured even if market conditions for property are volatile.
Liquidity: All property investment is relatively illiquid to most bonds and equities.
Tax Implications: Apart from income tax which is to be paid on rental income and capital gains, there are two more levies which have to be paid by the investor i.e. property tax and stamp duty.
Risk of single property
Purchasing a single - property exposes the investor to specific risks associated with the property and does not provide any benefits of diversification.
Distress sales
Illiquidity of the real estate market also brings in the risk of lower returns or losses in the event of an urgent need to divest.
Legal issues
While stock exchanges guarantee, to a certain extent, the legitimacy of a trade in equities or bonds and thus protect against bad delivery or fake and forged shares, no similar safety net is available in the property market. It is also difficult to check the title of a property and requires time, money and expertise.
The writer is managing director, Trammell Crow Meghraj
