Assured returns projects are risky

Invest in assured returns projects at your own risk

These are very high-risk, high-return real estate deals with no regulator overseeing them. Unless you are a speculator and have the money, legal help and stomach for such deals, stay away

Devesh Chandra Srivastava, Mint 9/4/12

source: http://www.livemint.com/2012/04/08205625/Invest-in-assured-returns-proj.html

You can’t miss the billboards, the full-page advertisements, the television commercials offering you a juicy 12% per annum “assured” return on an upcoming residential or a commercial project. At a time when equity is volatile and high inflation is reducing the real return on deposits, the offer of a 12% return on a long-term appreciating asset like real estate sounds too good to pass up. The golden rule of investing is to question any deal that looks too good to be true; it often is too good to be true.

How do assured returns schemes work?

You buy a property outright (even when the completion of the construction is two or three years away) with either your own funds or a loan from a bank. Say, you pay Rs 1 crore for the flat. During the construction period, you get Rs1 lakh a month (12% per annum of Rs 1 crore) through post-dated cheques the builder issues you.

Once you get the possession of the flat, you can either exit the project or continue with the agreement, but the terms could change as the property will be leased out to a tenant and the developer may share the rent with you. There is no lock-in period for the agreement; it is usually for the next two, three, five or 10 years after possession.

SOUNDS GREAT. BUT LET’S ASK SOME QUESTIONS

From where is the developer giving a 12% return?

When a deal looks so good, we need to begin asking questions. The yield from residential housing is usually in the band of 2-6%. That means the annual rent as a percentage of the capital value is about 4%. A Rs1 crore property should get you an annual rental of about Rs4 lakh a year or Rs33,000 a month. So how is it that the builder is offering you a return that is three times the rental? There is obviously some other story at play.

Data from Kotak Securities Ltd, a brokerage house, shows that absorption levels in projects have deteriorated and there is an increase in inventory across prime real estate markets.

The excess supply is making some developers less creditworthy in the eyes of the banks and private equity (PE) that traditionally fund the business. This is forcing developers to turn to various other funding options, such as getting hold of bank finance but routing it through you, the buyer, because you get the loan at much lower rates. Says Gulam Zia, national director (research and advisory services), Knight Frank India, a property consultant firm, “This is a measure taken in desperation to raise cheap money from investors and buyers. If the same developer looks for a financing option from banks, he would get the money at a high cost (at a rate of 14-15%). Thus for him, getting money for 10-12% means cheaper financing.”

What is the guarantee that the post-dated cheques will not bounce?

Says Omaxe Ltd’s spokesperson, “In the past, it has never happened that any cheque has bounced from any developer.” The company that is running the scheme at one of its commercial projects at Greater Noida accepts payment from buyers in the company’s account, he adds.

However, it is worth mentioning that banks sometimes lend money to real estate developers by creating an escrow account. The receivables from customers also come in this account. The deposits made in this is strictly meant for the construction of the particular project. Says Ramesh Nair, managing director (west), Jones Lang LaSalle India, an international property consultant firm, “There is no such mandatory rule for creating an escrow account. However, this has been discussed in the proposed real estate regulatory bill.”

So is there a regulator overseeing this promise?

Seems not. In an email response to our query, the spokesperson of Reserve Bank of India said, “We do not regulate real estate firms so I won’t be able to respond to the queries.”

Capital markets regulator, Securities and Exchange Board of India (Sebi), too, does not regulate real estate projects, but has regulatory oversight over the collective investment schemes around real estate like PE funds.

India does not have a real estate regulator in place as yet. So you are believing the good intentions of the developer and his ability to keep the promise of payment. Questions Anurag Mathur, managing director, Cushman and Wakefield India, an international property consultant firm: “These are basically non-secure schemes. If there is some default from the developers’ side, what is the recourse for investors in these schemes?”

Unless you are a speculator and have the money, legal help and stomach for such deals, stay away from the assured returns projects. They come in with very high-risk (almost 90% of the cost is paid upfront to the developer) and high-return category of assets. There is an investor for whom these will work, but if you are the average salary-earning and EMI-paying homebuyer, stay away.

***

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