December 31, 2011 12:18:09 am
The fragmented nature of the Indian developer community provides scope for Real Estate Private Equity (REPE) funds to source off-market investment opportunities and strategic relationships. This has led to Indian HNIs viewing domestic REPE funds as a preferred asset class for diversified investment.
However,REPE is not suitable for small retail investors,since the minimum ticket size in most funds is R 25 lakh.
REPE funds usually have a five-to-seven year life span. The period includes a two-year investment period where properties are acquired,followed by a 3-5 year holding period where active asset management is carried out. At the end of the whole period,the investors make an exit when the acquired properties are sold.
The typical expenses for such investor include:
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Annual management fees
One-time setup fees,and
A performance-based fee (also known as carried interest).
As in all other types of private equity investing,REPE investors have to review their financial condition,investment purpose,risk openness,time horizon,diversification and liquidity needs before making an investment decision. They also need to evaluate a number of aspects of the REPE fund itself. These are:
Integrity,quality and stability: The integrity of the fund manager and the quality and stability of the management team are extremely important,as are the quality of financial and operating controls,corporate governance and reporting.
Financial soundness: The investor also needs to evaluate the REPE funds overall capital structure,the soundness of the company assets and the sustainability of earnings. The due diligence should include its historical and prospective financial health and the potential returns on investment weighed against the perceived risk.
Market responsiveness: The funds ability to source off-market deals also need to be studied.
Commitment to ROI: The capital commitment by the fund manager and ability to enhance returns with leverage should be evaluated,as also the funds cash distribution structure and management fee.
Asset focus: The investor should look at the fund managers geographic and asset class focus,diversity of the investment structures,methodology for selection,management of JV partners and focus on asset management
Growth potential: Finally,the growth prospects of the company and its competitive position within the industry should be evaluated.
REPE funds attempt to provide returns independent of traditional asset classes. As a result of the low correlation to traditional asset classes,investments in REPE increase the diversification of an overall portfolio. A typical REPE fund seeks both income and capital appreciation from its portfolio investments,the overall goal being to achieve a gross IRR in excess of 25 per cent.
The funds manager will seek to achieve returns through several means,including:
Capital appreciation on land holdings
Net operating income on real estate projects
Capital gains from disposal of real estate projects
Income and capital gains on equity stakes in real estate companies
Project rental yields,and
Proceeds from financing activities.
The objective is to invest opportunistically in order to generate sustainable,scalable returns that fully compensate for the inherent risk in the underlying investments. Currently,the leading players in the domestic REPE industry are Kotak,ICICI,HDFC,IndiaREIT,ILFS,ASK,Aditya Birla,UIOF,Anand Rathi and Milestone.
The portfolio holdings in REPE funds may be difficult to value,because they are not usually quoted or traded.
Some REPE funds may employ leverage as a means to enhance returns,but leverage also increases risk because it magnifies negative returns if investments are poorly underwritten or executed,or if market conditions deteriorate.
Other risks include the sizeable entry costs and,as in any other equity investment,the possibility of losing significant amounts of money if not invested well.
The author is MD-West,Jones Lang LaSalle India
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