Structured Realty Debt a Big Hit with HNIs

Experts find the trend disturbing as real estate cos facing low demand could default

Investment products structured around high-yielding real-estate debt are becoming increasingly popular among rich investors. Conventional money managers, however, view this as a disturbing trend as they expect real estate companies to face low demand, default on payments and fire-sell prime assets to raise funds over the next few months. 

Financial services institutions such as Barclays, JM Financial and IIFL Wealth, among other smaller players, are offering equity-linked real estate notes to rich clients who insist on capital protection, but would also like to pocket higher yields in real-estate debt and participation in equities, wealth managers said. Barclays, JM Financial and IIFL officials were not available for comment. 
An equity-linked real estate debenture is a typical debt note, but it differs from standard fixed-income product as the final payout is based on return of the underlying equity, which in this case is the Nifty stock basket. The structure follows an 80:20 ratio, where 80% of the funds are invested in debt papers issued by real estate companies. The fund manager uses the remaining 20% of the corpus to buy Nifty optionswhich ensures 100% participation in the stock market. 
Nifty-linked real estate debentures park nearly 80% of the money in high-yielding short-term bonds and non-convertible debentures issued by developers. According to three wealth managers, a typical structure would include papers of companies such as DLF, Lodha Developers, Purvankara, Unitech and HDIL having maturities in the range of 12 to 24 months and yields in the range of 11–14%. Some structures also have lowrated issuances of smaller real estate companies, which generate coupon rates in excess of 16%, wealth managers said. Affluent investors are advised to invest in the range of . 5-10 crore in this product, with a lock-in period of 18 to 24 months. 
"If all goes well, this product will deliver very high returns for investors," said the product head of domestic private bank. 
"Equity-linked real estate note is a high-risk product. The issuer, in effect, is bundling NCDs which they've bought from realtors and passing it onto investors. The structure could crumble if the developer defaults of payments," theproduct head said. 
Issuers are taking adequate precautions to prevent payment defaults by making real estate companies keep three to four times collateral cover on their borrowings, wealth managers said. In the case of smaller real estate companies, investment product manufacturers only includ bonds that are raised to complete certain projects. "Issuers of such products are providing adequate cover by pledging assets (land or projects) three or four times the value, with debenture trustees," said Richa Karpe, director – investments at Altamount Capital. "However, one cannot rule out risk as 80% of the funds are locked in real estate papers," Karpe said. 
Sector analysts expect real estate companies to face headwinds in the form of low demand and lack of easy working capital loans. Property transactions in top Indian cities have declined 50–60% over the past six months as a result of higher home loan rates and artificially-supported property prices. According to Sunil Rohokale, CEO & MD, ASK Investment Holdings, which manages a . 1,000 crore real estate fund, real estate companies face two major risks – one, cash flows have dried up for most companies and second, the risk of de-leveraging. 
"We do not expect cash flows to return immediately even if rates start moving downwards. Realtors, in their desperate bid, may try to sell assets to deleverage themselves. This will shrink their assets significantly," Rohokale said. 
Investors in equity-linked real estate notes run the risk of developers not being able to complete their projects on time, he said. 
"Repayment of investors' money will only happen if there are cash flows… In the absence of it, we'll see lot of payment roll-overs happening," he said. 
Risky Bets 

• While HNIs insist on capital protection they also like to pocket higher yields in realestate debt and participation in equities 

• An equity-linked real estate debenture differs from a standard fixed-income product as the final payout is based on return of the underlying equity, which in this case is the Nifty stock basket