Real Estate Debentures 101: Pros & Cons For Investors

The developers solicit the loans of the investors and repay them with quarterly or monthly interest payments. It provides a consistent flow of money for the investment.

Non-Convertible Debentures, as opposed to convertible, cannot get converted into equity shares. The higher interest rates of the Non-Convertible Debentures justify this. Also, investors can put their money in NCDs via unsecured and secured NCDs.

But, firstly, what is a debenture?

A debenture is a sort of bond that is not collateralized.

Most bonds get collateralized in some way. If the borrower cannot repay the loan, the borrower’s assets may get auctioned to repay the lenders. For investors, collateral is an excellent kind of safety.

A business, for example, may issue a bond to obtain funds for a new product line. Corporation real estate is utilized as collateral, maybe two or three valuable assets owned by the company. If the corporation cannot repay the bondholders, it will liquidate the properties and utilize the earnings to repay the bondholders.

Debentures, on the other hand, are not guaranteed by any collateral. If a borrower cannot repay a loan, investors may not receive the remainder of their investment. As a result, they are riskier than ordinary bonds. They do, however, have advantages.

Debentures get routinely issued by corporations and governments to raise funding.

How Do Real Estate Debentures Work?

These products, which effectively involve three parties, have been created/facilitated by wealth management businesses. The real estate developer who issues the debentures, the HNI client who ‘buys’ them, and the wealth management business that advises the clients all perform the necessary due diligence to determine the developer’s creditworthiness and facilitate the entire transaction.

HNIs lend to property developers who need capital to begin or execute the project using this. HNIs stand to benefit from returns spanning from 16 percent to 23 percent, which is much greater than the returns on regulated loan instruments. The contract is for two to three years. Why, therefore, would these builders contact HNIs rather than knock on their doors?

There was a time when the real estate sector did not receive appropriate funding from banks and other financial institutions. Historically, developers obtained capital from private money lenders, who charged interest rates of up to 30%. HNIs serve as a bridge between conventional institutions and private money lenders, who issue debentures for 18-20% interest rates.

Borrowing from HNIs via real estate-linked debentures is thus advantageous for property developers.

These debentures are a type of secured financing. For example, if the debenture is for 10 crores, the collateral will be worth 2-3 times that amount. Typically, the builder commits the land, as well as any receivables and other properties, to the HNI lender.

Pros of Investing in Realty NCDs?

• Real estate NCDs are safer investments than other types of debentures. You have a physical asset in Real Estate to assist you in collecting your debts in the case of an unanticipated occurrence.
• The duration of NCDs in real estate is only a few years. As a result, short-term investments such as NCDs provide a fantastic opportunity to generate a consistent income through handsome interest payments.
• You may invest in a high-net-worth property using NCDs and receive profits without owning it. It is a convenient way to make money.
• The coupon payment or interest received at regular intervals draws investors to this sector. These might get done monthly, quarterly, or bi-annually. It is a safe investment since the underlying security is worth twice as much as the investment. As a result, if the developer is issuing NCDs of Rs 100 crore, the underlying securities should be worth Rs 200 crore.

Cons of Investing in Realty NCDs?

• Development Risk: Most NCDs get discovered during the project’s development stage. If the project takes a long time to complete, it may also take a long time to redeem the NCDs. While this is an excellent moment to invest in NCDs, with yields ranging from 17 to 20%, this is dependent on sales. NCDs may get extended if sales get delayed. So be prepared to wait a year to two longer than first promised. While a total default is uncommon, the developer may occasionally delay payment. Thus, your money may get stopped.
• The end-use of funds: Another danger is the end-use of funds collected via NCDs, as there are no restrictions on utilization. As a result, investors must keep an eye on whether the funds are being used for construction, payment for floor space index or transfer of development rights, or repayment of existing debt. It is not a good indicator if the majority of the NCDs get used to service outstanding debt. Investors should request quarterly or semi-annual updates on fund utilization. It may be accomplished by requesting a certificate of completed payments from the issuer corporation. While most NBFCs undertake this on behalf of their clients, it is not an issuer practice.

• Selling too soon might be problematic: If an investor purchases these NCDs to sell them before maturity on stock markets, his investment may be subject to interest-rate risks. Any downgrading in the credit rating of these bonds might result in a significant drop in bond prices on the bourses. When attempting to sell their NCDs in such circumstances, one may encounter insufficient liquidity on stock markets. Even if a buyer gets located, the amount suggested may be significantly below the bond’s actual market value.

Should you invest in real estate debentures?

Debt, according to analysts, is currently at an all-time low. Fixed deposits, bonds, fixed maturity plans, and non-convertible debentures provide high yields, enticing investors in droves.

But when you’re a high-net-worth investor, ‘good’ isn’t always enough. You want to participate in debt while outperforming traditional debt products. If it means assuming more risk in favor of higher returns, then ok.

This urge to make a little additional money frequently drives individuals to exotic goods, which wealth managers continuously build with such clients’ expectations in mind. If equity-linked debentures and other capital-protected structured instruments were popular after the 2008 market crash, real-estate-related debentures appear to be the rage again.

Real estate as an asset is never out of favor with HNIs. Developers create these debentures. They are governed by the Companies Act rather than the Sebi or the RBI.

How do Realty Non-convertible Debentures stack up against REITS?

NCDs are bonds issued by real estate firms. REITs are similar to mutual funds or collective investment schemes in that they deal in real estate projects on behalf of investors, whether in properties, mortgages, or mortgage-backed securities. While real estate NCDs are fixed-income investments for investors, the returns on Reits are market-linked. As a result, they may appeal to different types of investors. Individuals interested in real estate should explore Reits and await for the same.

REITs are safer since an investor receives units equal to his investment in a tangible and running income-generating asset. But, total returns (minus yield) will depend on rent escalation for the property price to rise.

When you invest in REITs, you know precisely your cash flow because it has already been set with minimal changes. In the case of NCDs, project sales and actual value may or may not be realistic, but there is a massive opportunity for higher returns.

How safe are real estate NCDs?

Investments in real estate NCDs are not unsafe since the security that is the continuing real estate project and land held for the NCD issue, is more than 2-3 times the amount funded. Interests on the investment will only accumulate 6 months after the investment gets made. The principal gets paid in installments one year after the investment gets made. Also, in case, the real estate developer defaults, the debenture trustee will always ensure the investor gets compensated because it can dispose of the retained securities.

However, a few problems of real-estate NCD investing should not get neglected. So, you should not invest if you wish to exit before maturity. Consequently, there will be no liquidity for the product on the stock exchange. Plus, even if you can find buyers, the offered price will be well below the bond’s actual market value.

Do you wish to put your money in Real Estate Debentures as well? Assetmonk is a property investment platform that provides interested investors with services. Assetmonk’s NCD investment products are the Sparkle series in Chennai and the Ascend series in Hyderabad. These have an estimated IRR of 21%, allowing investors to put their bucks in high-value properties without property management.