Real estate investment or loan to builder?

In a recent development, the real estate firm Unitech was asked by the Supreme Court to refund the money to home buyers for failing to deliver the homes as per the schedule.

However, the firm’s lawyer told the Court that the firm has no money to refund to the home buyers. (See the news).

Many home buyers probably wanted to buy a home to live in, but some might be buying the property for investment. Having said that, this was a classic case of not understanding the risk one was taking. While these buyers were buying property, the investment would be considered an investment in real estate only after the said property is constructed, all legal approvals are taken and the possession given to these home buyers. Till that time, it was akin to a loan to the builder. If the broker defaulted on the commitment, getting the money back would take looooong time.

Here is a paragraph from the book:

Investors investing in “under-construction” properties are taking a credit risk by making payments to builders. Very often, they consider the property as their security. However, a property, yet not constructed, cannot be considered as a property. Someone would be required to complete the construction, whereas the builder has already got the money, and the chances are, already used it.

This is evident in the Unitech case going by the argument of their counsel. The company has no money to refund, which means the money the home buyers paid to the firm has been used already.

It is important for one to understand the risks associated before signing the cheque.

#RidingTheRollerCoaster – 218

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Understand the risk you are taking

Recently, we came across this news item involving two cricketers’ and their investment in a “assured return” real estate scheme. Yes, we are talking about the news involving the Pathan (Irfan and Yusuf) brothers. (Read the news article here).

We will not get into the specific case of what happened here. However, there is a clear lesson to be learnt. The Pathan brothers and many other cricketers have seen a lot of money through their cricketing skills – thanks to their success at the international stage as well as the IPL. When so much money becomes available, the question is, “Where to invest?” This is the time to exercise caution (Too much money, where to invest? Don’t invite the Pied Piper), but usually we tend to become more aggressive as the amount of money makes us feel comfortable and safe.

Some numbers from the said article give us some wonderful insights. Read the last two paragraphs about the price at which Irfan Pathan was picked up by various IPL franchises.

Year              IPL franchisee                       Price for Irfan Pathan

2011              Delhi Daredevils                                  Rs. 8.74 cr

2014             Sunrisers Hyderabad                          Rs. 2.40 cr

2015             Chennai Super Kings                          Rs. 1.50 cr

2016             Rising Pune Supergiants                   Rs. 1.00 cr

As you can see, this is a case of falling income. Some things happen (though I do not know for sure if that was the case; I am only assuming) in such cases:

  1. You anchor your earnings at the highest level and assume continuation of the same. So if Irfan Pathan might have thought in 2011-12 that his base price would keep going up or at least stay there. Did not happen, at least in this case.
  2. When you see the fall in income or anticipate the same, you want to take some chances to increase the income through some other source. This could be the possible thinking in 2013 when the investment was considered.

Whatever the reason behind the thinking, 12% assured return must have looked a mouthwatering opportunity in 2013, especially considering what all happened in that year. (Read our article as a reminder of what happened in that year:  Here are events that shook world in 2013). This was a very interesting combination – a lot of money at hand and the world looked scarier than ever. We seek guarantees in such cases. However, is the guarantee good enough?

Please understand the investment these brothers made was a credit risk taken on the builders. When someone guarantees some return, we are taking credit risk – we are taking the risk that the guarantees would be honoured. We are assuming that both the ability and the willingness are sound. However, we tend to forget the word “risk” when we hear the word “guarantee”.

Be careful. Understand the risk that you are taking. There is nothing wrong in taking risks, but everything wrong in taking it without understanding it.

#RidingTheRollerCoaster – 109

 

Credit – an act of belief

“During the time of the Civil War (1642-51), English goldsmiths had taken on the functions of the bankers, making loans and creating a market for merchants’ bills of exchange (credit notes). By the 1690s, the total value of bills of exchange in circulation was believed to exceed the currency of the kingdom. Several writers observe that through its circulation this new form of credit had many properties in common with money. Yet credit, unlike gold, could be created and destroyed. It has no utility and its value depended on an act of belief” – wrote Edward Chancellor in his classic “Devil Take The Hindmost

Centuries later, today banks and institutions can create money through derivative contracts. By 2007, we had more money created through synthetic derivatives than the currency in the world. As Chancellor has mentioned, it could be created and destroyed unlike gold. History suggests that while this may be a good thing, as it provides credit to businesses and liquidity to markets, too much of a good thing is often bad.

#RidingTheRollerCoaster – 60