Mumbai: For a sector that is projected to contribute ~14% to the country’s GDP by 2030, the Indian real estate sector is still contending with significant funding gaps across different development stages. Consequently, while traditional financial institutions like public and private sector banks account for two-thirds of real estate debt today, the contribution of NBFCs and other alternative financing channels has been on the rise in recent years. In fact, Alternative Investment Funds (AIFs), fractional ownership platforms and structured credit are the most notable financing routes that the developer community is increasingly tapping into from the alternative financing space. Among these non-bank financing mechanisms, private and structured debt has been supporting real estate developers in bridging capital gaps during the early stages of construction activity; even as investors achieve superior risk-adjusted returns for their invested sum. In a bid to understand how retail investors can benefit from such investment avenues, it is pertinent to take a deeper dive into the world of structured credit.
How to invest in structured credit
Recognised as a financial instrument that is usually backed by real-world assets, structured credit in India utilises instruments like secured non-convertible debentures (NCDs), mezzanine debt and lease rental discounting (LRD) to provide real estate developers with project loans. These funds are to be repaid using tailored repayment schedules; with the underlying assets often pooled together and used as collateral. For investors in India, there are a number of fractional real estate ownership platforms as well as alternative fixed-income platforms that offer them the opportunity to participate in this space. Alternatively, investors can choose to invest in SEBI-regulated Real Estate Investment Trusts (REITs) or Alternative Investment Funds (AIFs) that in turn take equity or direct stakes in large-scale quality commercial and residential real estate projects. Depending on the developer’s and project’s risk profile, investors directly plonking their capital in structured debt opportunities can earn inflation-beating yields on their investments.
Promise of regular income and capital appreciation potential
Unlike directly investing in real estate, which carries significant liquidity risk, structured credit investments often deliver periodic interest payments. Due to their specialised nature, structured credit providers not only earn higher net interest margins (NIMs) on the loans extended to developers, but also safeguard a large portion of the loan extended by taking the underlying land or rental rights as collateral. Thus, they can earn higher interest income without having to contend with risks associated with equity ownership. From an investor perspective, these instruments offer more predictable earnings visibility with sizeable downside protection. They can also choose where to invest depending on the levels of risk and return offered, making structured debt instruments as well as AIF & REITs that invest in them suitable for those wanting better risk-adjusted returns.
Competitive returns with lower risk than buying real estate
Unlike equity investors who depend on price appreciation in the underlying property to score long-term returns, structured credit investors ought to rely on the interest income generation potential, borrower repayment history and adequate collateral value to make an informed decision. Evaluating returns on the basis of risk-adjusted return measures such as the Sharpe Ratio can help investors in deciding between two or more opportunities. In fact, structured credit performs well on such metrics on account of their lower volatility, downside exposure protection and consistent income generating potential. As compared to many real estate equity strategies that deliver a higher expected return in a real estate bull market, structured credit are distinguished by better returns per unit of risk taken; deeming it ideal for investors focused on earning regular income while preserving the invested capital.
Disciplined deal structuring and investor protection
Considering that developers usually resort to availing structured credit when banks have lending constraints, lenders are careful to ensure that the property's value remains above the residual loan amount at all times. This is done to ensure that the lender, and by extension its investors, may be fully repaid in the unfortunate scenario where the developer fails to meet repayment schedules. For this reason, such credit is also supplemented with legal and financial protection by virtue of loan-to-value (LTV) covenants, cash reserve accounts, debt service coverage requirements as well as personal/corporate guarantees where applicable. That said, investors would do well to remember that investing in structured credit is not risk-free, making it imperative that they analyse the borrower’s credit quality, interest-rate risk and the loan structure along with laid-down covenants.
As India's real estate sector matures and the demand for alternative financing grows, structured credit is emerging as a compelling investment avenue for Indian investors. Investors cannot only achieve superior risk-adjusted returns on the capital employed, but also play an important role in facilitating the development of high-quality real estate and urban infrastructure projects. While many institutional investors are already using it as a core component of their diversification strategy, further democratisation of the alternative financing space will undoubtedly be the next growth driver of the structured credit space in the foreseeable future.
