More investor education about REITs is needed: Certus Capital founder

He talks about the sector's prospects, including the performance of real estate investment trusts (REITs) and the country's real estate debt investment market

The Indian real estate sector received about $5 billion in institutional investment during the first nine months of 2024. Ashish Khandelia, founder, Certus Capital, in a virtual interaction with Prachi Pisal, spoke about the sector's prospects, including the performance of real estate investment trusts (REITs). Edited excerpts:

 

Indian real estate received about $5 billion in institutional investment in the first nine months of 2024. What investment trends would you like to highlight?

 

Domestic investors’ participation has significantly increased, while foreign institutional investor participation has remained fairly robust over the last 10-15 years. India is an important destination for many global investors. A significant amount of investment by global investors has continued to be in either office or warehousing segments lately. We have also seen some successful initial public offerings (IPOs) of hospitality companies, and the hospitality sector is performing well. However, in my view, office and warehousing will continue to hog the limelight of foreign institutional investors. In the last quarter, domestic investors invested about $400 million. Many domestic investors are moving towards residential, and we continue to see that trend building up because of the change in the landscape of the residential segment. Earlier, there used to be a lot of informal lending by high net worth individuals (HNIs) or investments by retail investors. Now, investments have become institutionalised. Domestic investors can sense how strong the residential sector has been, and it is expected to continue. There have been significant improvements in volumes, as well as in prices, and I think the volume trends will continue. This is also reflected in the stock prices of realty companies.

 

What do you have to say about the overall performance of REITs in terms of annualised returns, capital appreciation, and distribution per unit (DPU) yield?

 

In India, there are three office REITs and one retail REIT. The REITs do not have a long history. The retail REIT (Nexus Select Trust) is performing well. However, most of the REIT stocks belong to the office segment. If we look at the returns of the three office REITs from their listings to June 2024, Embassy and Mindspace REITs have given total returns of over 10-11 per cent, while Brookfield has delivered slightly lower returns. Overall, the DPU has ranged between 5.5 and 6 per cent on a post-tax basis. I think that is what they are supposed to do. REITs are a debt-plus, equity-minus kind of product, offering greater stability. For long-term plans, investors consider REITs for capital appreciation and DPU returns. However, the fundamental problem with REITs is that, as an asset class, they are still not well understood by many investors who are otherwise active in the equity market. Additionally, REITs cannot be directly compared to equities. Some HNIs are leveraging REITs better than other investor categories. However, REITs are not a standard product for many institutional investors, leading to lower institutional investments. As a result, trading volumes have remained thinner than what the industry would prefer. More product discovery is needed. For this, increased education and visibility through various initiatives by the REIT association will be crucial for making REITs a prominent asset class.

 

What are the emerging real estate assets that you think will gain momentum in the near future?

 

With about $400 million of domestic capital inflow, the credit aspect of the sector will be important. Some AIFs have raised funds from domestic investors recently. There has been a strong recovery in the residential real estate market since 2020. At the same time, non-banking financial companies (NBFCs) and housing finance companies (HFCs), which accounted for about 55 per cent of real estate credit assets under management (AUM), are now down to about 14-15 per cent of the sector’s credit AUM. Consequently, a lot of capital has been pulled back while the sector continues to perform well, and there is a need for growth. There is an attractive opportunity in senior, secured, or special situations lending in the real estate sector. Institutions have excelled in this space. We have participated in about 9,000 such transactions between 2020 and 2022. Solution-oriented, senior secured debt opportunities can offer net returns of 14 to 16 per cent with solid collateral backing the investment. We believe it is currently one of the most attractive risk-reward options.

 

What details can you provide regarding your first credit-focused alternative investment fund (AIF)?

 

We are looking at a concentrated portfolio of five to seven investments through this fund, which we are planning to launch. We are working with legal advisors, although we already have an AIF licence. Our target is about Rs 500 crore. We aim to raise a fund suited to current market opportunities rather than a large fund, using our debt platform Earnnest.me. The investment period would be 18 to 24 months, with an expected return of over 20 per cent.

 

In one of your statements, you mentioned that the western and southern cities will account for about 70-75 per cent of your transactions. What is the strategy behind this?

 

We favour the western and southern cities because they are less speculative and have a large number of quality developers. Bengaluru has been performing strongly, as has Mumbai. Chennai is also a stable market. We appreciate the stability of these markets, where moderate long-term price growth is driven by fundamental factors rather than speculation.

 

What is your overall perception of the country's real estate debt investment market?

 

The real estate debt investment market in India has evolved from being a challenging space to becoming a mainstream investment class. It is aligning with the broader growth we are seeing in the fixed income markets. A lot of education is being provided about fixed income as a category, with real estate debt investments as a sub-category. Tailwinds in the fixed income space are similar to what we saw with equities with the advent of mutual funds about 30 years ago. Now, mutual funds and fixed deposits (FDs) offer returns of about 7-8 per cent, which drops to about 5 per cent post tax. This has become less appealing, given the rise in financial education. Moreover, banks are finding it difficult to mobilise deposits. Our finance minister stated that financial institutions need to focus more on retail participation, and our sovereign bond market needs further development. This broader trend will also benefit the real estate debt investment market. Today, the real estate sector requires annual debt funding of over Rs 1 trillion for growth, approval premiums, and construction. While banks and agencies play a role, there is significant room for an alternative, organised real estate debt market. The Real Estate (Regulation and Development) Act (RERA) and Goods and Services Tax (GST) have greatly improved transparency, which is crucial for attracting debt. We are optimistic about this market. As the real estate debt investment market matures, returns are expected to gradually decrease as its acceptance and track record improve. Over time, it could evolve into a large bond market similar to that of NBFCs.