Do your research in real estate

by Hansi Mehrotra

15th August 2014

Khushru Jijina, managing director of Piramal Fund Management, talks to Hansi Mehrotra about lessons learnt by real estate funds and how research is very important in this asset class.


The disappointing returns from real estate funds that raised capital around 2006 was a result of a number of things, some the fault of the industry and some by the investors. While the real estate industry is still evolving, investors should also do their homework before investing in real estate, which is an extremely local business. Experts recommend investors should partner with best quality names.


One of the best names in real estate is the Piramal group. This is reflected in the many series of funds that the group has raised including a recently closed joint venture with the Canadian Pension Plan. The managing director of the real estate business, Khushru Jijina, is obviously pleased that the most discerning global institutional investors have placed their faith in the group.


Lessons learnt


One of the most common questions asked of anyone raising capital for real estate funds is why they should be trusted given the poor performance of funds raised in 2005/2006. Jijina defends the industry by saying it had just come into being and hence, wasn’t really professional. “Even the big developers were doing a project or two in their town or cities, and those too were not big. Then came along the global funds, which encouraged those developers to aggregate land and do bigger projects without any experience. People went overboard. Some developers were hearing of concepts like IRRs and terminal value etc for the first time and the investors naturally assumed that the development life cycle would follow the west without giving credence to local nuances like delays in sanctions, approvals etc.,” he says.


Another aspect was the life expectancy of the funds was mismatched against the investments. Global funds with 7-year tenures invested in townships that would take a minimum of 10 years to develop by any reasonable estimate. “In a township, you are your own municipality and hence have to provide for essential civic services like roads, schools etc all of which take time to gestate.”


Another example he cited was the amount of construction assumed to be completed in the timeframe given. Funds had assumed impossible construction targets. “Even today, a big developer cannot do more than 4-5 million square feet. A mid-size developer is happy doing 1-1 1/2 million a year. So where is the question of 40 million square feet assumptions being achievable. So I think people have learnt the ground reality the hard way,” he quips.


The real estate industry has evolved somewhat but has a long way to go. The global funds should also have been more cautious given the nascent stage of the industry. Jijina admits there were also some developers who misled funds and investors, which further highlights the need for due diligence and partnering with a reputable local partner.


Real estate is a local business in any part of the world. “Just like a Chicago developer will not got to New York, a NCR developer won’t go to Mumbai. So we have to have local teams to deeply understand and manage local issues,” he elaborated.


Investors should do their research on the developers.


“Leaving all of the underwriting aside, the single most important factor determining the success of an investment is the quality of the development partner. This is extremely important in this business. Backing the right developer who has the capability to execute despite the cyclical nature of the industry and attempting to identify and box the risks associated with your investment will all contribute towards a successful exit in the future.”


Jijina is not perturbed by the developers who have preferred short-term gains over long-term reputations. “Developers who have focused on short term gains rather than a long term capability are suffering today as fund managers such as us will not fund them. So in a sense, they have alienated the providers of their single largest raw material i.e. funding”


However, he warns that people have short-term memories and could suffer again. “Once there is a sustained euphoria, with healthy economic growth, capital will come back to chase transactions. And we will also suffer given deals may start getting mispriced all over again”.


Big cities still offer opportunities


While local investors maybe starting to look at smaller cities, Piramal continues to concentrate on the five big cities – Mumbai, National Capital Region (Delhi and surrounding), Bangalore, Pune, and Chennai – as these have depth, intrinsic end user demand and established sales velocity. These also have decent margins providing a further cushion in the event that there is a deviation in assumptions.


Within these markets, one also has to break down sub-markets by locality and also by property type. He encourages high net worth investors to invest in these micro-markets directly if they know them.


Jijina’s says a fund’s value proposition is that his group offers a HNI the ability to access the other large markets – with the ability to co-invest for anchor investors. A lot of HNIs like the fact that they can invest alongside an institution such as Piramal who is an aligned sponsor. “Today, we commit anywhere from 7.5% to 10% of each fund as a ‘sponsor’ so we have a reasonably high amount of skin in the game”.


REITS will be a game-changer


Jijina is conscious that although some clarifications remain, REITs have the ability to become a good value proposition over time. He believes very few developers currently have the portfolio of investment grade assets needed for REITs, but those that do, will have a chance to raise cash and reduce debt. It is also good for investors who will have an alternative to investing in fixed maturity plans (FMPs).


He shared his concern for valuations getting too rich again, but he hopes the marketability of REIT units should ensure relatively quicker price discovery.


His advice to overseas investors – whether they pick unlisted real estate funds or listed REITs – is that they stick to credible names. “A credible local partner is extremely important to navigate the intricacies of the real estate sector given the misgivings of the past. There are a relatively few names who have established a track record of a full cycle – i.e. raising, deploying and ultimately exiting their previous funds.”