Assured Return Investments as an Opportunity:

One of the major fixed return investment opportunities in the real estate space is in Assured Return early stage investments in builder projects where the builders give a fixed monthly return on the capital invested and a 3 – 4year lease guarantee post possession. This investment opportunity becomes fairly tempting for investors as the builder typically offers a much higher return on the investment than is currently on offer in ready rented properties or that which is offered on fixed return financial instruments by banks.

The Basic Elements of the Scheme:

• Builder takes up front payment from the buyer in down payment mode for the property
• Builder offers a return which is higher than the bank rate of return on the money (typically 10-12%)
• Builder offers a lease guarantee post possession at a return which is slightly lower than the assured return offered (generally 1% point below the assured return offered pre-possession).
• There are three scenarios post possession:In case the property does not get leased the builder pays the assured rental post possession,
• If it is leased at a lower value, then the builder pays the balance amount due to the investor post possession.
• In case the property leases at a value higher than the lease guarantee then either the profit above the guaranteed lease rental is split between the builder and the investor or the investor capitalizes the profit and pays that amount to the builder.

Let’s understand this with an example:

• Property being Sold at Rs. 12000 / sq.ft.
• Return being offered is 12% hence the investor gets Rs.120 /sq.ft /month during the period of construction
• Assured Lease Post Possession is Rs.110 / sq.ft /month (which works out to a return of 11% annualized)
• Post possession scenarios:Property not leased: builder keeps paying rental at Rs.110/sq.ft for the period of lease guarantee (typically 3 years)
• Property leased at Rs.100 / sq.ft. The builder pays the balance Rs.10/sq.ft to the investor till the period of lease guarantee.
• Property leases at Rs. 120 /sq.ft.Either both the builder and the investor share the Rs.10/sq.ft profit or the builder capitalizes Rs.10/sq/.ft @ the assured return rate which is 12% – this works out to Rs.1000/sq.ft and asks the investor to pay that amount.

Things to keep in mind while investing in Assured Return:

The idea of investing in an assured return property as opposed to a rented property is to get capital appreciation on possession. The execution risk and the leasing risk involved in buying an early stage development is generally not justified by the additional yearly return (typically 3-4%) in the assured return scenario.

How does one get capital appreciation on possession:

The capital value of the property post possession will be determined using the actual rental accruing from this property and at the expected return of rented properties in that market. Let’s assume that number is 8% (expected return from rented properties) for the Delhi NCR market. Hence if a property is leased at a rental value of Rs.110 /sq.ft then the capitalized value should be Rs.16500/sq.ft. hence in the above scenario the property we bought at Rs.12000/sq.ft and which is eventually leased at Rs.110/sq.ft could be sold at R.16500/sq.ft which is a return on capital of about 35%. added to this is the additional return (over and above that of a ready rented property) of 4%/anum (over the 3 year development cycle). Hence the total additional return on this investment over and above a traditional rented property investment is about 35+12 = 47%. This return can potentially justify the additional risk taken in an early stage investment.

Things to keep in mind to maximize probability of Capital Appreciation:

Since the entire basis for pricing of the assured return property is back calculated from the future assured lease value – this is how it works:

• An assured lease value is determined say Rs.110 /sq.ft.
• This is capitalized at 1% point below the assured return to be offered – so 11% in the above scenario arrive at the current sale price of the property
• Assured return is offered till possession at 1% point higher return than the assured lease.

Hence there are two things to consider:

• The spread between the assured return and the return on ready rented properties in the area should be significant. For example, if the builder is offering a return of 12% and assured return properties sell at 8% then that gives us a good 4% arbitrage on possession.
• The major thing to consider while evaluating the investment opportunity is the assured lease value. If it is at par with the expected lease value in the area at the time of possession (say 3 years hence) we would benefit from the capital appreciation due to reduction in yield (owing to the reduction in risk – since we have absorbed the risk of delivery and leasing at our end) offered on the property at the time of possession (yield coming down from 12% – > 8%).

Ideally if the builder is selling the property at an assured lease equivalent to the current lease rental then the potential leasing risk is reduced significantly. However, if the builder is making valuations basis an expected rental which is at a premium to the current rental in that area for the same quality of development we need to make an assessment if such a future rental is reasonable or not. Of course, the risk is slightly mitigated by the fact that the builder would bridge the lease rental gap during the assured lease period.