Saturday, November 24, 2007

Taking the mutual fund route to realty

Donald Trump Junior is in India. The Trump name is synonymous with 'spectacular' real estate success in the US. That this global moneybag is planning an India foray is advertisement enough for Indian real estate.

However, having said that, the options for investors who want to capitalise on India's real estate boom without investing into real estate directly are largely limited to a few listed real estate stocks.

The ICICI Real Estate Securities Fund, for one, promises to offer a strong realty flavour. The fund will predominantly invest (51-100 per cent) in high-yielding debt securities issued by companies associated with or benefiting from the real estate sector. At the same time, the fund plans to invest up to 49 per cent in equity of companies, which are engaged in industries that benefit from the real estate sector or have substantial investments in property (including land holdings).

Nimesh Shah, managing director, ICICI Prudential Asset Management Co Ltd, said, "Indian real estate sector is growing rapidly and is expected to register a growth rate of over 30 per cent per annum in next five years."

An additional opportunity stems from the fact that banks' ability to lend to the projects is largely restricted to the book value of the property rather than the market value. Also, real estate projects are considered a risky space by the rating agencies and their debt instruments are usually rated A+, signifying high risk.

This is why real estate developers usually raise money at rates higher than other companies do. All this translates into additional returns for the fund.

What's more, the market value of the property being far higher than the book value, the fund will get to invest in debt that is of AAA (low risk) quality but get the returns of a A+ (high risk) debt. Typically, the returns are in the range of 13-14 per cent, according to the fund managers.

Since it is a three-year closed-ended fund, the fund would enter projects of small-to-medium size, which typically get completed by the maturity of the fund.

To begin with, the fund will invest 70 per cent in such debt securities. The remaining will be invested in equities of companies, which are into real estate or benefit from their landholdings. The fund manager says only companies with at least 51 per cent of their operating earnings from this stream would be open for investment by this fund.

So, how much is the default risk. Are we creating an Indian version of the subprime crisis? It doesn't seem so. The fund says it will invest only in companies that have long and established track records.

But, is past performance an indication of the future? Ask Donald Trump senior. The much-married, flamboyant real estate tycoon went to the brink of bankruptcy as the real estate market went into a recession. By 1990, the effects of recession left Trump unable to meet loan payments. Trump had financed the construction of his third casino, the $1 billion Taj Mahal, primarily with high-interest junk bonds.

That put him at a disadvantage with competitors who used more of their own money to finance their projects. Although he shored up his businesses with additional loans and postponed interest payments, by 1991, increasing debt brought Trump to business bankruptcy and the brink of personal bankruptcy.

Banks and bond holders had lost hundreds of millions of dollars, but opted to restructure his debt to avoid the risk of losing more money in court.

The Taj Mahal re-emerged from bankruptcy on October 5, 1991, with Trump ceding 50 per cent ownership in the casino to the original bondholders in exchange for lowered interest rates on the debt and more time to pay it off.

The Trump story sums up what can go wrong and what options are available for the lenders in case things go wrong.

Those who want to make a few bucks and get out before things begin to go wrong can put their money in this fund. Besides, didn't Trump senior eventually came out of his troubles and was left with enough money to give his son to scout for some Indian assets?


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