REITs and RIET of Real Estate

There seems to be a heady buzz in the Real Estate (RE) sector on the back of the new FDI (Foreign Direct Investment) policy and the new reality of Real Estate Investment Trusts (REITs) announced by the current government. This excitement was clearly evident at a conference that I attended on real estate organized by the Royal Institute of Chartered Surveyors (RICS).  I am always keen to hear where this sector is headed as hotels are an integral and important part of this core sector.  The theme stated "What's New: Predictions for the future - Trends shaping Indian Real Estate". It covered residential, retail, commercial segments; and nothing about hotels. Nothing; not even a mention in any one of the topics discussed. So, from being the super star - flavour of the season - and what not a few years back; this segment seems to have seriously fallen to the bottom of the barrel for the RE guys. I took consolation in the thought that maybe hospitality now truly belongs to the Infrastructure sector and not "Real Estate" and will probably get better visibility at larger - more important - forums. In all honesty, even I know that hospitality is no longer hot property with RE given the number of deals falling on my table for rescue. But, this is not a blog on hotels. (Guys! eggs and tomatoes are expensive so think before you toss them at anyone - especially someone who can do miracles with them).

Back to the topic. The new FDI policy has considerably reduced the project qualification requirements to allow much smaller projects to be consider for funding. Idea being to encourage growth in T2 and T3 towns with a larger agenda to promote SMART cities in those locations. There seems to be a lot of scepticism if it will actually achieve it's goal as FDI of now will rarely chase high risk. The beneficiaries may be smaller projects in Metro and T1 Cities and small to medium size developers with a good track record in delivery and with a professional team that treats that money with respect will end up as the real winners. But, there is a social change emerging in the way the younger generation perceives life. No longer is there a thirst to go Urban with the high cost and high stress lifestyle associated with it; rather go RURBAN where the lifestyle is relaxed; costs of living are low and where one does not live in a pigeon hole. That is the real SMART city of tomorrow and I have come across examples of villages that have transformed themselves into clean, green, eco-sensitive, reliant on renewable energy, with 100% literacy, completely net connected and so on.
http://www.scoopwhoop.com/inothernews/mera-gaon-mahaan/?ref=social&type=fb&b=0

I actually hope that FDI becomes the RIET choice (Rural India's Economic Thrust). However, attracting FDI today may be a bit of challenge. Yes, there is a strong case for India to attract capital for real estate - afterall there are very few places left in the whole wide world that actually can. But, the real returns on capital that had come into India between 2006-7 to 2009-10 (good times) is barely in single digits when one considers that the Rupee has depreciated 50% in the last 4 years and that it is hard to quote successful exits to begin with. Moreover, the end of  "Quantitative Easing" in the USA - the interest rates overseas may slowly and steadily inch up making investments in emerging markets a tad more unattractive. Then, do we need foreign money when there is so much money in India itself? That is exactly the belief many fund managers have - having raised tons of money locally for the RE sector. Investors, both big and small believe that deploying money in RE through an institution is a lot better given its better abilities to conduct the due diligence much  as well as secure the property as tightly a bank would. So, Indian money raised has been more structured debt at high interest rather than pure risk high return private equity. Most FDI post 2009 has also come in the same form to ensure a year on year return at a rate when adjusted would match the high interest rates charged by banks.

The developers were the happiest when they got PE money as there was no pressure to guarantee any form of return. Guess they were not the only greedy ones and those in control of giving out development permissions joined the party and no one really cared as playing on "Other People's Money" was always fun. No transparency, no reporting requirements, no project takeover threats either, and with local litigation laws being the way they are; the developer was under no threat at all. I know of cases where developers have asked Board Members representing their PE investors to exit at super low returns or not see a single rupee be returned for the next 100 years. Well wisdom does catch up and that's the reason why nearly 60% of the money brought in by PE from overseas sits undeployed.

The money sitting on the fence is waiting for the final brushes on the REITs policy to facilitate purchase a portfolio of good quality, income earning assets at good locations and get the required returns on capital through listing exits. While there is excitement that it will improve quality of construction, bring in transparency and become a source for raising funds for those with a proven track record; REITs will compete more with debt instruments in terms of returns; and with equities returning into the favourable zone with investors - will find it hard to attract capital to itself.

As a sector, real estate in India is suffering from "premature obesity" created by over inflated valuations by the greedy few that control the market. The actual user is still not the buyer and inventory meant to make housing and commerce more affordable is actually being bought by the very people who should not. Luckily for all, India is looking to enter its growth cycle and the excess inventory in all segments may soon find actual buyers. A massive correction will help; but that's not happening anytime soon as most developments have come up on no-pressure money. That in itself will keep new money away from the sector as at current values most acquisitions are unable to give healthy returns. Property Consultants and Developers believe that Indian RE sector is still an infant given the rising population and wealth in India. They have no choice but to believe that. Yet across the border a more populous and richer nation has swanky vacant dead cities that no one wants to go to.

I will not put a wreath on Real Estate anytime soon; but it's time the arrogance of this industry took a hard beating before it becomes to look like a snake eating its own tail - where one does not know if it is reinventing or killing itself.