Real Estate Portfolio Management Schemes- Caution

I came across a ‘real estate’ scheme cobbled together under a Portfolio Management Scheme umbrella from an AMC. It was a plain product, where your money is invested in to residential projects under construction with builders, presumably at some agreed price and then the builder sells out the project and the profits are shared between the builder and the financier (the PMS scheme). The interesting thing is that the PMS scheme merely acts as a financier and hence there is negligible chance of making big money on this. The sales force promises fancy numbers but I do not see anything like that happening. The investors are asked to ‘commit’ amounts, with twenty percent or so paid up front. The upfront depends on the investment projects identified by the AMC. As they identify more investment opportunities, they make further demands from within the committed amounts.
As and when any project is exited, the AMC distributes the money to the investors.
Unless the PMS buys out a property outright, full profits cannot accrue. In the opaque real estate industry, I would not be surprised if the PMS managers also strike some ‘side’ deals, which by pass the investor. Each investment follows a different style. In some cases there would be outright loans to builders, in some cases it would be ‘right to buy’ flats on completion, at pre agreed prices and a series of ‘arrangements’ with builders. Most would happen to be builder friendly deals, with the AMC not having the expertise for exit. Many will also talk about investing in a “SPV” or investing in to a project by way of “Convertible’ bonds etc., The more complex the structure, the lower the chances of an easy exit. In fact, I do not understand why the AMC does not invest in a simple fashion? They could just enter in to a profit share or a pure debt with the properties mortgaged. Or simply buy out the project, engage a developer and carry on with life. These AMC’s are opting for ‘user friendly’ transactions with builders.
A typical ticket would be for a minimum ‘commitment’ of around Rs.25 lakh. The terms would call for immediate payment of anything from twenty to twenty five percent of the commitment. The balance of the commitment would be ‘called’ in a time frame of anything from a year to more than that. The scheme would typically have a life of five to six years, with loophole to extend it further.
The AMC makes its money through the following routes:
i) A ‘management’ fee of around two percent per annum, on the committed amount!
ii) A ‘profit’ share of around twenty percent of the total gains made by the investor;
iii) Sometimes there is a ‘hurdle’ rate. What it means is that the AMC will not take a profit share unless the investor makes a return equal to the ‘hurdle’ rate. This ‘hurdle’ rate is kept at a ridiculously low level like ten percent or so.
These are the legitimate ways where they make their money. It does not mean that an investor would get everything else. That depends on the integrity of the AMC. Since it is real estate, exit prices could have cash components which never come to the investor. Similarly, some of the property can be sold at below fair prices to friends and associates of the AMC or the borrower.
In many cases, the AMC would not have the knowledge or the expertise to understand what is going on. For instance, in one of the schemes floated recently, I saw that only one person had some experience in an industry associated with real estate. All the others were either accountants or lawyers. And this scheme was targeting a total collection of nearly thousand crore rupees! I would steer very clear of such schemes, where the manager has no background. Real estate laws and practices vary from state to state and call for a high degree of experience and familiarity. Alas, the distributor does not give a damn. In a time where commissions from selling mutual funds are virtually vanishing, the real estate schemes are manna from heaven. Three to five percent upfront is welcome. Regulatory control is non-existent on launch of such schemes. This is a Greek tragedy in the making.
In a recent case, I had seen a distributor negotiating with the AMC for a share in the ‘profit share’ on exit. This used to be common in most PMS schemes. In this case, the response was interesting. The distributor was told by the AMC guy that they will not agree for this, but when there is an exit, they will sell him some property below then prevailing market prices, so that he could make some more money.
One more scam in the making, where even the regulator has absolutely no clue about the industry as well as the dynamics. These kinds of schemes come under the ambit of PMS schemes, for which SEBI is a regulator. It is time that real estate investments get a separate regulator. Till then, it is best that such schemes be put to a halt. I am fairly certain that most of the real estate scheme investors will come to grief as the number of schemes keep burgeoning. And burgeon they will, given the fact that distributors are now starved of businesses with significant selling commissions.