real-estate-instruments

Investing in real estate continues to be one of the top investment options, given the possibility of rental cash flow, asset appreciation, and tax benefits that this investment offers.

While physical real estate investment covers investing in residential, commercial, and mixed use properties, it is a capital-intensive activity. Investing a huge chunk of capital in one asset may not work well with many investors. For them, there are non-physical real-estate investment options that may result in high yields over a period of time.

Various Investment Instruments in Real-Estate

An investor can opt between direct real estate investment and equity/ debt-based real estate instruments depending on their needs. Let us understand each of the options:

1. Equity-Based Investment Instruments

Equity investment involves purchasing shares of real estate companies (e.g. Godrej, DLF, Prestige etc). The income is generated in terms of dividends and capital appreciation of the share price.

The capital appreciation depends on multiple factors including company’s performance, macro-economic environment, sectoral performance, etc. 

2. Debt-Based Investment Instruments

A financial debt instrument is used by entities to raise capital to address various end use requirements like land acquisition, approvals, construction finance etc.

Investors receive monthly/quarterly/half yearly/annual or bullet pay-outs depending on the structure of the instrument. There are multiple structures of debt instruments which are available and investors can select based on their risk appetite. The return/pay-out is known at the time of investment.

Pros and Cons of Real Estate Investment Options

ParticularsDirect Investment (Physical RE)DebtEquity
Quantum of InvestmentRelatively higher investment amtFlexibility in investment sizeFlexibility in investment size
Transaction Cost (Stamp duty, brokerage, etc.)HighRelatively LowRelatively Low
Investment ReturnsDepends on multiple factorsKnown at the time of investmentDepends on performance
Transparency & DisclosuresLowHigher transparency & disclosuresHigher transparency & disclosures
LiquidityLowMediumHigh

Benefits of Real Estate Investment Instruments Over Physical Real Estate

There are few  reasons why investors consider real-estate investment instruments over physical assets.

1. Tenor Options

Tenor is the remaining time before the financial instrument matures. These financial instruments offer tenor options which the investor can map with its risk appetite and align with availability period of surplus.

2. Risk Diversification

In cases of instruments like REIT, portfolio diversification helps mitigate risk effectively. Different REIT companies invest in different properties and geographies that help diversify real estate investment for investors effectively.

3. Flexibility

Unlike physical assets, the financial instruments provide flexibility in terms of quantum of investment required, structure and liquidity that meets the risk appetite of the investor.

4. Strong Governance

Since most financial investment instruments are regulated by SEBI and RBI, it is safe to say these options are governed by authorities to ensure the safety of investors. These also come with adequate disclosures that help investors stay updated on the operational and financial progress. 

Factors to Consider for Smart Investment in Real Estate Entities

While many indirect investment options are safe, investors should consider the following factors before investing in order to gain higher yields and interest.

1. Brand Recognition and Market Share

Voice of the brand helps improve its presence in the market. A real-estate player with a long-lasting presence and delivery record achieves higher sales velocity and is safer for investment.

2. Liquidity 

As discussed, liquidity is an important factor for investors to consider in case of emergencies. An investor should map their risk appetite and ability to commit capital over the investment tenure to avoid any liquidity mismatch. 

3. Credit Rating of the Issuer

Credit rating is a reflection of credit risk that is associated with financial institutions and outlines their ability to repay their investors.

The highest rating is AAA followed by AA which means that the issuer is highly likely to achieve their financial obligations and pay their investors back. Higher the rating of the issuer, safer the funds are.

4. Security Cover

The investor should look at both, hard collateral and cash flow cover provided by the issuer for the respective debt raise.

The cash flow cover can be calculated with the help of the following equation.

security-cover-real-estate

 

Conclusion

Conclusion

Real estate investment, especially in financial instruments backed by real estate, has potential to increase substantially in the coming years.

Physical real estate investment offers conventional cash flow security while real estate investment instruments are regulated instruments that help diversify investment options and reduce risk. Both options are equally beneficial to investors based on their requirement and ability to invest.

However, regardless of the choices, before making any decision, investors must background check their issuer and analyse their creditworthiness to make safer investment choices.

 

 

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