But when you are a high net worth investor, ‘good’ is not necessarily good enough. You want to invest in debt and yet beat the regular debt instruments’ performance. If it means taking on additional risk in exchange for higher-than-market-returns, so be it. If equity-linked debentures and other capital protected structured products were popular when the markets nosedived in 2008; it’s the real-estate linked debentures that seem to be the fad now.Real estate as an asset class never runs out of favour for HNIs. These debentures are created by developers. They are not regulated by Sebi or RBI, but the Companies Act
HOW THEY WORK A clutch of wealth management firms have been creating/facilitating these products, which essentially involve three parties. The real estate developer who issues such debentures; the HNI client who ‘buys’ them; and the wealth management firm that advises the clients, does the requisite due diligence to ascertain the developer’s creditworthiness and facilitates the entire transaction. Simply put, through such instruments, HNIs lend to the property developer in need of funds to start or complete a project. What HNIs stand to gain here is returns ranging from 16% to 23%, which is considerably higher than the regulated debt products. The tenure is between two and three years. Now, why would these builders knock on the doors of HNIs, instead of approaching banks or financial institutions? There was a period when real estate as a sector was not getting adequate funding through the banking and other financial channels. Traditionally, developers sourced funds from private money lenders who charge an interest rate of up to 30%. Borrowing from HNIs through real estate-linked debentures, which carry an interest rate of 16-23%, thus, is a beneficial proposition for property developers. These debentures are a secured form of lending. For instance, if the debenture is priced at Rs.10 crore, the collateral will be 2-3 times the amount. Typically, the builder pledges the land, plus any receivable and also some other properties with the HNI lender.
THE DUE DILIGENCE : When financial institution identify such deals, they always co-invest in the real-estate debentures. This is a comforting factor for HNI, as institution stay in the debentures together. Similarly as an intermediary they make clients meet the builder who is credible, financially sound and has a good pedigree. Sometimes, a developer may face temporary cash flow issues in the middle of a project. At such times, these debentures act as a good vehicle to raise money. Often wealth managers ensure the project is 80-85% complete so that the investor can be assured of its completion. For some reason, if the builder is unable to cough up the repayment at the time of maturity, the HNI can charge a penalty at a pre-fixed rate. This inculcates a financial discipline even in the builder with respect to his repayment.
THE RISKY PROPOSITION: Such transactions are usually not meant for retail investors, given the quantum of risk involved. Besides, the investment amount required puts such instruments out of their reach. Even HNIs who find such options lucrative need to enter with great caution after factoring in the risks, advise wealth managers. Investment in real estate debentures should ideally not exceed 5% of the portfolio. Also, these debentures, unlike the others that are open to retail investors, are not rated by any credit rating agency. So, the credit risk, or the risk of the builder turning a defaulter, cannot be wished away despite extensive due diligence by the HNI as well as his/her advisors. Here, the wealth manager’s assessment of the builder is the only assuring factor. Often, investors want to issue debentures to builders who are willing to borrow at a rate higher than the average. This should be avoided as a higher coupon rate implies a higher risk quotient, wealth managers say. Thus, like all exotic financial products, investment in real-estate debentures, too, call for high-risk appetite and a thorough understanding of inherent risks involved and, more importantly, resisting the temptation to take a large exposure to these products.
Courtesy: ET
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