Financing Real Estate in India

Merrill Lynch has forecasted that the Indian realty sector will grow to a $90 billion industry in the
next eight years

It’s a huge figure we are looking at US$ 90 billion. That’s what Merrill Lynch forecasts that the Indian
realty sector will grow to by 2015. As industry is enthusiastic about that figure, RBI has raised its voice
of concern. It reasons that the portfolio inflows should confirm to the norms applicable to foreign direct
investment (FDI) in the sector. Analysts feel that the central bank should revisit the FDI norms rather
than curbing the portfolio inflows.

As they say, no matter how thin you slice, there are always two sides. A growing economy comes with
its own burdens creating demands on infrastructure and real estate. The relevance of real estate further
enhances when we look at the following statistics:

1. It is the second largest employer in India (including construction and facilities management)
2. It is linked to about 250 ancillary industries like cement, brick, steel through backward &
forward linkages
3. A unit increase in expenditure in this sector has a multiplier effect and the capacity to
generate income as high as five times

Thus, to support growth, various concessions and benefits have been given to the sector. This would
help change the current contribution of housing and real estate to India’s GDP which is at 1% against 3-
6% for developing countries.
Funding can be sourced using debt, equity or a mix of both. Debt funding could be done from sources
like banks, Non Banking Financial Corporations (NBFC) or via External Commercial Borrowings (ECB).
Equity participation would involve investments in the firm at an entity level or project level. FDI is one of
the ways of financing a firm’s projects. FDI in real estate is permitted in construction and project
development related to both residential and commercial development in housing townships and
commercial office space subject to certain project conditions. With yields at around 11.0% for office
space, which go upto 20-25% in greenfield projects, investing in India is certainly a good option. A
November 2006 ASSOCHAM study estimates share of real estate in FDI to rise to 26% by the close of
2007 from around 16% last year. Table 1 shows the levels of investments that have taken place in the
first quarter of 2007.
Table 1
Investor Entity Location Investment Stake Investment
Type and (%) Amount (USD
Sector million)
Evolvence India Emaar-MGF Delhi Entity level n/a 41
Evolvence India CCCL (Consolidated Chennai Entity level n/a 12
Construction
Consortium Ltd)
IL&FS Ansals Properties & Delhi SPV 49 29
Infrastructures (APIL)
HDFC Realty Fund Ansals Properties & Delhi SPV, commercial 33 n/a
Infrastructures (APIL) IT Parks
Nakheel Group Parsvnath Pan India Entity level, 50 550
residential and
commercial
Nakheel Group DLF Gurgaon, Entity level, 50 10,000
Mumbai and residential
Pune
Morgan Stanley Oberoi Constructions Mumbai Entity level, 10.75 152
Special Situations mixed use
Real Estate Fund
Samsara Capita IDEB Projects Bangalore Entity level n/a 33
TPG-Axon Capital DivyaSree Bangalore Entity level n/a 100
Developers
Vornado Realty Gurgaon SEZ Delhi SPV, industrial 50 n/a
Starwoods Hotels & Brigade Hotels Bangalore SPV, hotels n/a n/a
Resort
Citigroup Venture Indu Projects Hyderabad Entity level 9 33
Capital International
Maurtius Ltd
Goldman Sachs Unitech Delhi, Mumbai SPV, mixed use 33 66
and Bangalore

Table 2
Name Date Capital(USD million)
Trinity Capital April 2006 500
Eredene Capital May 2006 115
India Hospitality Corp August 2006 100
Ishaan Real Estate Plc (K.Raheja) November 2006 405
Unitech Corporate Parks Plc December 2006 750
Hirco Plc (Hiranandani December 2006 750
Source: Jones Lang LaSalle Research, 1Q07

SPV: special purpose vehicle

As listing in local markets (BSE/NSE) gets difficult many investors are trying to look west. The Alternate
Investment Market (AIM) with its easier norms has been one of the easiest foreign shores where various
players have raised money (Table 2). These funds will be used in FDI (foreign direct investment)-
compliant mega property projects ranging from residential townships to commercial establishments
across the country.

Table 2: Firms listed in AIMNameDateCapital(USD million)Trinity CapitalApril 2006500Eredene

CapitalMay 2006115India Hospitality CorpAugust 2006100Ishaan Real Estate Plc (K.Raheja)November
2006405Unitech Corporate Parks PlcDecember 2006750Hirco Plc (HiranandaniDecember 2006750

Source: AIM

Lately, there have been many flags raised and questions asked in this context. As investments
increased so did the prices and the obvious fear of a real estate bubble. With no clear methodologies
and norms on valuations, there was the imperative fear of the bulls chasing away the bears and
shattering many dreams. There were doubts raised on what to define as an FII investment vis-a-vis FDI.

Some of the issues, which have been raised or resolved, are –

1. On issues of pre-IPO placement, the finance ministry has concluded that if FIIs wish to invest in
a pre-IPO placement of realty companies, the investment would be classified as foreign direct
investment, or FDI, which is subject to a longer lock-in period, thus trying to eliminate the
speculation in such investments.
2. On valuations, the SEBI issued directives that valuations of real estate companies to be based
on their development plans and not on their land banks. There is also a proposal for valuers to
be registered with the SEBI.

With the advent of Real Estate Mutual Funds (REMFs), corporate governance issues, stricter
compliance by players, maturing markets and greater transparency this market offers great potential for
its players – be it the developers, funds, FIIs or retail investors. Also the new locations in mind of
investors would be the Tier III cities which offer fewer entry barriers in the form of competitive land prices
and availability of land banks.