Diversify with real estate PMS

But it means high cost and you cannot withdraw mid-way

People are looking for new and exciting investment options besides the same old fixed deposits, mutual funds and shares to invest their hard-earned money. Though the few existing options could be sufficient yet sometimes there are specific products that could suit some investors. Portfolio Management Service (PMS) is one such option.

PMS could be an interesting avenue if it provides access to something unique, which is not available to retail investors otherwise. One example would be real estate PMS.

Since real estate bounced back after correcting in 2008-09, people are willing to bet on it again. Also, the absolute profit numbers they see in the sector are eye-popping. A property bought in 2006 for Rs 50 lakh is worth Rs 87 lakh four years down the line — a whopping Rs 37-lakh profit.

 

INVESTMENT IN REAL ESTATE
Retail investors face challenges while investing in property. They have issues about where to invest, in which type of property, the areas with potentially high returns and which developers to trust.Most investors base their decisions on hearsay. This, surely, is not the best way of going about investing in property. They also tend to get carried away by the euphoria when the market is soaring. And investment in property is coupled with the tax-saving option on housing loans, which makes the investor assume this investment is in their favour.

The other major problem is the amount of money needed for such investments. That’s a huge concentration risk as property investments have not been uniformly rewarding. But it need not necessarily be done directly. You can also invest in real estate through funds that invest in it. Let’s understand how.

INVESTING THROUGH PMS
Suppose a real estate fund is launched and it will mop up Rs 1,000 crore in six years, with an option of two more of one-year extensions. So, the fund’s tenure would be eight years. Investment at the retail level would be Rs 25 lakh. But the money will have to be paid over a period — 20 per cent upfront and the balance in tranches over a three-year period. This is the investment period when the fund manager locks in the investments.

The payouts will start happening somewhere in the following three years. In the first tranche, they will pay out the invested amount. In the second tranche, they will pay 10 per cent, which is the initial hurdle rate. This is the basic return they are offering. Then the next tranche of 2.5 per cent goes to the fund manager and the company. After that, if there are surpluses, it is shared with the client in a 80:20 ratio — 80 per cent to the client and 20 per cent to the company.

These funds typically cost two per cent of the total commitment amount annually during the investment period and two per cent a year of the residual capital commitment thereafter (total drawdowns, less cost of investments sold). And a one-time set-up fee of three per cent of capital commitment in the beginning.

TWO SIDES OF THE COIN
The advantage of investing through such funds is that these are managed by expertise. Due to the amount they are investing, they will have access to investments which are typically out of bounds for a normal investor. Like, they may jointly develop a commercial property with a builder and lease it. Or, develop serviced apartments with a back-to-back arrangement.

This investment option also provides more diversification to the portfolio in terms of places, builders and property types (residential, commercial, malls, resorts, hotels and others). The investor need not worry about property titles, legal issues in interacting with builders, etc, as all that is done by the fund.

But, there are costs attached that have to be paid irrespective of the returns. There is no guarantee on the capital or the return you might be expecting or are promised. The returns, if above a certain percentage in such funds, have to be shared between the fund and the investor. That makes it a little less attractive, as there is less risk for the company and more for the investor.

Investments in such funds cannot be stopped unless you are ready to forfeit the investments made till that time. Like, if one had handed out Rs 5 lakh as the first tranche and after that the investor decides he does not want to go ahead, the entire sum will be forfeited. Once invested, there is no liquidity for the money. The investor will need to wait for the tenure of the fund to get the money back. Last, the income tax payable on this is adverse. The entire profits are treated as income and will be subjected to tax, unlike the prospect of 20 per cent indexation for long-term capital gains or investment in capital gain bonds as in case of one’s own property.

Since there are benefits and downsides, one should carefully weigh both aspects. Investors should take a considered decision after fully understanding the pluses and pitfalls. These products, clearly, are not for everyone. For most, simple products would fit the bill just as well. These may be boring, yes, but they would work fine.

The writer is a certified financial planner