By Dr. Sanjay Chaturvedi, LLB, PhD.
Introduction :
Real Estate Portfolio management is different from normal portfolio management because of nature of business and sector specific norms. It is also because there is no regulator nor any specific index. Real Estate is not having industry status in India hence regulatory frame work required for nay industry is not present.
In view of the above one’s acumen to capitalise and maximize the wealth has overruled financial tools like IRR and some of the researched based formulas. For any portfolio management the prime objective is to have maximum yield and appreciation of assets. Real Estate is dominated by market players. Since there is a huge demand for every piece of it, suppliers have their monopolistic approach in the sector.
For any Portfolio Manager it is direct competition with the supplier i.e. Builders and Developers. These manufacturer not only construct and sell but also behave as intermediaries between investors and actual buyers or occupants.
The Process
Stage -1 Planning
Stage -2 Implementing
Stage -3 Monitoring
An investment process is a plan of action for implementing an investment philosophy. To be successful, an investment process must be highly disciplined and consistently applied over time. At the very core of the investment process is the need to choose from among alternative investments. Selecting assets for an investment portfolio requires the investor to understand the risk-return trade off for the alternative investments available.
In planning investments, which more than likely are tied to some goal or a number of goals, the first step is to determine an appropriate asset allocation, given the individual risk tolerance, investment time horizon, financial big picture and the nature of the goal for which a person is investing.
Once we have determined our asset allocation strategy, we turn our attention to selecting individual asset for each portion of our portfolio. This can be one of the most interesting and challenging parts of the investment process.
An investment process for active investment management requires ongoing and regular monitoring, as well as feedback on performance.
Understanding Risk and Returns
Let us find answers to question like “How do investors measure expected return and risk?” “ What are the risk and return characteristics of various major asset classes?” “ What are some various alternative risk measures?”
Measuring Return :
In term of return, the first measurement to look at is the historical return on an investment over a given single time period ( or holding period return).
Single period holding period return :
If an investor commits Rs.100 to an investment at the beginning of the period and receive back Rs.120 at the end of the period, what is the return for the period? The answer is the holding period return. The period during which investors own an investment is called its investment holding period. The return for that period is the holding period return (HPR), or holding period total return. The HPR is defined as the percentage change of the investment for this period. I this example, the HPR for this single period is calculated as follows.
Rs.120 – Rs.100
HPR = ——————————– = 0.20 = 20%
Rs.100
As this simple formula suggest, the HPR can be positive, Zero, or negative. An HPR greater than zero reflects an increased value in the investment for the period; an HPR of zero indicates that the investment value remained unchanged for the period; and an HPR less than zero indicates a loss.
The holding period in the example just cited can be a month, a quarter, a year, 2 years or any other time period. In order to compare alternative investments with varying holding period, investors typically need to evaluate returns on an annual basis. ( In general, annual HPR can be computed by “Annual HPR = (1+HPR)1/n -1.)
Example 1 :
An investment that starts with Rs.100 is worth Rs.150 after a 2 year holding period.
Rs.150-Rs.100
Annual HPR = ( 1 + ——————)1/2 -1 =1.51/2 – 1 = 22.47%
Rs.100
Example 2 :
An investment that starts with Rs.100 is worth Rs.110 after a 3 months period
Rs.150-Rs.100
Annual HPR = ( 1 + ——————)1/0.25 -1 =1.51/0.25 – 1 = 46.41%
Rs.100
Since Real Estate price do not fluctuate within a year, the above calculations for annualizing HPR assume a constant annual return, as well as compounding from period to period.
Average Historical Multi-period Returns:
Over a number of years, any given investment will likely to have good years with high positive returns, flat years with low positive or zero returns and even bad years with negative returns. While investors should analyze each of these returns , they also need some summary measurement to analyze the investment’s performance over time.
Risk Measurement of expected and historical Returns :
Risk means uncertainty about future rates of Returns. Volatility or Standard Deviation is a popular risk measurement that quantifies how much a series of investment returns varies around its mean or average. With this risk measurement, investors can judge the range of returns that our investment is likely to generate in the future.
The Key indicator :
Like we have it for stocks and now for commodity also, Real Estate do not have any index. BSE’s Realty Index and NHB’s Housing Index may be taken into consideration for market trend but real trend can be followed in the public domain like classified of newspapers, new project ads etc.
Keeping in an eye on supply side is a good idea since supply normally effect the trend in real estate. For example Mumbai will soon have 19000 odd dilapidated structure’s redevelopment, Salt Pan Land, Mill Land, and land availability after repeal of ULC Act in Maharashtra.
Second basic point is affordability. To what extent a buyer can afford a property, is the question which will answer the highest point for a particular location.
There are reasons for investment. One of them is keeping an asset for life long yield. Second for appreciation. And third for Tax planning. The first one being followed by an individual besides some of them wants to invest for appreciation also. Second type is mainly followed by institutional investments like Sector Specific Mutual Funds. Third again by individuals who wants to save on taxes and built an asset.
Portfolio management applies for all of them except for keeping an asset for lifelong. The only aim for it is to gain regular income and yield. Hence optimization of yield is the main objective. It all depend on how you find a best occupier and keeping the relation well within the purview of Law of Land.
For appreciation and short term margin trading, real estate is best bet when it is under construction stage because from purchasing land till completion stage the time period is normally 18 months and in that stretch many investors and actual users invest. Hence exit is easy. It is difficult to exit at completion stage since you will be competing with the builder himself.
Non Performing Assets
Non Performing Asset means an asset or account of borrower, which has been classified by a bank or financial institution as sub-standard, doubtful or loss asset, in accordance with the directions or guidelines relating to asset classification issued by The Reserve Bank of India.
Prudential Norms
The NHB guidelines to HFCs on prudential norms for income recognition, accounting standards, asset classification, provisioning for bad and doubtful debts, capital adequacy and concentration of credit/ investments are:
Income Recognition: For the policy on income recognition to be objective it should be based on recognized accounting principles. Income from NPAs should be considered to have accrued and be recognized only when it is actually received. Interest on NPA should not be booked as income if such interest has remained outstanding for more than six months.
Accounting Standard: All accounting standards and guidelines notes issued by the ICAI dealing with lease accounting/depreciation / income recognition and so on may be followed by an HFC.
Accounting for Investment: All investments in securities should be bifurcated into current investments and long-term investments. A current investment is an investment that is by its nature readily realizable and is intended to be held for not more than one year from the date on which such investment is made. A long-term investment is an investment other than a current investment. Quoted current investments should be valued at cost or market value whichever is lower. Unquoted current investments should be valued at cost or breakup value whichever is lower. Long term investments should be valued in accordance with the accounting standards issued by ICAI.
Asset Classification
The HFCs should classify their loans and advances and any other form of credit into four broad groups: (a) standard assets (b) sub-standard assets (c) doubtful assets and (iv) loss assets.
Following definitions can be used for classifying assets:
Standard Assets: A standard asset is one in respect of which no default in repayment of principal or payment of interest is perceived and which does not disclose any problems nor carry more than normal risk attached to business. Such an asset in not an NPA.
Substandard Asset: A standard asset is one which has been classified as NPA for a period not exceeding two years. Such an asset would have well-defined credit weakness that jeopardize the liquidation of the debt and are characterized by the distinct possibility that the HFC would sustain some loss, if deficiencies are not corrected.
Doubtful Assets: A doubtful asset is one which has remained NPA for a period exceeding two years. Term loans, where installments of principals have remained overdue for a period exceeding two years, should be treated as doubtful asset. A loan classified as doubtful has all the weaknesses inherent in that classified as sub-standard with the added characteristics that the weakness may make collection/liquidation in full, on the basis of currently known facts, conditions and values, highly questionable and improbable.
Loss Assets: A loss assets is one where loss has been identified by an HFC on internal/ external auditors/ the NHB inspection but the amount has not been written off, wholly or partly. Such an asset is considered un-collectable although there may be some salvage or recovery value.
Provisioning
The HFCs are required to provide for loans and advances assets as follows:
Loans, Advances and other Credit Facilities including Bills purchased and discounted: Taking into account the time lag between an account becoming doubtful of recovery, its recognition as such, the realization of the security and erosion over time in the value of security charged, the HFC should make provisions against sub-standard, doubtful and loss assets in respect of loans advances and other credit facilities including bills purchased and discounted as under:
Loss Asset: The entire asset should be written off. If they are permitted to remain in the books for any reason, 100% of the outstanding balance should be provided for.
Doubtful Asset: 100% provision to the extent amount is deemed to be unrecoverable. For others, 20-50% of the secured portion depending upon the period for which the asset is considered to be doubtful.
Sub-standard Asset: A general provision of 10% of the total outstanding should be made.
Portfolio investment primarily comprising foreign institutional investors’ (FIIs) investments and American Depository Receipts (ADRs)/Global Depository Receipts (GDRs), witnessed net outflows in April- December 2008 as against net inflows in the corresponding period of the previous year. Outflows under portfolio investment were led by large sales of equities by FIIs in the Indian stock market and slowdown in net inflows under ADRs/GDRs due to drying-up of liquidity in the overseas market. During 2008-09, FIIs recorded a net outflow of US $ 15.0 billion as against net inflows of US$ 20.3 billion a year ago. In the current financial year, up to April 10, 2009, there were net inflows under FIIs to the tune of US $ 0.9 billion as against net outflows of US $ 1.5 billion during the same period last year.
Banking capital mainly consists of foreign assets and liabilities of commercial banks. NRI deposits, which constitute major part of the foreign liabilities, recorded a net inflow of US$ 2.1 billion in April-December 2008, a turnaround from net outflow of US$ 0.9 billion in April-December 2007, responding to the hikes in the ceiling interest rates on nonresident deposit schemes. Including other components, total banking capital, in net terms, turned marginally negative to US$ 0.1 billion during April-December 2008 as against net inflows of US$ 5.9 billion during April-December 2007. According to the latest available information, net inflows under NRI deposits increased to US$ 2.8 billion during April- February of 2008-09. Reflecting the tight liquidity conditions in the overseas credit markets and increased cost of borrowings, gross inflows under external commercial borrowings (ECBs) to India moderated sharply during April-December 2008. However, ECB repayments by Indian companies increased marginally during April-December 2008. As a result, the net inflows under ECBs slowed down to US$ 7.1 billion in April-December 2008 (US$ 17.4 billion in April-December 2007). During 2008-09 so far (April-February), approvals under ECBs remained low at US$ 17.2 billion as compared with US$ 26.5 billion a year ago. Despite tightness in overseas credit markets, gross disbursements of short-term trade credit at US$ 31.4 billion during April- December 2008 were comparable with US$ 32.2 billion in April-December 2007. However, repayments of short-term trade credit increased to US$ 30.8 billion during April-December 2008 from US$ 21.5 billion during April-December 2007 mainly due to some problems in roll over observed during the third quarter of 2008-09. Net short-term trade credit stood at US$ 0.5 billion (inclusive of suppliers’ credit up to 180 days) during April-December 2008.