Realty schemes and the ground reality

People are investing money with builders in housing projects that are under construction. Here are a few of the loopholes in such investment schemes

I came across a ‘real-estate’ scheme cobbled together under a portfolio management scheme (PMS) by an asset management company (AMC). Your money is invested in 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 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, 20% or so paid upfront. The upfront amount 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 bypass 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 “special purpose vehicle (SPV)” or investing in 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 does the AMC not invest in a simple fashion? They could just enter 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 AMCs are opting for ‘user-friendly’ transactions with builders.

A typical ticket would be for a minimum ‘commitment’ of around Rs25 lakh. The terms would call for immediate payment of anything from 20% to 25% of the commitment. The balance of the commitment would be ‘called’ in a timeframe of anything from a year to more than that. The scheme would typically have a life of five to six years, with a loophole to extend it further.

The AMC makes its money through the following routes:
i) A ‘management’ fee of around 2% per annum, on the committed amount.
ii) A ‘profit’ share of around 20% 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 10% 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 Rs1,000 crore! 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. A commission of 3% to 5% 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 than the prevailing market prices, so that he could make some more money.

This is one more scam in the making, where the regulator has no clue about the industry as well as the dynamics. These come under the ambit of collective investment schemes, for which the Securities and Exchange Board of India (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 and these schemes offer fat commissions.

1 decade ago
Good article, but without the names it hardly is help to the investors, which primarily is your motive. Moneylife itself insists and requests to 'name' the companies so that people know who they are, then why is it suppressed in their own article. What if an investor is about to invest in the mentioned Real Estate Fund with only one experienced person, as stated in the article. How will it help that investor ? I suggest that if your motive is to alert and educate the investors, which I am sure it is, then giving names would actually help.
1 decade ago
The write-up is a timely warning investors. But since no names have been taken investors still remain in the dark about specific entities to avoid. Considering that Moneylife has earlier mentioned Country Club etc would it be too difficult to name these PMS schemes which we can avoid. Specifically what about ILFS-Milestone?
1 decade ago
I fully agree with the author. One of the biggest fraud prone businesses in India is that of real estate development. One of the worst form of agreement from the angle of the buyer is the agreement to be signed with a builder while buying a flat. In fact, real estate developers in India openly loot with silent and sometimes not so silent conivance of the authorities. Politicians pay lip service to buyers as their lips are sealed with the financial glue supplied by the so called builders and developers. Can anybody explain to me what is this animal called 'built-up area' and 'super built-up area'; if this is not fraud then what it is? There should be only one common parameter and that should be 'carpet area', anything else should be treated as fraud.
1 decade ago
Good that media reporting this.. but big newspaper always help builders...common people are in big trouble because of real estate and black money in it..
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