Principle of aggregating or seggregating money

Principle of aggregating or seggregating money

The core of all finance & investment activity

In all of investment and financing activity, there runs a central theme. This theme is so strong that it recurs in all investment classes, investment vehicles and is central to any asset class investment as well as financing. This is “Principle of money “aggregation-seggregation”

The principle of money aggregation-segregation can be explained easily as follows:

“The act of money changing hands for financing or investment purpose happens mainly to suit the varied needs related to timing of money-flows, of each party to the money transaction. This in turn has the impact of either breaking up (segregating) money flows in different parts for one party to the transaction. For the other party to the transaction it results in combining (aggregating) money flows into a single part.”

An investment or financing transaction in itself necessitates a change in pattern of cash flows and will take place only if this primary objective is in line with the needs of the transacting parties. The profitability merely makes the transaction attractive and is a catalyst.  The necessity or the main reason for the transaction is the need to change the pattern of timing of returns. To elaborate, let us look at the following:

1.      Investing: This is taken as an investment in an asset which will generate returns in future. An investment decision is an offshoot of this principle. The act of buying any asset is converting a single lump sum amount to result in either of these possibilities:          

a.       A lump sum cash flow in the future by way of disposal (sale) of the asset

b.      A periodic cash flow (or flows) in between the purchase day to final disposal

OR a combination of the above

To compensate for this lag in time, an investor needs more nominal amount of money later than what is invested now. The basic need to do this is already present: to convert the lump sum available into an asset generating flows later. Thereafter, it is the profitability of the investment, which helps the buyer to decide the best way to fulfill the need.

Similarly, the seller of an asset needs a lump sum amount at the time of selling the asset. The idea is to convert future streams of cash flows / returns to an amount now. The seller’s decision to sell the asset is based on this need. The seller’s outlook of lower time adjusted returns from the asset in future (whether periodic or in lump sum) helps catalyze the decision to sell.

The necessity or main reason for the transaction to happen from view point of both seller and buyer is the need to change the pattern of cash flows from this particular asset being transacted.

In the above transaction, one may say that the seller undertakes to sell the asset not for his need for the lump sum amount, but to invest elsewhere to gain higher returns i.e. the ultimate objective is higher returns. However, as far as the particular transaction in question in concerned, the need is to convert the timing of flow of money from this particular asset to a way suited to the seller. The new investment will further place this seller in the position similar to that of an investor, as outlined above, with a need for converting lump sum amount to periodic cash flows (the new investment being catalyzed by higher returns and the last transaction catalyzed by lower returns).

Here we assume a rational investor as well as a rational seller acting on a logical set of decision making framework & not acting on whims and fancies or emergency/peculiar situations.

2.      Financing: One can put finances (in asset /business), by way of debt or equity.  Even this transaction impacts the timing of returns.

In case of a debt or loan being given, we first see the lender’s perspective. The lender changes his lump sum amount to:

a.       A lump sum cash flow in the future by way of return of principle and interest

b.      A periodic cash flow (or flows) in between the lending day to final closure of loan by way of return of principle and interest

(Or the above in various permutations & combinations)

From the point of view of borrower, it is easy to see that he is taking a lump sum now and parting with flows in future i.e. an inverse of the lender’s position outlined above.

Similarly, in case of equity investments the equity stakeholder parts with a lump sum and the recipient of equity money takes the lump sum cash flow (parting with the stake in asset or business). In terms of understanding of the principle, the other mechanics remain quite the same in terms of cash flows arising out of loan.

In both cases of loan and equity finance, the catalyst (profit/ gain) is similar though outlined a bit differently. The profitability generation, seen alongside risk aspects, has different characteristics. In case of loan, the profitability for lender (or cost by borrower) is defined by the interest. In case of equity it is simply gain (or loss) by way of share in residual profits after all costs, including interest costs.

As seen above, the act of money changing hands for financing or investment purposes happens mainly to suit the varied needs for timing of  returns (in terms of cash flow) of any party to the money transaction. The risks and returns are at best either deterrents or catalysts.

Real Estate Education: Need and Importance

Confucius, the Chinese thinker and social philosopher has said, “Study the past if you would define the future”.

Things have been exciting in the Indian Real Estate in India. Yes, it may be a bit of a rough ride now for many stakeholders in the sector, with the recent slowdown and inventory pile-ups. Encouragingly though, the compass seems to point in the right direction. Today, we are probably at a threshold level in Indian Realty Industry, quite similar to the times that are of significance in the history of Capital Markets in India. As a direct comparison to the year 1992 onwards, which began with SEBI and technological advancement in capital markets, significant regulatory measures in recent years are opening up avenues in the Realty Sector in India. This, coupled with the changes at ground level, has resulted in a huge change- a change which is being led by the private players within a policy framework being created by the government.

At the grass root level, the industry has changed like never before. The product which earlier comprised of only limited government offerings has evolved into a bouquet of products – ever more sophisticated and even catering to specific needs like IT buildings, SEZs, affordable and luxury housing etc. This has led to evolution of rating mechanisms for real estate projects, growth of huge realty companies and many reputed financial consultancies creating separate verticals specific to the real estate sector.

At a macro level, we see numerous policy changes effecting Real Estate sector directly like: focus on smart cities, RERA, the SEBI REITs Regulations 2014, policy changes for SEZs, efforts for foreign capital infusion like the recent FEMA amendments & easing of ECB norms for affordable housing, the Sardar Patel Urban Housing Mission etc. All these changes are being done pro-actively in very recent years by the Government of India.

It is a result of this ‘one direction’ of macro and micro level efforts that we see the emergence of smart cities, integrated townships and integrated complexes. We see huge infrastructure being created. More professionals are entering the industry which has been somewhat tainted – again like the erstwhile stock market participants in India. India will soon have a regulator which will channelize the functioning – changing the way in which all participants in the realty space operate. The flow of global capital is being facilitated allowing integration of the sector with the world. Additionally, we are also trying to make sure that everybody reaps the benefits– housing for all by 2022 is a step in this direction itself.

The way forward is to educate more and more people. The question that naturally arises here is – “How can education benefit the sector?” The answer again lies in the past – analyzing the way in which financial market development has taken place in India and at a global level. All the study, research & analysis work at the education institution level helped create new and innovative financial instruments, different investment vehicles and many more innovations. The participants in the financial markets developed this knowledge further, applied it in practice and benefitted from them.  After all this, we realized one more thing- the cycle is still incomplete! We realized that apart from education of bankers, brokers, asset managers and analysts, all savers and investors must also be financially literate. And only then the cycle will be complete. To achieve this for inclusive growth, now an emphasis is laid on gaining knowledge of financial and capital markets in many higher education courses.

Similarly, we have in every economy people who are in one way or the other connected with or effected/ benefited by real estate. On the one hand are the participants in the realty sector, while on the other hand there are the users, investors and financiers. The regulatory and manpower fulfillment channels of education (elaborated in pt 1 and 2 below) would be good for one group i.e. participants in real estate sector. Development of financial skill sets (elaborated in pt 3 below) will be of great help to the second group i.e. users, financiers & investors. The fact that the mortgage crisis of 2008 happened with such severity points to the overall lack of knowledge regarding the functioning of the sector and the risks associated with leveraging. With the advent of REITs and more avenues for investment, the linkage of the real estate sector and financial sector will keep gaining strength in coming times. Here again, only educating both the groups will complete the cycle and increase the pace of the sector tremendously.

Along with other things functioning at both the micro and macro levels, the leap forward in real estate sector will be propelled by education and the growth itself will throw open a multitude of opportunities in Real Estate Education in India as well. It is a symbiotic relationship. As of now, three categories of education emerge - for development of higher skills related to real estate in India:

1. Regulatory Requirement fulfillment: Education catering to licenses and certifications, regulatory requirements etc- prevalent in most developed economies (e.g. real estate brokers’ certification). In India some courses - NAREDCO, REDCO, etc exist for the same.

2. Industry's manpower need fulfillment - These courses fulfill the “Direct Manpower Requirements” of the real estate industry for managerial / decision making skills. These can be either of the two: a. Short term courses- Say 3 to 4 months’ courses. Can also useful for in-house skill set development. e.g. Facility Management courses etc. b. Long Term courses - Can be one year/ two year courses - E.g. MBA in Real Estate.

3. Development of Financial Skill sets: Real estate NEEDS to be studied along with other asset classes. An inescapable asset class for any investor, its importance is growing with  growth in Indian/Global economy,  fractional ownership models, PE funds, huge credit volumes in the sector, new instruments  of financing etc.

Interestingly, apart from the above (regulatory understanding, manpower skill up-gradation and literacy for people), we have yet another side to real estate sector. It is a fact that the real estate industry is deeply connected to the natural and human resources of any country. In order for the sector to be profitable and survive in the future, sustainability must be ensured – both with respect to the environment as well as the connected people. The environment will be saved in case the participants inculcate sensitivity to the issue – and understand that this is the way forward to ensure survival. Similarly, the social fabric will be preserved with carefully understanding, in spirit, the provisions of LARR (the Act, modifications etc). We need to focus on these aspects as well, by choosing the right from the wrong. At the same time we must create a fine balance so that the growth of the industry is not hindered.

With such a large number of factors influencing the Realty Industry, proper education alone can remove the confusion and any negativity associated with it. It will be helpful in giving it the INDUSTRY STATUS that it deserves- one that will tremendously impact the future and fortune of our nation. The education sector associated with financial and capital markets blossomed post-liberalization period and is still growing. History is waiting to be repeated. Educating participants in real estate industry as well as people at large (even as a part of finance curriculum in various institutions), will play a great  role in making the sector a more organized and progressive one in times to come.

Confucius’ wisdom seems to be guiding us here. Are we ready to follow?