WHO IS RESPONSIBLE FOR THE SMALL INVESTORS BEING DUPED BY THE BIG PROMISES AND NUMBERS SHOWN TO THEM?

 Recently, some of the Indian real estate developer companies lost more than 80% of their valuations. In some instances, their share prices fell below the offer price.

Hi. Let me share the due credits before you read forward. This post on my blog comes through with the active support and contribution from my colleague Ruchika Bhardwaj. She had apparently asked the question listed above to a group of experts, primarily on the networking site – Linkedin. Most of the below mentioned answers are from the respondents, and not solely mine. The reason I am carrying this on y personal blog site is to enlarge the debate, and solicit more & more readers to respond, so that we can collectively brace ourselves against some intentional, and many erroneous decisions, wherein the investor becomes the loser in the end.

Due credits are given wherever possible to the contributors. If someone wants his name to be removed from the quote, please drop me a line on connect@ramesh-menon.com

Here is how everyone responded.

REPLY BY RAMESH MENON, Founding Partner, CERTES Realty Ltd.

Nice question.

In my opinion, most investors in the primary markets subscribed to the shares of these developers, on being coerced on certain valuations, and growth numbers. Most opined, probably that the India real estate growth story would continue, and that the management of these companies would deliver results.

Three issues were not considered by many.

1. The correct valuation

2. The funding for development

3. The management expertise & competence.

If the above have to be considered, then the question is – “WHO DID THE VALUATION OF THESE COMPANIES, AND THEIR ASSETS?” How can an assessing company make such a misguided valuation of the assets? (Most cases, the assets were overvalued). Deliberate? or lack of in-depth knowledge about the sectoral nuances? – I must say this ‘tongue in cheek’ – Pedigree irrespective.

Most of those companies referred by you have land holdings – but the lack of funds disallows them to convert it into a project. Hence, the land valuations are assumed to be much lower, than projected.

Thirdly, the talent pool is miniscule compared to the size of the investment projections. There is hardly any specialization in the companies referred by you. The same developers end up launching projects in all segments – SEZ, residential, Mall space, Townships, infrastructure, economy & super-premium..et al.

I tend to agree somewhat that some of the misfortunes of the small investor could easily have been avoided… had they been shown the correct picture. Much was concealed from them.

Sign off time now – It would take much more than the current abilities of these developers to bounce back… and deliver value.

Answer by Mr. Andrew Paddon– A director with an Australian Co. Specializing in M&A, PE, VC

Short answer- the government.

Some developers have had properties valued by their own valuers, have few developments in their portfolios and have not disclosed the nature of mezzanine debt to their investors.

In response the government must make property development and investing more transparent. In Australia it has sought to do this by establishing benchmarks and minimum disclosure requirements.

See ASIC RG170 which is the standards an Australian company must meet before publishing a return forecast. Also see ASIC RG69 which sets benchmarks for debt-based investment in property schemes.

In the absence of these requirements a developer could have a “good-faith” basis for making propsective statements about the returns, and if it is not illegal for them to: Use their in-house valuers; 1 valuer for all their properties; and; mark to a hypothetical market their property valuations; then it is not their fault for doing so, when doing so is cheaper and more effective for them.

Essentially there are two forms of corporations / securities law: MERIT BASED – the old english system where you had to petition the King for a license to incorporate a company and raise money- and that license would only be issued if the King’s advisors thought the company had legs.

The other is DISCLOSURE BASED – which is what most of the world’s CA is based on. You can sell dog investments, so long as you tell everyone about the fleas.

Given that the governments knowingly allow investments with little chance of success to get up, it falls on them to ensure that the risks of investing are properly disclosed to investors – c.f. in Australia the “Clear Concise and Effective” prospectus requirements.

The idea is that the authors of a prospectus have criminal and civil liability for false and misleading statements. This is meant to be sufficient inducement for proper disclosure. However quite a number of the authors of prospectuses do not have the skills to identify the risks of their own businesses….

So the question for you would be how much protection does the Indian government give to retail investors?

Contribution from Elaine Coffee, from Australia

Few in the industry had the foresight to see that real estate was about to implode. There was no criminal intent in the investments being sold to people as bundled, low-risk, investment vehicles, that were generally part of a package of other investment vehicles. Everyone assumed real estate to be inviolable, because it had been steadily climbing for 20 years. Many of the brokers had probably never experienced a decline in real estate prices, and assumed it couldn’t happen. The calamity of events conspiring to bring the market down, starting with tremulously low interest rates in the late ’90′s and early millennium, coupled with the declaration of an unnecessary oil war, by George Bush in 2003, followed by a subsequent surge in interest rates to cover the costs of that war, and then subsequently to prop up the dollar, when it was no longer resting on the strength of our reserves, caused the cascading failure of VAR mortgages that were written prior to that war, and brought our banking system to its knees, as the government tried to both cover its tracks, and ascertain a way to keep the dollar high during the current administration. That brought on the credit crisis, which has precipitated the current mess in real estate, that is likely to extend for some time.

Which of those events would you blame your broker for not having recognized in advance?

No one is really to “blame” here. Stuff just happens. If it was not this that caused the cyclical downturn in the system, it would have been something else. No one is operating with a crystal ball. And the more you make yourself responsible for your own investments (just like being a good, and educated patient) the safer you are from mistakes, and the happier you will be.

Contribution from a business editor of Deccan Chronicle

Small (or large) investors are responsible for the losses incurred in the stock market. Most of the real estate IPOs, which started out in late 2006, were running on optimistic valuations of ‘land-banks’. In many cases, these land-banks had been valued by consultants appointed by the developer – a very obvious conflict of interest. However, nobody bothered too much in a rising market. Now obviously, things have changed.

Moreover, prospects for the real estate industry have worsened because of rising interest rates – from a low of 6-7% three years back to over 10% now. You also need to consider that valuations don’t remain unchanged – they react to changes. Changes in interest rates, changes in raw material prices and changes in growth rates.

My sympathies to whoever has lost in the market, but then, equities are inherently risky. You can’t expect a higher return yet expect no or low risk.

Contribution from Atul Mehta, a business engineering expert

Real Estate market is consisted of two kind of assets as under:

1.Land
2.Building

Due to various Govt controls and and irritants, the prices of Real Estate Market are prone to all kind of manipulation in India. However it is also true that when prices are low/flat, then nobody in India would like to invest in Stock or Property Market. It is only when the Markets are at the peak majority of unique Gambling instincts of Indian minds drive them to invest in Stock Market or real estate etc. But when such people lose their money they feel cheated. In my opinion their complaints are not justified entirely becoz their motivation was GREED only then seeking a reasonable return. Actually expectations of decent/ reassonable return make you a prudent & calculative investor, while Greed induces to become Gambler/ Speculator only.

However, as earlier said Real Estate Market has two different components( Land & Building), therefore those who have made investments in the rights of land also need not to worry too much becoz in a billion plus growing economy, Land will remain the hottest commodity. Land prices will bounce back to touch not only the previous levels but will also surpass them in many cases. But those people who bought flats/ apartments only with no rights on land at the astronomical prices may consult their astrologers for some magic.

Contribution from Bhavesh Shah, Sales Trader

Hi Ruchika

Investors themselves are responsible, they do not study facts and believe on info gathered from various sources like media, newspapers or may be friends, which all time cannot be true.

Moreover retail people are last ones to get in the markets as well last one to exit the mkts.
Just watching TV channels does not mean you have gathered all info and start investing, you need to u/stand biz cycles of Industry, ,trends, mkt study etc before investing as INVESTING IS AN ART.

Contribution from Prasanna Jha, VP with the world’s leading bank

Think this is responsibility of the small investors, primarily. Driven by the greed of making a quick kill, they have invested in all and sundry IPOs (including the answerers, by the way). Small investors start investing in the stock markets direct on advice of their colleagues/ friends and others who have no idea of stock markets. Naturally, they invest almost at the peak, having seen everyone else gaining from the stocks. And hence, suffer the highest loss.

There is this big institution of small investors called Mutual Fund, which pools in individual money to invest as an institution and has the expertise of investing knowledge. Discounting the cons of MF investing, think small investors will be better off using the MF route for investing in the markets. The gains may be marginally lower as compared to direct investing but the downside also is limited, as Fund managers of MFs are able to churn portfolio and sell off something which is losing value.