Myth 1. Knowledge of debt
instruments is enough for investment in InvITs and REITs because they work
mainly as fixed income securities. There is no necessity for understanding the
financial aspects specifically related to real estate.
Answer: If this
understanding was true, the mortgage crisis of 2008 would not have
happened. On the face of things, mortgage related instruments function as
debt instruments, generating a percentage return, just like other debt
investments. If the financial markets, where the mortgage instruments
originated and traded, had a deeper understanding of property cycles, property
valuation and other aspects related to property financing and investment, the
crisis could have been averted. Even if averting the crisis was not possible,
the money managers for these instruments could have been more informed to limit
their exposure, had they understood the financial and investment aspects which
are typical of real estate
Myth 2: When we invest in stocks we do not need to understand the product (i.e. before we buy shares of a manufacturing entity making that product). Similarly there is no need to understand real estate nuances for REIT investment. After all both are instruments in the capital markets and will function similarly.
Answer: If I were to invest in
pharmaceutical companies, there is no need to study about medicines before
doing so. One would rather make assessments (in addition to other fundamental
and technical analysis) regarding the potential for pharmaceuticals to do well
in future.
A macro view is most essential to any industry, and holds equally true to real estate industry for undertaking any investment. Here, we can bifurcate the analysis in two steps.
The first is regarding understanding of a manufacturing scenario of both these industries. A set of similarities with pharmaceutical companies can be drawn out (with real
estate developers) :- in both cases raw is
gathered, assimilated and sold. Investment in manufacturing companies making
pharmaceutical products and investment in real estate development company who
‘make’ real estate products can thus said to be somewhat similar.Thus if one were to invest in activity of a developer, it turns out to be quite similar on the face value.
The second is with regard to the end product. Here, things can be completely different since the finished product is an
investment asset and not just a product. How this product is treated at inventory level with the manufacturer, or at sale level or alternatively, at retention level can be very different. The dynamics that go into an investment
asset are extremely divergent from the consumption products. Herein lies the need to understand financial and investment aspects of real estate and not merely analyze the
instrument that helps in such an investment. REITs and InvITs are these very investment instruments but the basis of this remains the actual products - the property that it denotes.
The proof of the above explanations: The mortgage crisis of 2008 proved that even if we were to invest indirectly in real estate through various instruments and investment vehicles, the asset’s nature & behavior has a strong bearing on the way our investment functions. Thus real estate investing is more complex and different from other investments. It
has a certain pattern of returns, unique characteristics and many other
nuances. And its classification as a debt instrument may warp our understanding and future profitability that comes with such investments.
If market participants understand investment and finance dynamics well - comprising of both the real estate markets as well as capital markets, the full potential of such investment avenues can be realized.
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