Real Estate NCDs ?

posted by : Moneybase


Real estate NCDs are high risk, high return instruments.

Consider investing if you are a HNI with an investible surplus of more than ? Rs.1 crore.

Non-convertible debentures (NCDs) issued by real estate developers and privately placed with high net worth individuals (HNIs) are not a new product. They have been around for three-four years and are quite a rage among a certain category of investors thanks to the high rate of return. Needless to say the return is at a premium because of the underlying risk attached to the product. This risk has played out in some cases; The Economic Times in January reported that Century Real Estate, an influential Bangalore-based realtor, failed to pay the timely interest on one such bond, placed with investors by Kotak Mahindra Prime, a non-banking finance company (NBFC). Recently, industry insiders indicated there were delays in interest payment from Sheth Developers, a Mumbai-based builder, who raised money from investors through IIFL Private Wealth. Yatin Shah, executive director, IIFL Wealth Management Pvt. Ltd, a wealth management company, did not deny that the payments were late, but said that the last interest payment due have now been received by investors.

According to Rajesh Iyer, head–investments and family office, Kotak Wealth Management, “Delays do happen but then the payments get regularized and there is a penal interest paid for delays.” While the risks are significant specially given today’s market environment where real estate sales have slowed, these NCDs are a “pull” product because of high yield. Before you take the plunge and invest, here is a quick look at what you are in for.

Why is it sought after?

According to Ashish Shanker, head–investment advisory, Motilal Oswal Private Wealth Management, “With other asset classes not performing in the last four-five years, there is an increasing demand for high yielding NCDs, which typically are issued by real estate developers.” This is clearly a product marked for the HNI with a minimum ticket size of Rs.1 crore. The draw is 16-20% per annum coupon that you can earn. Typically, this kind of fund raising happens from developers in tier I cities. They essentially raise working capital for a project or for the entity as a whole. They can either borrow from banks and NBFCs or sell the property they are building to generate this required cash flow. These days, however, real estate sales are in the slow lane and banks too have reached their upper limit of loans to this sector. Hence, additional funding from NBFCs and private placements with HNIs is a welcome source.

The reason these appeal is that the tenor of the product is not very long—mostly 18-36 months. Interest rates can be in a wide range depending on the developer’s profile and the profile of the project for which money is being raised. Moreover, the interest payment frequency is favourable with monthly, quarterly and annual options. So, for you cash flow can be seen at quick intervals. Often the developer may even have a call option to partly pay off or redeem bonds after four-five quarters. Nishant Agarwal, senior director, wealth advisory solutions, ASK Wealth Advisors Pvt. Ltd, says, “Call option is a flexibility developer keeps to either pay off this high cost debt ifhe has excess/surplus cash flow say from unexpected sale spurts or when he can refinance the on-going high cost loan from another bank or NBFC at lower rate and reduce his borrowing cost.”

There are no official estimates, but industry experts put the amount of outstanding NCDs anywhere around Rs.3,000-4,000 crore. There is scope for more issuances, too, as Shah puts it, “This market will see growth but is largely dependent on the previous track record and experience of the investor. Developer’s credit history will also play an important role.”


The other side of the coin is risks. Basically, the developer will offer land as security and land is seen as a very real and tangible collateral. The trend is to offer two times the value of funds raised. Additionally, in some cases personal guarantees and post-dated cheques act as further comfort. Prima facie, this seems fairly acceptable as a safety net against default. The catch is that the land against which security is given, is not broken into plots of Rs.1 crore value. Which means in the unforeseen event of a default, you may have to recover security from a large plot of land, whereas your claim is only on a small portion. In practice this can be a very cumbersome process, both for the developer and the investor. Agarwal says,“Security enforcement in dire situation could be a long drawn and cumbersome process. Advisers do not have a legal role to play; but thanks to their relationship with the developer, access to both borrower and lender and clout as financial institution, they act like mediators between all involved. ”Shanker says there are cases where ready inventory valued at two times the loan is used as collateral, thus mitigating the risk. Ultimately it is the trustees responsibility to ensure your interest is taken care of. Agarwal added, trustees get involved right from the first stage of default which could happen by delayin interest or principal payment. Shah says, “The consequences of default and recourse options for delayed interest payments are defined in the debenture documents and the same is to be enforced by the trustee.”

According to Iyer, “Institutional participation alongside individuals also gives comfort.” However, bear in mind that if an institution like an NBFC is off loading bulk of its assets by selling to individuals, they are simply reducing their own risk and passing it to you.

Mint Money take

Consider investing only if you are a HNI with an investible surplus much in excess of the Rs.1 crore minimum investment for the NCD and even then don’t over-allocate. Iyer recommends 10-15% of overall debt allocation. Even if you are bullish on the prospects of real estate industry in the next three-five years, remember you are not buying a physical property but just lending to a builder. In which case it is essential to investigate a few things before putting your money. Shah reinforces, “Clients are made aware of the risks of aproduct before they invest in the same and understand that high interest ratescome at a higher risk.” Agarwal cautioned, “While some investors do understand the risks, others are happy to just look for high return. As long as payment sare on time, they don’t question the risks.”

If the funds are being raised for a specific project, ensure there is an escrow account created for use of funds and you are first in cue for receivables from this escrow. Investigate the cash flow situation of the builder and how stretched cash balances are and lastly don’t forget to analyze the builder’s intent. Iyer says, “Merit of the project is very important. HNIs are sophisticated investors and ask the right questions about the developer and project.” Your wealth adviser showing a product with high interest coupon is only the beginning; don’t forget to ask the relevant questions. It’s not enough to just know the risks, understand that you also need to bear them in case of the unforeseen default.

Source : as detailed in