The Hindu Business Line : Turning ‘dirt to dollars’

With growing expectations from property investors, increasing sophistication of home buyers, and new pressures on developers, the days of casual investing, unplanned development, and little attention to asset management are coming to a close.

With rising competition, professionalism is a must for creating value and wealth in real estate.

John Macomber

Among the over $2 billion of private equity investment deals conducted in India this year alone, the recent $18 million investment by leading investment firm Blackstone in a Bangalore-based real estate project management firm may seem relatively small.

Beyond dollars

But as an investment in the Indian real estate sector — one of the largest asset classes in the world, that affects businesses and the decisions they make — the deal sends a message and has a significance that goes far beyond simply its dollar value.

This deal tells us that the Indian real estate market is dynamic and vital to the country’s sustainable long-term growth, and that international investors see real potential in the entrepreneurial spirit that is currently driving growth in this sector of the Indian economy.

Blackstone’s choice of investment, however, also suggests that as India continues to grow, the days of casual investing, of unplanned development, and of little attention to asset management are all coming to a close: Blackstone invested in management skills, not just in a property.

Sophisticated real estate property developers and investors, some Indian and some foreign, will demand modern tools to ensure effective management of an asset that does not behave like a commodity, fixed income instrument or common stock.

As the head of Blackstone Real Estate India told the media, “In India, there’s no shortage of land or capital but there’s a critical shortage of professional project managers.”

‘Dirt to dollars’

It’s helpful to think of real property on a continuum — one could call this continuum “from dirt to dollars,” a phrase coined by my Harvard Business School colleague, Arthur Segel. On the “dirt” end, entrepreneurs acquire property, organise financing, design and develop buildings, and get them constructed and occupied. Value is created from dirt and building supplies.

On the “dollars” end of the scale, real property assets and their cash flows are aggregated, disaggregated, leveraged, split up, hedged, repackaged, and otherwise optimised so that they are matched up with buyers, sellers, investors, and lenders who most want the characteristics of those assets. At this level, on Wall Street, Lombard Street, and in Shinjuku, enormous wealth can be created.

Wealth creation

So, what does it take to create value and wealth in real estate?

First, an understanding of the five major asset classes in which investors are interested and how each one behaves.

Office: The largest class, depends on rent streams from companies which are growing and need space for many kinds of transactions;

Multi-family housing: This class depends on a high number of individual tenants who choose to live in the building and who each need to pay their rent monthly or weekly, even when it’s a major part of their income;

Retail: Volatile and depends on local economies, on the attractiveness of space, and on relationships with what can be very powerful store brands as tenants;

Hotel: A quirky asset class with appealing property, but where the contracts need to be renewed every single day for each of hundreds of rooms; and

Industrial — warehouses and distribution centres: Out of the mainstream of most people’s view, but critical strategic assets in a manufacturing and export economy like that of India

Secondly, knowing that for each of these, sophisticated real estate managers think about three phases of a project: the initial cost to acquire the land and build the building (first cost); the annual cash flow after expenses; and finally a projection of value at sale or disposition, which can often be the key variable in the overall profit of a project.

Finally, our research shows that it is common — but short-sighted — to think about individual property deals on their own. Instead, the most successful property users — and property owners — think on three levels:

The deal level: What can this one piece of ground and building become and how much cash can it generate?

The portfolio level: Should my firm focus on one type of property, or on many? What are the pros and cons of each?

The company level: What will it take to build an enduring enterprise in the face of rapid change, fast growth, and multiple opportunities in an environment where real estate and management skills are very hard to come by?

India is undergoing momentous changes.

With escalating expectations from real property investors, increasing sophistication of real property users, and new pressures on developers of real property, Indian leaders will do well to think hard about the role of property and the skills it takes to compete and make the most of this critically important, expensive, and ubiquitous asset.

(The author is a Lecturer at Harvard Business School and co-chair of the South Asia Real Estate Seminar taking place in Hyderabad from June 17-20.)

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