The “value investor” in realty

In the hustle bustle of Goregaon in suburban Mumbai, in a quiet bylane off the busy SV Road, is a multi-storied building, dwarfed by a huge SRL Ranbaxy laboratory. On the fourth floor of the building is Albertsville Enterprises. A year ago, it was one small office, but today it has offices spread over two floors. Amid all the talk of slowdown, particularly with realtors going broke, Albertsville is showing signs of growth.

 Bobby Surendranath, its owner, is not your regular property investor or developer. An engineering graduate from IIT Chennai and MBA from IIM Lucknow, Surendranath cut his teeth in the world of equities before shifting to what he calls a far superior and reliable investment option — real estate. Although his stint as an equities fund manager wasn’t long enough to create any records, he is still remembered as a “sound” investor.

Starting as an analyst at SBI Mutual Fund in 1993, within six months Surendranath was managing a ₹100-odd crore fund called Magnum Multiplier 1990; he then moved to ITC Threadneedle, which was taken over by Zurich Mutual before HDFC Mutual Fund acquired Zurich Mutual itself. Surendranath quit Zurich Mutual in 2001 to spend the next three years managing money at insurance company Aviva Life and then about 18 months in Standard Chartered Mutual Fund before heading to Dubai to start his own fund in 2006. 

The market was climbing and it was a good time to raise money from overseas investors, given the high appetite for Indian equities. But the stint did not go as Surendranath envisaged. So, he knocked on another door that had opened a year earlier. In 2005, the Real Estate Bill had been passed, allowing foreigners to invest in Indian property. Surendranath smelt opportunity but again hit a wall as he wasn’t able to convince foreign investors to bet money on Indian soil. “There was too much mistrust because of the lack of transparency and land title issues,” he recalls. But that was then. Just the day before we meet him at his suburban Mumbai office, he had returned from a trip to showcase his key real estate projects (all a few hours drive out of Mumbai) to potential investors in Dubai.

Stable roots

Digging deeper, we find that Surendranath’s rendezvous with property began when he was still an equity fund manager. In 2005, while poring over the balance sheet of Hindustan Construction (HCC), he came across a subsidiary company called Lavasa that was developing a city on the outskirts of Pune. “It was hugely inspiring to see a new city growing out of a well-conceived master plan over several thousand acres of land, drawing development capital from established brands all over the world.” His curiosity grew and Surendranath decided to study the various business models in real estate.

The takeaway was profound: If the central planning agency has the foresight to create a sustainable growth model, even barren desert lands can be transformed into habitable oases vibrant with life. Investors then pour capital into such regions and land valuations rise beyond imagination.  That was lesson No.1 for Surendranath. A prime example was Dubai, which created world-class infrastructure in the middle of the Arabian desert. Closer home, the Gujarat government also created top-class infrastructure to ensure sustainable growth. 

Lesson No.2 was that land price appreciates in two distinct steps before settling at a high plateau. Land is cheapest when it is in “agricultural zone” although various states in India have placed restrictions on holding and trading agricultural land. The biggest leap in land valuation invariably happens when agricultural land with just a 4% FSI (permitted building area to land area ratio) is converted into urban land with FSI ranging from 50% to 100%. This is commonly called the “zone change arbitrage”.The next steep stage of appreciation occurs as development results in the region, creating new employment opportunities and, therefore, residential demand. This, in turn, attracts investor capital that creates a scarcity of developable land. Once this stage is over, the incremental returns will be small.

When Surendranath made up his mind to become a full-time real estate investor in 2007 after returning from Dubai, he did not look for properties in Mumbai as the city was already showing signs of having reached the “plateau phase”. In 2008, Albertsville Enterprises was born to identify, acquire and develop land plots that were expected to reach a “price breakout” over 5-10 years. Surendranath’s first experiment with large parcel land acquisition was through a joint venture with some established Mumbai-based developers to acquire a few hundred acres of land on the outskirts of Pune, close to the proposed Pune airport at Khed. 

Using some of his own savings and contributions from investors, Surendranath obtained permissions to develop a large format resort that could attract international brands such as Disney and Sentosa. However, in late 2008, the global financial crisis led to interest waning and a proposed private equity deal with a large Dubai-based fund fell through at the last minute. While the delayed project has the approval of the state of Maharashtra, Surendranath is waiting for investor sentiment to improve before making a fresh attempt at attracting foreign capital. The wait has paid off in any case, as the underlying land value has appreciated over 100% in the past five years, while the benchmark Sensex has given a return of 16% in the same period. 

Lesson No.3 was that land in remote locations far from the main city has very little intrinsic value. It is development capital that creates a spark to attract further capital and the positive spiral of investments leads to creation of tremendous value. For instance, in 2003, land in Panvel was available at ₹5 lakh an acre. Cidco-developed infrastructure acted as a trigger and attracted large industries. The resulting employment created demand for homes, which, in turn, created demand for shops, malls, schools and hospitals and an airport.

 The positive investment spiral took off, drawing external capital into the region and now, the going rate for land in Panvel is about ₹4 crore. Surendranath draws an analogy. The role of raw land is like the value of steel in a car — the metal itself constitutes only a minuscule percentage of the car value, but the car derives its value from the technology used to create locomotion.

Land is the basic ingredient that goes to create a lifestyle, a habitat, a work place, a way of life and that is what people pay for. Auroville, the 300-acre expanse created by Aurobindo Ashram at Puducherry, brings a gleam to Surendranath’s eye when he mentions it. From a dry, barren patch in the middle of nowhere, it is now a must-visit destination in India. “Anyone who has been there would wish to live there forever. Land has some value, but with creativity you can not only make money, but also improve the standard of living,” he says. It is this quest that prompted Surendranath to dive into developing his own properties in 2009. 

Branching out

This is where Surendranath’s lesson No.4 came in handy: Real estate development is one of the few businesses that require little or no capital and, once well-established, can run on negative working capital. This realisation led him to structure deals that made his properties profitable for him and lucrative for potential buyers. With his financial acumen, that has been a breeze. “It’s been all about creating the right financial structure and working with the right set of people,” he says. 

Some of Surendranath’s projects offer insights on how value has been created. Realising the average flat dweller in Mumbai would want to own a weekend villa where his children can be close to nature, a farmhouse project called Woodside Bali was launched at Murud-Janjira in Mangaon taluka. Spread over about 50 acres, the project has large-format farmhouses — over 20,000 sq ft plots on which villas of 1,200-1800 sq ft can be built. There are customised add-ons, be it a swimming pool, a jacuzzi or gazebo.

Affordability is the key to the success of these projects and prices are in the range of ₹20-50 lakh. “The idea is to provide a living space close to nature and for this we plant and maintain over 25 varieties of fruit trees and flowering plants on each plot, using the expertise of the Bangalore Agricultural University,” reveals Surendranath enthusiastically. The houses are built on the principles of Laurie Baker’s expandable housing, which means you initially have a small dwelling but as your family or aspirations grow, the architecture allows you to keep building around the existing structure without having to knock it down to erect a new one. 

In essence, then, Surendranath’s secret sauce has been to buy land in far-flung locations that have some guaranteed development plan, and overlay it with incredible financial engineering to make his properties a strong value proposition. For the Balinese-style beach apartments he is building at Murud-Janjira, he has roped in Key Hotels Group to run an 80-room resort within the residential complex. He is now offering the 200-odd residents of the project a lifelong zero-maintenance option along with a rental plan.

Under this, a buyer could purchase an ₹35-lakh fully furnished sea-facing apartment and lease it to the Key Hotels for a rent of ₹20,000 a month after covering maintenance expenses. This rent can partly cover the EMI if the buyer avails of a home loan for the purchase. Housekeeping services and access to the spa and other facilities of the four-star resort are free to the apartment residents. 

The idea is not just that the rental yield is reasonable, but that the property also holds good potential for appreciation in the years to come as it is located just 10 minutes from Dighi, India’s fourth non-major port that was partly commissioned last year. “In the 1980s, Juhu used to be a weekend home for celebrities, and now it’s a crowded residential area where celebrities also live.

In the coming 5-10 years, the beach houses and apartments in the Mandwa-Alibaug-Murud belt will transform from a weekend home destination just like Juhu. If Mumbai Port Trust saw the creation of Mumbai city and JNPT saw the expansion of Navi Mumbai, Dighi port will create one of the largest new cities in Maharashtra at Mangaon over the coming decade. Land values here are at a tiny fraction of values at Panvel,” explains Surendranath.

Bursting the bubble

Sounds swell, but who is to say that the current negative sentiment in prime metros due to piling inventory won’t eventually seep into emerging pockets? After all, there are many common investors in both the markets and how can one be sure of not burning one’s fingers by buying now? Surendranath’s repartee, “Just because you have a security guard standing by the door, you can’t sleep with your door open.” In other words, caution has to be exercised at all times while investing, especially when you are in a bubble phase. 

Surendranath has a rather simple way of looking at things. Largely, he says, the cost of building a structure, be it commercial or residential, is about ₹1,800-3,000 per sq ft, depending on the materials you use. So, in a sense, the price per sq ft in excess of this material cost is the bubble value or the land premium. For instance, in South Mumbai, the cost of construction for a flat is ₹3,000 per sq ft while flats are selling for ₹60,000 per sq ft, so the “land premium” or the “bubble value” is about ₹57,000 per sq ft.

One could argue that a superior location like South Mumbai commands a premium because of better connectivity and other legacy reasons. While you have no way of really knowing when this bubble will burst, the chances of that happening increase as the location advantage wears off, just like the financial centre has now shifted from Nariman Point to Bandra-Kurla Complex.

Surendranath’s strategy, therefore, is to stay away from bubble locations, and buy plots at a price closest to the construction cost. That takes us back to his lesson No.1, which is to go to areas where land is cheap, really cheap and where incremental returns are likely to be maximum. 

Despite his deep understanding and years of experience in managing a stock market fund, Surendranath is now so sold on real estate that he hardly owns stocks even for the sake of diversification. “Stock prices are not easy to predict as they are more a creature of sentiment rather than any fundamental underlying asset value. In fact, the value of the underlying asset itself is so complex and unpredictable that the entire community of analysts spends its lifetime predicting it, knowing fully well that a majority will get it wrong. To predict the bottomline of a company, you have to get two things right — the income and the expenditure. A small tweak in some variables can cause a disproportionate change in profits.” That makes investing in equities not only difficult but also gut-wrenching. 

In contrast, predicting outcome of investments in “land” is far simpler and secure, says Surendranath. There are only two economic variables to consider, demand and supply. Over time, demand is a one-way street as long as the location is creating employment opportunities and has a growing population. Supply is limited as there is only so much land to go around. Simple economics will assure you that sooner or later you will make good profits, so long as you have not entered a bubble/plateau phase for that specific location. 

Unlike stocks, where technically, penny stocks can actually go to zero and turn into totally worthless paper (with shares now in demat form, it won’t even be paper but only a binary bit), land can never become worthless, because sooner or later there will be demand for it and the asset, after all, cannot vanish. The big risk in real estate, though, is with regard to the title of land and how you protect the asset once you have bought it, especially when you buy something that is not in your vicinity. 

There is another reason real estate investments have been known to beat any other asset class, including stocks, over longer periods. In India, particularly, with stocks markets not having seen a secular rise over time, for most wealthy people, the second biggest asset they own ends up being real estate and for the average person on the street the biggest asset that they own is probably their own home. By its very nature, you cannot easily get in and out of real estate — it is more like a marriage, unlike equities, which is usually only a fling with most people rushing in when sentiment is good and opting out when the sentiment turns bad.