Real Assets: Investing in Things Rather Than Claims

A real asset is a thing that earns by being used rather than a claim on a business's profits. Nilgiri Real Assets Fund I, invented, holds five: an office, a warehousing park, an operating solar asset, a road under construction and a retail centre bought to be improved. Four of the five produce rent or contracted payments today. The fifth has not been built yet, so it produces nothing at all.

The familiar case comes first. When a shareholder holds a share, the money that eventually reaches the holder has travelled a long way. A business sold something, collected the cash, paid its staff and its suppliers, paid its interest and its tax, and arrived at a profit. Then a board sat in a room and decided how much of that profit to hand out and how much to keep. Only after that decision does anything reach the holder. The share is a claim, and a claim is a position in a queue behind somebody else's judgement.

Now change one thing. Instead of a claim, the holder owns the thing itself: a floor of an office building, a shed on a highway, a field of solar panels. The payment is not a share of a profit at all, so nobody has to decide to pay the owner. The money is what somebody owes for using the thing. A tenant occupies floor space and owes rent under a signed lease. A buyer takes the electricity a station produces and owes a payment under a contract. The cash starts where somebody uses the asset, and that single difference produces every measure in this subject: occupancy, net operating income, the lease expiry ladder, the contracted payment.

What makes an asset real, and how is that different from a share or a bond?

A two-storey house on an ordinary street makes the point. The household living downstairs lets the upper floor to a tenant for a monthly rent. The rent does not depend on anybody's profit, on any board, or on any market being open. The rent depends on one thing: whether somebody is up there using the space and whether the paper they signed says what they owe. If the tenant leaves, the rent stops the same month, whatever the house is worth and whatever the street thinks of it.

The upper floor of that house is the whole of the idea, and a real assetA thing that earns by being used, such as a building, a road or a generating station. at institutional scale works exactly the same way. A grade-A office in a business district is the upper floor of that house multiplied by three hundred thousand square feet. A road is the same idea with a different user paying: not a tenant occupying space, but a stream of vehicles or a public counterparty paying for the road's availability. A solar generating station is the same idea again, where the user is whoever contracted to buy the output.

The test is not whether the asset can be walked into, or how large it is, or which sector it sits in. The test is where the cash starts. A share is paid out of profit after a decision. A bond is paid because a borrower promised a schedule. A real asset is paid because somebody is using it and owes for that use. Two of those three are claims on somebody else's finances. The third is a claim on a physical thing's usefulness, and it stops the moment the usefulness stops.

What can a real asset actually pay, and how many routes are there?

Two, and only two. While the asset is held, somebody using it pays the owner: rent, or a payment under a contract for the output. Then, on one day at the end, somebody buys the asset and pays a price for it. There is no third route. Everything written about property and infrastructure anywhere sits inside one of those two boxes, and a great deal of confusion comes from readers who do not notice which box a sentence is in.

The first box holds a figure that can be checked against a bank statement and the second box holds one that cannot. The office produced Rs 15,00,00,000 last year, and that is box one: money that actually arrived because 2,64,000 square feet were occupied. Box two holds the office's value today, what anybody would pay for it, and what it might fetch when the fund sells it. A valuation is not a cash flow, and the difference between the two is taken apart separately.

Keeping the boxes apart matters more than it sounds. A cash flow is a fact about the past twelve months, and the Rs 15,00,00,000 could in principle be traced to a bank statement. A valuation is somebody's present opinion about a future transaction that has not happened. A cash flow and a valuation are measured in the same currency and printed in the same schedule, and they are not the same kind of number at all.

What actually sits inside one private real asset fund?

Five things a person could stand in front of. Nilgiri Real Assets Fund I is a closed-end property and infrastructure fund managed by Nilgiri Alternatives Advisors Private Limited. The fund has put Rs 3,75,00,00,000 into five assets, and that Rs 3,75,00,00,000 is its deployed capitalThe money actually put into assets, as against the money committed to the fund., meaning the money that has actually gone into things rather than the money investors promised.

The cash runs upward. Each of the five assets earns its own money from its own users, and the fund's income for the year, Rs 34,90,00,000, is simply the sum of what the five produced. There is no central engine at the top generating anything. A real asset fund is an addition sum sitting above five separate physical situations, and the reason a total moved can only be found by going down to see which of the five moved. That is why every schedule in this subject is presented asset by asset, and why a reader who only ever looks at the total will never be able to explain it.

The office alone shows how physical this gets. The office has 3,00,000 square feet of leasable areaThe floor space in a building that can be let to a tenant, measured in square feet., of which 88.0 per cent is let. Change that one number and the office's Rs 15,00,00,000 changes, whatever anybody thinks about property as an idea. The way that percentage is measured, and the second meaning of it that answers a different question entirely, are covered separately under occupancy, and the headline figure is used here as it stands.

What is each of the five, and what did each one produce?

Almost everything that follows in this subject refers back to these five rows, so the schedule below repays slow reading. Each asset's income figure is its net operating incomeA property's rent less the cost of running it, before financing and before tax., meaning what the asset earned from its users less what it cost to run, before any financing and before tax. Each percentage is that income divided by what the fund paid for that asset. The division is the asset's yield on costA year's income divided by what was paid for the asset, and nothing more than that., and it is nothing more than a division.

A total should never be taken on trust. The cost column: 120 plus 80 plus 90 plus 45 plus 40 crore is Rs 3,75,00,00,000. The income column: 15.00 plus 7.20 plus 9.90 plus nothing plus 2.80 crore is Rs 34,90,00,000. Both add.

One sentence has to be said before that last column is read again. Every one of those five percentages is Nilgiri Real Assets Fund I's own figure on its own cost over one stated year, and not one of them is available to anybody, expected by anybody, or a statement that one asset is better than another. A yield on cost is a division with a past on both sides of it: last year's income, and a purchase price fixed years ago. A yield on cost says nothing whatsoever about next year, and nothing about the asset's value. The 12.5 per cent on asset 1 is high next to the 7.0 per cent on asset 5 for reasons not yet shown, and several of those reasons are exactly what the rest of this subject exists to take apart.

Why does one of the five produce nothing at all?

Because it is not finished. Asset 4 is a road under construction. Rs 70,00,00,000 has been committed to it and Rs 45,00,00,000 of that has been drawn and spent. A road that is still being built has nothing to sell, so not one rupee has come back. Nobody is driving on it and no counterparty is paying for its availability. An asset in the phase before it can earn is not an asset that has failed. No write-down has been taken and no dispute is running: the road is doing what a half-built road does.

An asset that must be built before it can produce anything is called greenfieldAn asset that has to be built before it can produce anything., and an asset that was already producing when it was bought is called brownfieldAn asset that was already producing when it was bought.. Asset 4 is the first and asset 3, the solar asset already running when the fund bought it, is the second. The contrast between the two, and the whole of what happens during a construction phase, is worked properly under the construction phase. The consequence for the schedule is the part that matters now: one of five rows is blank, with Rs 45,00,00,000 of drawn cost behind it, until construction ends.

A portfolio holds an unfinished asset for a plain reason. A fund that has stated it will invest in infrastructure has to invest in infrastructure that exists at the time it is looking, and infrastructure already finished is a different purchase from infrastructure still being built. Both are real assets. Only one of them pays anything this year: Rs 9,90,00,000 from the solar asset, and nothing at all from the road. The blank row has to be noticed before any arithmetic starts, and the arithmetic done without noticing it produces the error worked out below.

Which capital is a portfolio yield actually measured on?

One extra question is the single most useful habit in the whole subject. Somebody hands over a yield. Before anything is done with it, the question is what sits underneath the division line.

Nilgiri Real Assets Fund I's own figures show it. The five assets produced Rs 34,90,00,000 of net operating income last year. Divided by the Rs 3,75,00,00,000 of deployed capital, that is 9.3 per cent, and it is arithmetic nobody can argue with. But Rs 45,00,00,000 of that denominator is a road that produced nothing and could not have produced anything, so the division has put capital in the bottom that had no chance of contributing to the top. Taken out, Rs 34,90,00,000 divided by the Rs 3,30,00,00,000 that is actually producing income is 10.6 per cent.

Same fund, same day, same rupees of income, two correct divisions, and a gap of 1.3 percentage points produced by nothing except which capital was chosen as the denominator. The income-producing part is 88.0 per cent of everything deployed, and that 88.0 has nothing at all to do with the office's 88.0 per cent occupancy a few paragraphs above. The two figures are unrelated, and their landing on the same number is pure coincidence. A reader who spots the coincidence and builds a story on it is building on sand.

How does a private property fund differ from a listed property trust?

Private Real Estate vs REIT

Both hold buildings. The similarity stops being useful there, and the three questions that separate the two vehicles have nothing to do with the buildings at all. The questions are about how an investor's money goes in, how it comes out, and who decides the number that appears on the statement.

In Nilgiri Real Assets Fund I, an investor promises money to the fund, Rs 4,00,00,00,000 in total across its investors, and the manager calls it in as assets are bought. There is no exchange, so there is no screen and no buyer waiting. The investor gets capital back when assets are sold or when the fund's term ends, and the value shown in between is set by a valuer appointed by the fund, being Palani Valuation Advisors LLP, an invented limited liability partnership. A holder in this fund is waiting for a transaction rather than watching a price.

A listed real estate investment trust is the other side of that: its units change hands on an exchange, so a holder buys and sells at whatever price the market shows that day rather than waiting for the fund to sell a building. The exchange is the whole of the contrast. Every condition attaching to such a vehicle, whether about listing, distributions, borrowing or who may hold what, is set by the Securities and Exchange Board of India at sebi.gov.in, and those conditions change, so only the current text at the source can be relied on.

Does the same contrast hold for infrastructure?

Infrastructure Fund vs InvIT

Yes, and the repetition is the reason for setting the two comparisons side by side. Asked the same three questions, a private infrastructure fund and a listed infrastructure investment trust give the same shape of answer as property did, with roads and generating stations in place of buildings.

In the private fund, capital is promised and called, it comes back when an asset is sold or the term ends, and the value in between is an opinion produced by a valuer. In the listed vehicle, units change hands on an exchange and the price a holder sees is whatever somebody paid for a unit that day. The physical assets differ completely and the three structural answers do not. The private and listed split is a question about the wrapper rather than a question about roads or buildings. As before, every condition attaching to the listed vehicle is set by the Securities and Exchange Board of India at sebi.gov.in, and those conditions change.

Why does one schedule show rent and another show a contracted payment?

Because the document behind the payment is different, and for no deeper reason than that. Two different documents sit behind what the five assets collect, so two vocabularies end up in the same column of the same schedule.

Is that two different kinds of income? No. In both live cases somebody is paying to use a physical thing, and the payment starts where the using happens. The paper behind the payment is what differs, along with how long that paper runs, and the length of the paper is one of the most consequential facts about any real asset. An output contractAn agreement to buy what an asset produces, at a set price, for a set number of years. with fifteen years left and a lease with eighteen months left describe two entirely different situations even if this year's rupees happen to be similar.

One warning attaches to all of that. A contract is a contract, not a certainty. A contract says somebody has agreed to pay. A counterparty still has to be able and willing to pay, so a contract does not say the payment will arrive. A long lease is a long lease and nothing more than that. The way a lease is actually read, term by term, and the ladder of when leases expire, are both covered separately.

How does anybody actually use a schedule like this one?

Four people read those five rows and none of them reads the same thing. Watching how each one moves through the schedule is the fastest way to see why this subject has so many separate measures.

A lender starts at the bottom of each row and works out how much of the income is contracted and for how long. A lender is not looking for the largest income figure. A lender is asking which rupees are likely to be there when an instalment is due, so the fifteen years still to run on asset 3's output contract is a more interesting fact than asset 1's larger Rs 15,00,00,000. Until the road is finished it services nothing, so the road with no income at all is a different conversation entirely.

An analyst inside the manager reads the schedule as five separate explanations of one total. A total that changes for unknown reasons is a total nobody can report on. If the Rs 34,90,00,000 moves next year, the analyst has to be able to say which of the five rows moved and why. The analyst also needs the denominator habit more than anybody else, being the one asked for a single headline figure by somebody who will not read the schedule.

An investor in the fund reads the schedule to find out what has actually happened and what has not. Four rows describe the Rs 34,90,00,000 that arrived. One row describes the Rs 45,00,00,000 that was spent and has produced nothing yet. None of this decides the investor's own return. The return depends on what the assets are eventually sold for, and the eventual sale is covered separately.

And an ordinary household reads a much smaller version of the same thing without calling it a schedule. A household that lets out a room and counts the rent already has a one-row version of asset 1. A household that also spent money last year putting a second floor on the house that nobody can use yet has a one-row version of asset 4. Dividing last year's rent by everything spent, including the unfinished floor, is exactly the error the failure block above describes, in an ordinary house, with ordinary money.

What is the vehicle around these five assets, and where was it settled?

Nilgiri Real Assets Fund I is a closed-end fund with Rs 4,00,00,00,000 of commitments from its investors, of which Rs 3,75,00,00,000 has been deployed. Nilgiri Alternatives Advisors Private Limited manages it, Nilgiri Financial Holdings Private Limited sponsors it, and it is settled as a trust whose trustee is Nilgiri Trusteeship Services Private Limited. Its administrator is Kolar Fund Services Private Limited.

Everything about how that vehicle is put together and paid is covered separately and is used here rather than explained. What a commitment is, how a capital call works, what the management fee is charged on, what a preferred return and a carried interest are and the order in which money reaches investors before the manager sees anything, are all covered separately. So are the ten-year term and the extensions attaching to it.