ELK ASIA PACIFIC JOURNAL OF FINANCE AND RISK MANAGEMENT. ISSN (Print) ISSN (Online) Volume 4 Issue 2, April (2013)

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1 THE INTER - RELATIONSHIP BETWEEN THE INDIAN REAL ESTATE DIRECT & SYNTHETIC (INDIRECT) INVESTMENTS B. Muthupandian Doctoral Research Scholar, Department of Commerce, School of Management, Pondicherry University Dr. Velmurugan. PS Assistant Professor, Department of Commerce, School of Management, Pondicherry University ABSTRACT The market value of Indian commercial and residential properties keeps appreciating. The Indian real estate investment avenues are broadly classified into two categories one is direct investment and other is synthetic (indirect) investments. The physical (direct) real estate investment is much attracter than the Synthetic (indirect) real estate investment in India. Hence, this paper attempts to know the interrelationship between the Direct and Indirect investments in Indian real estate market. By using various inde values on since 2007 and try to convert all in the same reporting units for the easy computational and comparison purposes, in addition to calculate the Compounded Average Growth Rate (CAGR) and also deploy the cross correlation to find out the inter relationship between the direct and Synthetic investment in real estate. It is found that s the direct real estate investment avenues are showing the bullish trend; whereas Synthetic investments are continuously recording the bearish trend. The present Indian real estate scenario shows that direct and synthetic real estate investment avenues are negatively correlated. Therefore, there is huge chance for using either of the investment avenues as a risk protecting instrument in portfolio construction. There is no strong evidence to use the present Synthetic (Indirect) investments instruments as the close substitutes of the direct Investment. Keywords: Synthetic (Indirect) Investment, Real Estate Investment, Real Estate Inde Introduction In India, the market price for residential and commercial properties is increasing year after year due to increasing demand from population eplosion, developing economy and increased purchasing power. As several studies have indicated that investment in real estate will give increased returns compared to other investment vehicles, 1 Indian investors are increasingly parking their hard earned money in real estate related investments. As returns are sky touching, India has been voted as the fifth most preferred real estate destination amongst the nations worldwide. The market value of Indian residential properties keeps appreciating. As estimated by the Global Property Guide, the market value appreciated 33.91% 2 within last 3 years. India is now on the radar screen of many cross-border real estate investors, and a substantial part domestic and global capital in now seeking real estate investment opportunities in India. Indian Real Estate Investment Avenue As against increasing returns from real estate investments, stock market investments are highly volatile due to unstable market conditions and hence investor can t blindly trust on it for fied returns. So, investors are fascinated to park their hard earned money in real estate for much safer returns as compared to investing in stock market. Especially Indian investors always strongly believe that property is a great avenue for investment and highly rewarding as it s secure, tangible and rarely goes down in value. Past statistics has proved that Indian properties are touched sky-kissing prices, which attracts rest of the world that India investments are yielding huge and immense investment returns. The improved and revised government pay 1 Chakraborty, Ayan, Real Estate Investment: The Race between India and China (November 29, 2010)

2 scales, standardized corporate sector, and growth of NRI s foreign echange earnings are all responsible for the pulling factor of the eponential growth of Indian property market. The Indian real estate investment avenues are broadly classified into two categories one is direct investment and another one is called synthetic (indirect) investments. (Ehibit on chart # 1) In direct investments, the investor directly invests their money in the physical residential and commercial properties. They deliver the rental income and the property values appreciation as the capital profit. Under synthetic (indirect) investments the investors do not directly invest but interest to invest in the equity shares of property development and property management corporate companies. Under these options investors deliver dividend income as revenue income and the price change over the equity shares as the capital gain. Both the direct and synthetic investment avenues have many pros and cons. It is pointed out in a concise form in the table #1. Research methodology a) Statement of the Problem & Research Objectives It is believed that physical (direct) real estate investment is more attractive than the synthetic (indirect) real estate investment in India. Hence, this research is an attempt to identify the interrelationship between the Direct and Indirect investments in Indian real estate market. In the process, the research paper also aims to eamine the present scenario of real estate investment avenues in India. The following were the specific objectives:- 1. To study the fundamental factors of direct and synthetic real estate investments in India. 2. To calculate the return of direct and synthetic real estate investments in India. 3. To measure the inter relationship between the direct and synthetic investment avenues. b) Data Source & Tool for analysis The study is conducted purely based on the secondary data collected from various web data base portals. The study variables are classified into two type s namely direct investment indicators and the Synthetic (Indirect) investment indicators. Under the direct investment indicators, proies are Residential Inde (RESIDEX) Inde Value and the Real Estate Sensitivity Inde (RESSEX)Inde value. Likewise for measuring the Synthetic (Indirect) investment price movements, the proies are Indian stock echange reality inde namely CNX Reality Inde and BSE Reality Inde of NSE and BSE respectively. The RESIDEX Inde was launched on July 2007 by National Housing bank at the direction of Ministry of Finance and Real Estate Sensitivity Inde (RESSEX)was launched by Mumbai based Realty research firm Liases Foras on November 18, 2009 and provides the data from 2007 onwards through property science dot com. In the synthetic sector, the proies are CNX_ Realty _Inde lunched by National Stock Echange (NSE) on December 29, 2006, and the BSE_ Realty _Inde lunched by Bombay Stock Echange (BSE) on July 09, Even though data is available from different points of time, data was taken from 2007 onwards. The data was collected from the respective official web database portals. The data is converted into reporting units for easy computational and comparison purposes, since in direct investment inde; the base value is 100 whereas in the case of Synthetic (Indirect) investment Inde, the base value is Average of daily closing price of the Synthetic (Indirect) investment inde as well as to convert the quarterly direct inde value into year inde to quite at the year closing price. In addition, Compounded Average Growth Rate (CAGR) and Cross Correlation were used to find out the growth rate and relationship between the direct and Synthetic (Indirect) investment in real estate. Empirical Analysis The Indian real estate investors are mostly attracted by the physical (direct) investment market. From the table # 2 it is evident that this avenue gave 10.5 to 14 per cent CAGR in the last five years based on the RESSEX and RESIDEX Inde. This sector shows a continuous growth trend from the year 2007 onward as shown in chart # 2 Contrast to the above, synthetic investment through equity share of the builders and property developing companies recorded a 29 per cent negative CAGR. The NSE and BSE reality inde also shows continuous decreasing trend from the year 2007 onwards as shown in chart # 3 There was the negative trend in the synthetic investments from 2007 epect the year In the year 2010 both NSE and BSE reality inde performance depict a positive trend on year to year comparison to the

3 preceding year 2009 (refer table # 3). The BSE reality inde shows negative trends , and from the year 2008, 2009 and 2011 respectively. Whereas, the NSE Reality inde also show the same movement via , and in the year 2008, 2009 and 2011 respectively. Among this, the year 2009 has eperienced a deep down trend in Indian real estate synthetic investments market. But in the year 2010, the market repealed from the bearish trend and showed some positive hopes in the minds of synthetic investors. But this trend did not continued in the year This kind of oscillation may contribute to the negatives impact on the minds of Indian real estate synthetic investors forcing them to park their money in direct real estate investments avenues. The Indian real estate Synthetic investments market is high year to year. In the year 2007 BSE inde value moved from a minimum of 5, to a peak of 12, point; the NSE reality touched the yearly low of and the yearly high of 1, The table # 4 revels that in the five year period from 2007 to 2011, BSE minimum inde values is 1, in the year 2009 and reached the peak of 13, in the year During the same period NSE reality inde low is in the year 2009 and high is 1, The cross correlation results reported in table # 5 its revels that Inter correlation between the both direct and synthetic investments are moving in opposite direction. Its shows highly negative correlation (i.e. 85 per cent) between the direct and synthetic investments. But in the intra correlation between the direct and synthetic investments are positively high correlated with each other. this clearly eplain that the Indian real estate direct and synthetic investment markets are not moving together in the same direction and it s moving in the opposite direction. Therefore, huge opportunities are available for using the direct and synthetic investment avenues as the hedging tool for preventing risk of one market in the other market. Conclusion It is statistically proven that the direct real estate investment avenues are showing bullish trend; and whereas the Synthetic investments are continuously showing bearish trend. If both markets go together, investors can strongly believe that the Synthetic investment instruments could be a close substitute to book their profit in the property market instead of investing in the physical form. But the present Indian real estate scenario is reverse; the direct and synthetic real estate investment avenues are negatively correlated. Therefore, against other in, there is good chance for using one avenue as a risk protecting instrument in the portfolio construction. There is no strong evidence to use the Synthetic (Indirect) investment instruments as a close substitute for the direct Investment. Chart #: 1 Indian Real Estate Direct & Synthetic (Indirect) Investment Avenue Table #1 Divergence between Direct & Synthetic Real Estate Investment in India: a Bird s View Instrument Building Equity Share Traded in OTC Market Stock Echange Investment High Low Liquidity Not easier Yes Originators Property Investors Real Estate Development Company Intermediates RE Developers / Brokers Stock Brokers Profit Sharing ( 100 % of profit to the Investors Percentage decided by the company

4 in percentage ) management Returns Rental Income Dividend from company Profit Epectancy Property prices will rise and the Company and Real Estate Sector will increase the rental income perform Diversification No Can diversify by the way of buying different company s stock Issue Getting clear title property, Equity holders as the real owners of the ownership hassle company s properties Valuation Based on the Ground rent value / As a Joint Stock Company value is Market value assed by the surveyors based on share s market price and inde Table #: 2 Investment Indicators of Indian Real Estate Industry Investment Indicators CAGR % Direct RESSEX Inde RESIDEX Inde Synthetic BSE Realty Inde (Indirect) NSE Realty Inde Chart #: 2 Indian Real Estate Industry: Direct Investment Inde Movement Chart #: 3 Indian Real Estate Industry: Synthetic (Indirect) Investment Inde Movement

5 Table #: 3 Indian Stock Market Reality Inde: Synthetic (Indirect) Investment Average Yearly Closing Prices Year BSE_ Realty Inde YoY Change (%) NSE_ Realty Inde YoY Change (%) Table #: 4 Indian Stock Market Reality Inde: Synthetic (Indirect) Investment Yearly Range of Closing Prices Year BSE Realty Inde NSE Realty Inde Min Ma Min Ma , , , , , , , , , , , , Table #: 5 Cross Correlation between the Indian Real Estate Investment Indicators Direct Investment Synthetic (Indirect) Investment Cross Correlation RESSEX_Inde RESIDEX_Inde BSE_Realty_Inde NSE_Realty_Inde Direct RESSEX_Inde Investment RESIDEX_Inde *** BSE_Realty_Ind Synthetic *** *** e (Indirect) NSE_Realty_Ind Investment *** *** *** e References