Uncertainty in markets drives developers to PE for funding

In future, pulling off a successful IPO will become more difficult. “With sentiments on the stock market not so bullish anymore, only developers with a good reputation and a track record will succeed. Their offer price too will have to be more realistic,” says Anshuman Magazine, MD, CB Richard Ellis South Asia.

• Private equity (PE). This was already a popular option, and now, with IPOs becoming difficult, it will become even more attractive in the days to come. “Expect more PE investments both at the SPV (special purpose vehicle) and the entity level. A lot of funds have already been raised and are waiting to be invested in the Indian real estate market,” says Maheshwari of DTZ.

According to DLF vice-chairman Rajiv Singh, “In terms of appetite, anywhere between $10-20 billion private equity money could be in the pipeline for investment in the Indian real estate sector.” Adds Magazine of CB Richard Ellis: “Earlier, Indian developers were reluctant to part with equity. But now that raising funds from debt sources and through IPOs has become difficult, the mindset is changing.”

Could the subprime crisis affect PE fund flows into India? According to Maheshwari of DTZ, “Only private equity funds that were planning to raise money from institutional investors in foreign markets will be affected.”

Meanwhile a number of sources have closed down or become difficult for developers to access, either due to RBI regulations, high cost, or adverse market conditions.

• Bank loans. RBI regulations do not allow bank loans to be used for land acquisition, though it is available for construction. But the interest rate is high at 13-15 per cent. Besides the higher cost, availability has become an issue because of RBI imposing a cap on individual banks’ exposure to the real estate sector.

• ECB. External commercial borrowing was earlier available for townships of 100 acres or more. At an interest rate of 6-7 per cent, this was an attractive source till the RBI banned it completely.

• Mezzanine capital. This is a form of bridge loan offered for a limited period. Foreign mezzanine has been banned completely by RBI. Domestic mezzanine is available from non banking finance companies (NBFCs). But there are very few NBFCs, and the interest cost demanded by them is high at 16-20 per cent.

• AIM. Listing on the Alternative Investment Market (AIM) in London had emerged as a popular option for real estate developers about a year ago. According to George Mathew, senior VP at Edelweiss Capital, “This option has dried up in recent times because most of the funds listed there are trading at a discount.” Adds Magazine of CBRE: “Investors will want to see the performance of Indian companies listed earlier on AIM before investing further.”

In India, RBI’s regulations have led to overwhelming reliance on equity. And now with equity sources like IPOs also drying up due to adverse stock market conditions, is it time to open up new sources of finance for the real estate sector? Making real estate investment trusts (REITs) operational in India could be one options. By allowing developers to sell off their ready assets, REITs would free up capital and allow developers to start new projects.
Funding blues
• Volatile stock market conditions mean IPOs will become risky.
• Reliance on private equity funds will grow. A lot of funds have been collected and are waiting to be invested in Indian real estate.
• Bank debt is available only for construction, not land purchase, and that too subject to sectoral exposure caps.
• Sources like ECB, foreign mezzanine, and AIM have dried up