Piramal takes a contrarian call

Even as real estate investors wait for that elusive price correction, Piramal Fund Management has taken a contrarian call through its Indiareit Apartment Fund which was launched in October. The fund, the first of its kind in India, has raised Rs 550 crore from high net-worth individuals, promoters and family offices to purchase residential apartments across India at discounted rates.

Even in such market conditions, the fund is looking to generate IRR (internal rate of return) of 26 per cent over two to three years, unlike other private equity funds which have a lifespan of five years or more. The fund has already deployed more than 50 per cent of the money raised last year.

The risk factor associated with project completion is addressed by the underwriting skills of the Piramal Fund Management team. The team delves deep into project specifics like location, pricing in the area, sales velocity and quality of the developer before writing out a cheque.

Karan Bhagat, CEO of IIFL Wealth, who marketed the fund, calls this an innovative product as it allows investors to participate at the equity level in a project. When a large fund which understands the real estate market and has a suite of financial offerings strikes bulk deals with developers, the risk is minimised for investors because the fund ring-fences the risk through binding agreements with developers.

In order to minimise risks, the team enters into rather stringent contracts with the developers and in many cases also builds in clauses whereby the fund can take over the project if completion is not according to schedule.

So how does this fund work? The developer gets upfront cash for an under-construction project, which enables him to complete it. In return, Piramal gets some apartments at a discount. The developer, while taking the money, commits to sell one tranche of these apartments 25 months down the line. The developer can sell the remaining apartments at a later date. If the sale price is higher than the agreed price at which Piramal wanted to exit, the upside is shared by the developer and the fund.

Omkar Realty has sold apartments in its Malad project worth Rs 100 crore to Piramal's apartment fund. Babulal Varma, managing director of Omkar, says: "Construction is happening now at a much faster speed, which gives comfort to buyers too. When a large fund like Piramal invests in projects, it helps ease financial pressures and service debt easily. What it also does is help the developer hold on to prices."

Omkar's Malad project, Alta Monte, was launched at a price of Rs 7,500 a square foot three years ago and the price now stands at Rs 16,700 a square foot. On an average, developers like Omkar give an upfront discount of 25 per cent to bulk buyers like Indiareit Apartment Fund.

Easing liquidity

Real estate funds like Piramal's are a boon for developers in these market conditions as they help unlock liquidity and complete projects on time. Developers typically take bank funding for construction and the tenure of such loans is 33-42 months. These days, their cash flows are affected because they are unable to sell their inventories, which results in delayed payment or even non-payment to the banks.

Money from funds like Piramal's prevents build-up of stress and helps maintain price discipline. "Bulk sales form a part of every developer's model as he cannot keep piling up debt. We are able to negotiate lower than market rates given our cheque size and payment terms alongside some form of minimum guaranteed return across each transaction. The individual units are specifically selected (keeping in mind considerations like layout, vaastu, flat size, etc) and held in a separate special purpose vehicle with charge given to the Fund," says Piramal Fund Management Managing Director Khushru Jijina.

What makes Piramal's apartment fund unique is that the banks are co-investors, which helps bump up returns. Bank loans for such apartments are in the 12-13 per cent range, which is way below the desired IRR of 26 per cent.

The key challenge for the Piramal team is to identify the right project. That will depend on the fund management team's expertise and ability to mine primary data from a sizeable portfolio in Tier 1 markets. So far, the Piramal Fund management team has identified six opportunities in under-construction or near-ready projects where it thinks investors can earn appropriate risk-adjusted returns.

"In some instances we also factor in a rerating of the underlying micro market given our ability to hold apartment units over the medium-term (target hold period of two to four years) for a further upside on our investments. This upside, in turn, is also shared with the developers in ratios agreed upfront - something that the developers forego in typical bulk discounted sales to retail investors," says Jijina.

Minimum risk

The concept is not altogether new because high net worth individuals have historically invested in residential projects in early stages to generate attractive returns. The difference in this case is risk assessment by the Piramal team. "The risk is addressed by our underwriting and for this particular strategy the project specifics (location, pricing, velocity), stage of construction and quality of the developer counterpart (and, in turn, the contractors) become very important," says Jijina.

From an investor's point of view, a fund like Piramal's apartment fund works very well because it allows him to invest in real estate without the relevant risks. Also, in order to invest in multiple geographies, investors need to have in-depth understanding of the market. The investment is structured through listed non-convertible debentures, whereby the incidence and impact of 'transaction costs' such as stamp duty are largely reduced. Income, too, is taxed at a lower rate applicable to listed securities, the fund management team explains. Therefore, on a like-for-like-basis an HNI investor who is contemplating a residential purchase for investment reasons would be better served invested through the fund route rather than negotiating and buying from the developer directly.

The timing could not have been better for a product like this to come about, as the real estate market is sluggish right now and investors can earn an upside a couple of years down the line.

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