Real estate developers looking at newer financing options
Posted Date : 31-Oct-2007
Big residential townships, SEZs (special economic zones) and mega retail malls are prominent among the recent trends in the real estate landscape. To cope with these mega developments, the developers are looking at various options of financing, says Mr. R. Venkatesh, Regional Director, Transaction Advisory Services, Ernst & Young, Chennai.
“While debt funding, private equity (PE), IPO (initial public offer) route shall continue to happen, though at realistic and reasonable valuations, new avenues such as listing of REITs (real estate investment trusts) at overseas exchanges is expected to attract developers’ attention to plan their fund raising exercise,” he adds, during an email interaction with Business Line.
Major challenges, however, can be RBI (Reserve Bank of India) guidelines on housing loan interest rates and FDI (foreign direct investment), valuations, dynamic SEZ regulations, land acquisition / title issues, and developer’s transparency in operations.
Mr Venkatesh has over fifteen years of experience in dealing with M&A (mergers and acquisitions), PE funding, capital markets, and corporate restructuring. He has advised companies on financing and acquisitions, in industries such as automobile and industrial products manufacturing, real estate, banking and financial services, and retail/ FMCG (fast moving consumer goods).
Excerpts from the interview.
What are the financing options of the different segments of the real estate industry?
The real estate industry can broadly be classified into three segments, namely residential, commercial and retail. While the major portion of the residential projects is funded by advances from customers, commercial and retail projects need significant external funding (both debt and equity) to develop the project.
Currently, the equity options prevalent in the market include PE, primary and secondary market, listing at AIM (Alternative Investment Market) etc. Developers also continue their strategy of looking at joint development opportunities to minimise their investment on land cost.
Why are new avenues of funding becoming necessary?
Traditionally, developers confined themselves to banks and financial institutions to fund their projects, including land acquisition costs. In the last 3-4 years, with the real estate markets witnessing buoyant activity, developers leveraged their balance sheet to the maximum extent possible to create land banks and fund major projects.
In the process, most of the banks have hit the sectoral exposure caps; and the RBI brought in stringent norms (such as, restriction on funding land acquisition etc) to regulate new sanctions in the real estate sector. Thus, developers were compelled to look at alternative options to raise funds to continue with their developments plans.
Our FDI policy has room for real estate, hasn’t it?
Yes, it has. For instance, when in February 2005, the Indian government relaxed the regulations governing foreign investment in real estate, it paved the way for capital infusion into the market. As a result, a significant weight of foreign capital is now chasing Indian real estate.
What are the norms? And the restrictions.
Foreign investors can now invest in commercial development projects (under construction) over 50,000 sq metres (5,40,000 sq feet), or plotted residential developments with a minimum size of 10 hectares with a minimum capitalisation of $10 million for wholly owned subsidiaries and $5 million for joint ventures with Indian partners.
Funds have to be brought in within six months of the commencement of business of the company. The original investment cannot be repatriated before a period of three years from completion of minimum capitalisation. However, the investor may be permitted to exit earlier with prior approval of the Government through the Foreign Investment Promotion Board (FIPB).
Furthermore, foreign investors are not permitted to sell or trade in undeveloped plots or raw land. Recently, RBI has come out with revised guidelines for foreign investment clarifying that investments made post May 2007 as preference shares (non-convertible / optionally convertible / partially convertible) shall be considered as debt and shall conform to ECB (external commercial borrowing) Guidelines or ECB caps. This has become a major challenge for investors in structuring a deal leaving very few options for the exit route.
How enthusiastic have the real estate funds and PE investors been in entering this sector?
Highly. The policy changes introduced by the Government in FDI guidelines have created a lot of interest among the foreign investors. But the real attraction for foreign investors is potential investment returns of 25 per cent and more in Indian projects that might be hard to come by in the US and in Western Europe today. A report by property consultants Jones Lang LaSalle estimates that $10 billion foreign investment is expected to be injected into the Indian real estate sector in the next 12-18 months.
Industry sources say over 90 foreign investors are already in the country tapping investment avenues. Nearly two dozen US funds are raising $3.5 billion for investments in Indian realty. Those who have already raised or are in the process of raising the funds include Wall Street powerhouses such as the Blackstone Group ($1 billion), Goldman Sachs ($1 billion), Citigroup Property Investors ($125 million), Morgan Stanley ($70 million), apart from JP Morgan, Warburg Pincus, Merrill Lynch, Lehman Brothers, Warren Buffett’s Berkshire Hathaway, Colony Capital and Starwood Capital.
And how enthusiastic is the response that the PEs elicit here?
Let’s not forget that most of our real estate companies are still closely held or family run. It is therefore not uncommon to find the promoters being cautious in diluting stake at the parent company level. Instead, they are keen to look at PE participation for specific projects or assets essentially to fund the development (including land consolidation).
Depending upon the funding requirement, the promoters also prefer to cash out the excess brought in by the investor as premium on land cost. Investor’s exit in this case is usually through cash out of proceeds from the project, buyback arrangement with promoters, or sale of stake to asset management companies.
