Technical evaluation & returns on investments

Technical evaluation & returns on investments
By AT Bureau

Parameters affecting value of property
The decision of investing in real estate is a scientificate decision. A lot of due deligence goes into the investment, primarily due to the nature of the investment. The investment horizon is long term involving heavy investments. Unlike other investments where the exit barriers are absent or are not so considerable, real estate investments involved high cost implications while exiting. Thus, prior to investing a very detailed evaluation has to be carried out for the property. The various parameters that have to be critically evaluated are as follows:
Geographical Location: Real estate prices as well as trends differ widely across regions, states and cities. Commercial centers within a state predominantly have higher real estate prices as compared to other cities in the same states. Besides the commercial development other factors like physical and social infrastructure also affect the movement of real estate prices.
Type / quality of Property : The return on investments depends largely on the type of property invested in. Commercial real estate investments involved larger capital as compared to retail investments. Commercial real estate would essentially comprise of projects for office use (front / office/ back office) purposes of companies. Retail real estate comprises of Malls, Family Entertainment Centres, Multiplexes, Shopping Centres and Hotel. The returns, quantum of investment and the risks associated with the two types of property differ significantly between them and within the two types also. Quality of real estate also matters, as good quality properties are able to draw high rentals on account of status value enjoyed by the occupants.
Tenant Profile : For buildings already having tenants in form of offices of big multinational companies, the tenant profile is quite important to the investor. The profile of the tenant would essentially include the following:
· Nature of the Business : The occupier should belong to a sector, which is not very much vulnerable to economic downturns. The business should have a stable cash flow source ensuring financial feasibility of the business. This would limit the exposure of business risks. Banks are considered to be best tenants for any investor and command a premium over other tenants. Thus the reputation of the company presently holding occupancy of any property surpasses all other factors for consideration.
· Historical Trends : The history of the occupier as a tenant is also carefully analyzed to predict the future stability. A frequent mover is considered to be more risky from the investor’s point of view.
· Other factors: The importance of that particular business to the company is also crucial. If the business being conducted form the premises is its core competenancy, then it would not be under too much pressure However, if the business is an allied business, then it may decide to shelve it during turbulent times to focus on its core business. The amount of investment made by the tenant in the commercial space in the interiors also acts like exit barrier. The higher the investment the higher is the exit barrier and binds the tenant to the building.
Location within the City : Within the city, location is most critical in predicting the future movement of prices for that property. Thus, under stable real estate markets properties in the Central Business Districts (CBDs) tend to appreciate with time. Alternatively under changing (instable) real estate markets, property values tend to stabilize or decline in CBDs.
Overall suitably of the city as investment location: It is equally important to check the overall investment environment in the city before taking a leap into real estate. Growth pattern and stage of the development of the city matters the most. Appreciation of the value in real estate is largely governed by the present and future demand for real estate in the city. It is equally important to study the demand drivers in the economy, government policies and incentives offered in the city for investments. Clear understanding of property tax structures in the city is also essential as it is a recurring and incremental cost in property investments. Investors should also analyse the social and political environment in the city before putting their money as it affects demand for real estate. Low liquidity of property investments also justifies the need of such analysis. To illustrate the above mentioned point, take for example the demand for space by ITES companies. States with a stable government, good quality human resources and company friendly ITES policy have seen a boost in the demand for real estate in them. Prominent amongst them are Karnataka and Andhra Pradesh.
Structure of lease : The structures of lease is important in deciding the net outflow of the lessee and the lesser. It also incorporates the escalation clause in the rent of the property. The duration of lease and renewal clauses are largely governed by the regulations applicable in various states. Stamp duty and registration charges amount to a significant one time cost in the investment transactions. The agreement can be structure din such a manner that this cost is reduced as much as possible. Brokerage is also a component of this one time cost. The investor should carefully look at the gross and net rentals within the agreement and find out the difference. The investor has to pay property ax and other outgoings from gross rentals achieved. Income tax is deducted from this net rent to arrive at the net income from the property.

Tenure of various avenues of Investment
The various avenues of investors available can be categorized into three broad segments. These would generally be on the basis of the investments horizon.
Long term investment: The investments would typically have a tenor of more than 5 years and more, after which they start showing good capital appreciation. Real estate, Bullion and G-secs would comprise of this segment. Real estate in particular is one segment where the product life cycle is long as compared to other investment opportunities.
Medium term investment : These investments would have an investment tenor of 2-3 years. These instruments include bonds issued by corporates, mutual funds, foreign exchange and fixed deposits. The bonds are with “AAA” rating by credit rating agencies like CRISIL, ICRA etc.
Short-term investment : The capital markets form this segment of investment classes. The average tenor of investment would be 1-2 years. The volatility in the market prohibits the investor to maintain a long position in the investments.
2.3 Investment Returns
General returns in various avenues of investments are summarized in the graph below:
Sources ICICI Property Services Research
Returns on forex and bullion are capital appreciation while others are annual income
The above ranges of returns are for 8 – year rolling (min to max)
Equity markets have shown negative returns which have not been shown above.

2.3.1. Bullion
Bullion has been for long considered a safe investment by many people mainly, on account of the limited supply, consistent demand and as its appreciative nature. Gold especially stored in the form of bars or coins (99.99% purity) offers easy liquidity. The graph below shows the capital appreciation an investment in bullion would be giving.
The above graph gives the return on a 3 year rolling period. It clearly shows the fluctuation in the bullion market over a 10 year period. The returns have moved from 10.5% in 93-96 period to touch negative levels I the 96-99 period and have finally moved to the 10% mark in 00-03 period. There is a standard deviation of 5 % for the bullion returns for the period analyzed.
A longer investment horizon gives a return as shown in the graph above. As seen, these returns are quite low and are in the range of 1.0% to 4% in recent times.
2.3.2. Foreign Exchange
The forex returns have not shown a negative return. The returns have however been decreasing. From a peak of 22% in the 90-93 period, the returns have come down drastically to nearly 2% in the 00-03 period. The current trend of the appreciation of the Rupee against the dollar will also be a deterrent in investments in forex.
8 year rolling returns as shown in the graph below do not show as wide a range as 3 year rolling returns. Also the returns are range bound form 5.75% to 11% and do not have a negative return period.
2.3.3. Government Securities
Government Securities (G-secs) are considered to be the safest of all sources of traditional investment vehicles by investors. The returns however are quite low and vary from 6-8% (Yields in this case).
With interest rates decreasing in the last few years, most of the securities issued by the government are offering lower yields.
2.3.4. Corporate Bonds
Large Indian Corporates have been raising money from the markets by offering better yields then G-Secs. “AAA” rated bonds by corporates have been offering a spread of 100-200 basis points more than the yields offered by G-secs which make them an attractive option.
The only gray area is the number of such reputable corporates. There are very few players in the market, which command such credibility where people are ready to invest in such issues.

2.3.5. Equity Markets
The capital markets are seeing the maximum volatility in today’s market. The sense had reached astronomical heights (5500-6000) in 1999-2000, and 14000+ in 2007, owning to the technology boom before crashing to reach at levels of 3000-3300. It has scaled newer height sin 2003-2004 of 6200 before reaching to the present levels. The high volatility in the market has made it difficult to predict its direction.
The graph clearly shows the maximum volatility for any investment avenue. From an abnormal return of 55% in the 90-93 period to abysmally low negative returns of –3%, the capital markets have become quite speculative and unforeseen.
A longer investment horizon as depicted in the above graph shows a steady decline in the capital market returns with lesser uncertainty as compared to 3 year rolling returns.
Courtsey : ICICI Securities