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Mapping risk-return profiles across real estate life stages

By Jasmeet Chhabra

  • 16 Jul 2015

A well-reasoned investment decision never undermines time, risk and return—the three essential constructs of money—which otherwise is fungible across deployment avenues. Within the broader gambit of real estate it is therefore essential to deconstruct the various stages in the life of real estate to correlate it to the constructs of money.

Plotting and layout developments

Plotting and sale of layouts is the most primitive step in the value chain of real estate. Having been through the pain of aggregating land, ensuring access, contiguity and sanctions, mostly the land aggregator with aspirations to move up the value chain and become a developer is tired and then he resorts to simple layout sales. In its most basic form, the developer needs to only provide a spinal road, storm water drains, electricity for common areas and access to specific plots and then cut plots in different sizes and sell them.

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This trend would be most visible in upcoming cities or in undeveloped outskirts of large city. Since the value add is minimal and there is no attempt at community building, typical buyers also are not end users but investors who are looking at parking extra capital albeit of a smaller magnitude then a land aggregator. The developer would still have made money on account of the first degree of economies derived from having bought undeveloped land by the acre and selling sanctioned land by the square yard. This is a bit of speculative investment given that there is no real value addition to invite habitation. In lucky circumstances if the city develops in the general direction of such layout the price uptick may be visible but mostly such increases would be in a spurt, rendering better part of the holding period of 7-10 years reasonably flat.

A tad bit improvement to primitive layouts are relatively well developed layouts wherein the developer goes the extra mile to make the development livable. Herein, he may not still develop the villas/row houses, but he does attempt to create the civic infrastructure for a community by master planning the site. He would provide central and peripheral roads, provide street lighting, electricity, sewage treatment, landscaping and club house. In larger developments, it would also include convenience shopping, schools, etc so that the buyer is tempted to buy the plot and develop a house thereon.

Typically such developments do not happen in speculative outskirts but in areas which show promise of rapid urbanisations which may have been triggered either by large scale infrastructure projects like airports, roads, etc coming up in such locations or promised movement or development of industry hubs like special economic zones, industrial parks, etc. As the community grows, the value in such developments also moves up albeit exponentially with a holding horizon of 5-8 years.

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Moving up the value chain, is the single family homes and row houses within large gated communities. In addition to all the civic infrastructure the developer here also takes care of maintaining homogeneity of housing units by actually developing them. By virtue of developing residential units, the focus clearly shifts from investors to end users who would eventually like to use the units. This helps build a community upfront and the ramifications of a good community quickly snowball into price appreciations and rental potential for the units. Typically such developments are not too far away from the economic nerve centres of the city and given higher ticket sizes than apartments, such projects tend to attract a clientele with relative elasticity of pricing. Overall, such investments have the potential to generate healthy returns and multiples within 3-4 years of investments and are often more liquid than pure plots.

Apart from the fully developed villa projects which are the most advanced stage of layout development lifecycle and hence fully exploited in terms of development potential as well as restrictive in terms of ability add on or redevelop ones specific plot, the former forms of development have a potential for additional upside in terms of additional development potential that may be declared for the area. Such development also offer the freedom for one to design the homes to one’s specifications but the flip side to them is heterogeneity and often lack of aesthetics which are a value killer in the long run.

Apartments

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Apartments follow a lifecycle of their own within the larger gamut of development. While trader investors like to get in early in what is called the “pre-launch” stage wherein, often, the project is still in the process of establishing entitlements and approvals and hence a developer does not want a formal launch, yet is keen to test the market and raise capital to fulfill early stage capital requirements. Mostly, the pricing at this stage is subdued, offering a potential 15 per cent uplift on launch. The investor puts in between 20-35 per cent payment upfront. Thus, by the time of launch, there is a notional gain of 30-45 per cent on his investment already. Typically such investors look at staying  in the project for the a maximum of 12 months, work on the basic premise that they would not need more than 50 per cent of the consideration and opportunistically trade the unit ones he sees visible uptick in prices post launch.

Most “hedge” investors look at getting into real estate post launch while it is still under construction. This offers a two-fold benefit. On one hand, thee investor gets between 3-5 years to pay for the unit thereby providing him adequate payment terms. On the other hand, typically as the risk premium on the project decrease with construction and delivery, the prices tend to increase in tandem. As a thumb rule, the launch price to delivery price follow a ratio of 1:1.7. Most investors in this category look at a long-term horizon for their investment spanning north of 7-10 years. Since such investments are backed by a heavy mortgage with average repayment cycle of 7 years, these investments are quasi insurance for the family, purchased keeping in mind future requirements of the family including education, marriages, retirement, etc. While rental income is a major play for such investors, however, rentals are the not the primary value drivers.

Finally, “user” investors are not investors in true sense given their buying decision is an outcome of need rather than investment. Looking at an apartment for end use, such buyers tend to pay the maximum price given their desire to assume least risk and hence buy ready to move in property. Such buying decision cannot strictly be considered as an investment, as the underlying asset is not tradable and hence its value is also not realisable.

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(Jasmeet Chhabra is managing partner at ARGIL Advisors LLP. Views are personal.)

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