How to leverage debt to invest in commercial realty

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Representing innovation and connectivity, the commercial real estate (CRE) market is influencing urban ecosystems and most investors are eager to capitalise on opportunities it presents.

According to Mordor Intelligence, the India CRE market size is at $40.71 billion in 2024 and is expected to reach $106.05 billion by 2029, with a CAGR of 21.10 per cent in this time-frame. Experts are predicting growth of 7 per cent to 8 per cent in the CRE sector, thanks to the growth of global capability centres. 

While investing in CRE demands significant capital, it is possible for retail investors seeking shopping opportunities to explore this sector. Developers strategically employ tactics like ‘leverage’ to maximise returns from their CRE assets. By leveraging borrowed funds, investors can access higher-value CRE assets that would otherwise be out of reach. It proves to be a suitable investment option for risk-averse investors looking for a stable source of income and minimal exposure to market volatility.  

Debt is a rising investment choice for diversifying portfolios. It means investing in real estate companies’ debt rather than buying properties directly. Investors act as lenders, earning a fixed return secured by the property. This minimises risk as the property serves as collateral, in case of default. While equity investments offer higher returns, debt is attractive for its stable income and lower risk. 

Debt financing alternatives

Real estate projects require substantial funds, and there are various ways to raise debt funding. One of the popular options is lease rental discounting (LRD), where financial institutions provide loans to property owners by leveraging future rent receivables. Another option is to raise funds through loan against property (LAP), where properties serve as collateral. Non-Convertible Debentures (NCDs) in real estate are high-return investments that are usually deposited with high-net-worth individuals. Compulsory convertible debentures (CCDs) are debentures that must be converted into equity over time. Each funding option has its unique advantages and considerations, depending on the specific requirements and financial goals of the real estate project or investment opportunity. Therefore, it’s important to evaluate each option carefully before making a decision.

Debt investments in CRE are becoming increasingly popular among investors due to the stable returns they offer. Furthermore, assets serving as collateral provide a level of security, enhancing investor confidence. Lenders can also invest across various segments, providing ample opportunities for risk management and portfolio diversification.

However, it’s important to note that no investment is without risks. Investors may face challenges such as borrower defaults, which can impact the timely receipt of payments. Additionally, if the sales proceeds of the property are not enough to cover the principal amount, the investor may not receive complete returns. 

Investing in debts can be illiquid in nature, meaning that the principal amount is locked in once you have committed to funding the real asset. This can make it challenging to access your investment funds in case of emergencies. 

To mitigate these risks, it’s important to plan carefully and select the appropriate debt instrument that aligns with your investment objectives. This includes conducting thorough research on the property, its location, and the borrower’s financial stability. It’s also important to have a contingency plan in place to address any potential issues that may arise during the investment period. Investors should be aware of the potential risks involved and take steps to mitigate them through careful planning and due diligence.

Debt investments offer predictable income but come with risks, like market volatility, borrower default, and uncertainties, that investors should consider. To balance these risks, strategic planning is necessary.

One way to mitigate the risks associated with debt investments is by opting for senior tranche debt investments. These investments have priority in case of default by the borrower, thereby providing capital repayment to the investor. On the other hand, mezzanine tranche debt investment is a hybrid of debt and equity financing that offers the investor an option to convert the debt to an equity interest in the company if a default occurs after the senior lenders are paid.

Apart from these investment options, leveraging loan origination platforms can also help investors connect with borrowers and access a wider variety of CRE options that would not have been possible through traditional means. Investing in institutional-grade, high-quality properties that offer a relatively lower risk of non-payment of rent can also be a good option for investors.

Small investors can use a real estate crowdfunding platform to pool their resources to fund large projects and get access to unique projects. Regularly monitoring real asset performance is crucial to assess investment viability and make informed decisions.

To unlock capital appreciation and passive income potential, define your investment goals and explore alternative real estate investment options. Investors can seek help from real estate advisory platforms to make wise choices and tap into the unexplored potential of the Indian CRE market.

(The writer is Founder and CEO, Assetmonk)

(Published 14 April 2024, 21:17 IST)

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