Investors who opted for real estate private equity funds are finding themselves in the same sticky situation as many others who chose to buy property directly. While some funds have managed to rake in tidy returns, many others have shut shop. There is only a handful — about 10 real estate funds — in the market currently. Considering that there were about 50 real estate funds since the heydays of 2007, the current figure paints a dismal picture.

Slackness across segments Private equity funds that invested in real estate — be it residential or commercial— went into a tailspin owing to weak demand and falling prices. Investments made seven years back are stuck for want of exit avenues.

“Exits are happening at a slower place and most of them are through the refinancing route as many projects have been delayed due to want of approvals and slower absorption,” says Rubi Arya, Executive Vice-Chairman, Milestone Capital Advisors. She says that funds are instead seeking extensions to improve returns as opportunities for monetisation and exits are currently limited.

The commercial property segment has been beaten down in the last few years. The segment was hit by tepid rental demand, weak price appreciation and lack of buyers for large commercial developments.

In the residential segment, many projects carry high inventory levels. This has hurt prices and exit prospects of funds.

Shifting strategies To tide over the challenges in the sector, funds are shifting their strategies to improve returns.

For one, they are moving from debt to equity. Sunil Rohokale, CEO and Managing Director, ASK Investment Holdings, explains that debt funding relies on collateral and there is high risk of the funds being diverted for other purposes.

In contrast, equity funding is unlikely to throw up nasty surprises as the progress is monitored regularly and funds are managed more actively.

Developers have preferred debt funding in the past. “But now, with the market going through a rough patch, developers are open to equity funding,” says Rohokale..

There is also a transition from fixed high return debt deals to structured investment with lower fixed returns plus variable premium, based on the project performance, says Arya. She says that the average ticket size of transactions is falling as lower ticket size offers higher degree of certainty on timely exits.

Some of these strategies are working well. For instance, ASK Investment had at least four exits in the residential space. These investments have delivered 20-25 per cent annual returns. Likewise Milestone Capital has been able to provide rental income and exits in its commercial property funds.

Shorter tenures Investors, having burnt their fingers, have turned cautious.

With a lot of uncertainty in the market, many are opting for short-term investments of three- to seven-year horizon rather than sticking their neck out and locking funds for a longer period. For a three-year horizon, debt funding is a preferred choice.

“Uncertainties over taxation regimes and foreign currency devaluation have impacted the risk appetite of foreign investors,” says Arya. That said, foreign pension funds and long-term foreign capital are acquiring commercial real estate for its stable, high-yield rental income and price appreciation. She also notes that fund flows by way of NCDs in the residential real estate sector have dramatically gone up using the FPI (foreign portfolio investor) platform.

Some respite There are some signs of revival in the commercial segment, especially the prime office market. Data from property research firm Knight Frank shows that vacancies are falling and rents are inching up. In fact, office rents in Pune grew at a brisk 16 per cent rate in the first half of 2015, compared with the same period last year. And thanks to REITs (Real Estate Investment Trusts), there is likely to be more buyer interest. “We see exits happening in income-yielding assets from buyers such as Blackstone,” says Rohokale.

Nitin Jain, CEO, Global Asset & Wealth Management, Edelweiss Financial Services, feels that the commercial property market is turning the corner and returns may be favourable now.

But other themes, which may seem tempting, call for caution. Rohokale feels that township projects need ten years to generate returns and may not be suitable for those with a shorter timeframe. He also feels that retail segment may require a more favourable FDI policy. “Luxury property segment is risky and may be the last one to revive,” he notes. He is however, positive on the senior living segment, from a five-year perspective.

Investments in real estate are likely to see some structural shift. It is important that you do your due diligence before deciding on a fund. Aside from checking the theme of the fund and the team’s capability, it is pertinent to enquire about the track record of exits, advice experts.

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