Small Investors: EMIs, JIs & Private Money can make it possible!

As promised, here we go with our views on the next 3 options for small investors in real estate – Joint Investments, EMI options and Private Lending. You might be aware of these vehicles already, but we hope to add few extra points to your knowledge. So here we go:

1.       Joint Investments 

No awards for guessing what joint investments are! Consider this scenario - You and your friend want to invest in real estate, but are short on money. There is a lucrative property deal available which is sure to yield heavy returns; what to do now??

Yes, pool in money and share the property!

Pooling funds for Joint Investment

The above shown scenario is not very uncommon. Every now and then we come across people struggling with this issue, especially small investors. Joint Investments open up gates in such cases and investors can earn profits from the deal which otherwise they would have let go. Joint investments need not be in equal proportions, but it’s preferred so as to avoid any conflicts. Two or more people can join hands for an investment in different proportions and later enjoy the returns in the same ratio.

What is more important in this type of investment is clear agreement between different parties. Having a pre-signed agreement ensures that rights of all the parties are safeguarded and any possibility of conflict is minimised.

2.       Private Lending 

This may look like a new concept for some of our readers. The most common perception of Private Lending as soon as one hears about it is – “get a loan from private lender and go for your purchase”

WRONG!

Private money lending is actually the opposite of what common man perceives. It is giving ‘your money’ to investment companies to invest in real estate and return you your principal and a pre-decided interest portion.

Private Money Lending mechanism

This form of investment is relatively less risky in terms of returns and efforts to be put in by the first time investor. But sure, there are some other issues attached with this form of investing. Some of them may be:

a.       Credibility of the Investment firm

b.      No clarity on the ownership of the invested property

c.       No secularisation apart from the letter of deed

These issues can be mitigated if a proper analysis is done prior to selecting a private money investing firm.

 3.       EMI Options

Yes we know that it is very rudimentary to talk about EMIs. EMI is the most widely used concept today, not only in the field of real estate, but in almost every field. But more often than not, small investors fail to see its utility and neglects EMI as an option for investment.

Take an example of a young professional who wants to make an investment but is perplexed due to obnoxiously high RealT prices. As a result, he continues to reside in a rental apartment and invest in other vehicles like stock market. If planned and calculated properly, he can very well invest in a real estate property, making full use of available EMIs and resources otherwise invested in other investment vehicles.

Disclaimer: The purpose of our above analysis is to bring forth the channels of investment for small investors and make them aware of their in-and-outs. We are not advocating or recommending any of these methods. It is the rationale of the investor who has to take decision while making an investment choice.

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Financing - Funding a Real Estate Project

We got a feedback from some of our readers that our last post Ownership - Holding a RealT was a bit too much complicated to understand for a beginner. Totally respecting their valuable comments, we have tried to mellow down this post on RealT Financing (although the topic is way more complicated than the last one :-/).

What is Financing?

So coming back to the main business, the second level of Value Chain in Real Estate circumference – Financing. Just as you require money to pay for your household items, you need money to pay for your house (realty property) too. But financing a RealT deal is not as simple as buying vegetables down the street! More often than not, realty buyers need a proper plan, strategy and an agency to finance their dream projects. This is where this post originates J

How is Financing classified?

There are several ways in which a RealT deal can be financed. Typically all the ways can be classified under 2 heads – Equity & Debt.

To start with, we will cover the Debt portion in this post and try to explain the various options to raise finance through debt.

Debt

Debt, in literal sense means – “raising money from the market for a particular time horizon, at some interest rate”. Due to the advancement in the financial markets, many instruments have been developed to carry out this function. These instruments, if used rationally can benefit both lenders & borrowers, but improper use of such instruments can even lead to catastrophes like ‘Sub-prime crisis of 2008’.

Bank Loans

Raising money from a commercial bank is the easiest way for an individual investor. Banks offer attractive interest rates to the borrowers and are easily accessible. But this may not be the most effective way to finance a real estate deal due to the following reasons:

• Banks disburse loans for short-term
• The amount of disbursement depends on various factors like – individual’s net worth,  MPBF (maximum permissible bank fund), income statements, securitization etc.
• Indian Banks generally do not grant loans to a new real estate developer
• Banks generally do not grant loans on ‘land’ alone

Mortgages

Mortgage typically means taking loan from a party by pledging your property as a collateral against the loan. The mortgagee reserves full right to take a control over the pledged property in case of foreclosure (default, in simple terms).

Whatever you will read after this point is a bit complicated, but we have tried to simplify the concept as much as possible. Let’s see how much sense it makes. So, mortgages can be carried out in 2 ways:

Mortgage Broker:

The whole idea of Mortgage Broking is depicted in the above figure. Few points about this process:

• Brokers are independent agencies, having tie-ups with fund providers
• Fund providers generally prefer these brokers so that the borrower is already researched for credit worthiness
• Mortgage brokers are generally not involved in ‘loan servicing’
• They don’t use their own capital to fund the borrowers

Mortgage Banker:

These are specialized agencies which provides mortgages directly to the borrowers, using their own capital. These agencies do not accept deposits from the public, rather makes money from the loan origination fees & servicing fees.

They typically packages the loans & sell them to the institutional buyers or government sponsored enterprises in secondary markets. In US, there are Freddie Mac & Fannie Mae to carry out these functions while in India there is no such institution yet for this function. The nearest equivalent that can be thought of is Mortgage Risk Guarantee Fund.

We know that this has become a bit too much complicated to understand, but the following diagram may relieve our brain nerves a bit ;-)

So the whole process of Secondary Markets is depicted in the above figure. It shows step by step process followed by the loans to finally reach the borrower.

Note: We understand that this post has been a bit too much complicated. Please feel free to write to us in case you need any explanations on any of the above topics. The remaining portion of financing by equity will be covered in our next post. Stay tuned!!

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