What’s hot in realty finance: Debt or equity, residential or commercial, affordable housing or premium property?
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What’s hot in realty finance: Debt or equity, residential or commercial, affordable housing or premium property?

What’s hot in realty finance: Debt or equity, residential or commercial, affordable housing or premium property?

01 Jan 2018 Long Read
What's hot in realty finance: Debt or equity, residential or commercial, affordable housing or premium property? CW PROPERTY TODAY explores...
After a slump in 2014-15, real estate has a lot going for it now. The enactment of the Real Estate (Regulation and Development) Act (RERA), demonetisation, the Real Estate Investment Trust (REIT) and the Goods and Services Tax (GST) are transformational reforms that are expected to bring transparency, efficiency and credibility to the sector.

By giving consumer confidence a shot in the arm, these reforms are also expected to revive demand and stimulate investment. Already, funding for real estate was up 40 per cent YoY between January and June 2017. This is expected to sustain.

Relaxed foreign direct investment (FDI) norms for real estate projects, robust office space demand, potential for pick-up in residential demand in key cities and thrust on affordable housing through policy incentives make us believe that the funds inflow for real estate should remain robust,' says Rajesh Krishnan, Founder & CEO, Brick Eagle. We believe the inflows will further increase over the next two to three years,' says Ambar Maheshwari, CEO, Private Equity Funds, Indiabulls Asset Management Company. 'Path-breaking structural reforms, which are currently causing some pain, will actually become a driver for further institutionalisation and more fund flows into the sector.'

Once RERA is fully implemented, it will increase customer confidence, and, in turn, ultimately facilitate greater volumes in the domestic market and direct more investment flows towards this sector,' says Khushru Jijina, Managing Director, Piramal Finance and Piramal Housing Finance.

RERA is also expected to meaningfully increase funding requirements for residential development, according to Krishnan, given that the Act precludes pre-launches and imposes strict capital fungibility norms.

Preferring funding route: Debt or equity
Most of the investment in the residential sector has been made in the form of structured debt while the completed commercial space has seen a lot of equity investment, according to Maheshwari.

So far, structured debt has been financiers' preferred option for smaller developers while large (Grade A) developers, seen as a safer investment, comparably find it easier to attract quasi-equity funding. This trend is expected to continue, as per Nilesh Karkhanis, Partner, Milestone Capital Advisors.

With larger and respected housing brands, there is always a high possibility of earning a premium in any asset class, explains Karkhanis. 'So, institutional investors participating with Tier-I developers will find structured equity as an optimum way to achieve target Internal Rate of Returns (IRR). Here, structured equity can be a combination of lower rate of assured return with an equity upside to be achieved by the investor in case the project performance meets and exceeds certain pre-determined parameters.'

With local players, however, Karkhanis says such upsides are hard to anticipate or presume, and hence, a conservative approach is advisable. Basis such conservative estimating, a debt structure works to the advantage of the developer as well, in case the project revenues exceed expectations

Some funds are established to make equity investments.
For instance, ASK Property Investment Advisors entered the real estate private equity business to undertake equity investments at project level in the mid-segment residential sector when all funds had decided to shift gears to structured debt financing in 2008. Over the last nine years, ASK has raised Rs 4,600 crore through four funds focussed on equity investments.

What goes in residential realty?
Most of ASK Property Investment Advisor's investments are in the mid-segment or affordable self liquidating residential projects in the five cities of Mumbai, Pune, NCR, Bengaluru and Chennai. 'Our core investment philosophy of prudent partner selection, mid-income housing focus, selection of growth corridors backed by job creation has enabled us to provide exits of over Rs 2,100 crore through 10 full and four part exits, generating 20-30 per cent IRR at project level,' says Amit Bhagat, Managing Director & CEO, ASK Property Investment Advisors.

'We invest in residential projects in the top seven cities. Our prime criteria for a residential development project are location, approvals and the promoter's execution capabilities,' says Maheshwari. 'Our return expectation from residential debt funds is ~20 per cent IRR.'

Overall, residential realty project financiers have major concerns over developers who simultaneously take up many projects, as the funds meant for one project tend to get diverted to a different project, says VG Kannan, Chief Executive, Indian Banks' Association.

While a solution for such diversionary tactics is for the money to be deposited in an escrow account, Kannan says, to be on the safe side, financiers prefer funding projects that have all the relevant approvals in place (as this is also sometimes cited as an excuse for non completion or slow development) and for which the promoter has committed equity (as this shows self discipline).

'Within this space, we are seeing financiers commit a lower proportion of funds to a certain project, in the range of 20-25 per cent as compared with the 40-50 per cent that used to be forthcoming for a project,' adds Kannan. With equity, debt from banks and advances from homebuyers being the three main sources of funds for a developer, he says, this may lead some developers to sell in advance more than the usual 30-40 per cent of project properties and divert some funds to start new projects.

Specialised funding for affordable housing
A key government initiative, Housing for All by 2022 under the Pradhan Mantri Awas Yojna, put affordable housing in a good space. Sops added to the prospects, in particular, granting affordable housing infrastructure status, enabling access to cheaper funding via External Commercial Borrowings (ECB), allowing increased time to completion, reducing the tenure for capital gains, a new credit linked subsidy scheme for the mid-income, etc.

So far, however, Krishnan believes funding for affordable housing (Rs 6-30 lakh ticket size) is limited as most lenders are focussed on lending to developers building homes for the mid and high-income groups (>Rs 30 lakh ticket size). Also, most lenders are focussed on the top seven to ten cities in India while developers in smaller cities continue to face paucity of funds.

With the macros becoming favourable and policy incentives for improving the demand and supply of affordable housing coming in to place, Krishnan expects residential demand to improve, leading to an increase in the number of residential projects, and hence, an increased need for financing.

Refinancing schemes for low-end housing led by government expenditure, wage increases in rural India, higher farm incomes as a result of stronger minimum support prices, lower inflation, and an impetus on the creation of rural infrastructure, is making a predominant shift in expenditure pattern in the rural sector. The necessity consumption expenses are now being uptraded by discretionary asset creation, thus boosting consumer spending at the near lower-end of the pyramid, thus triggering investments in affordable housing and allied sectors,' observes Manish Jaiswal, Managing Director & CEO, Magma Housing Finance.

Magma Housing Finance has refocussed and is sharpening its strategy on affordable housing finance. 'With the premium and top segments seeing a glut with builders offering discounts, and a shift away from the climate of investing in such real estate for capital appreciation, the affordable housing sector is poised for a sharp growth,' says Jaiswal.

What makes funding for affordable housing a specialised segment, Krishnan says, is the fact that most low-income housing projects are being developed by local developers with a funding requirement of Rs 5 crore to Rs 20 crore. 'This requires an SME approach with standardisation, so as to achieve scale. With this approach in mind, to cater to the funding needs of these developers, we are currently raising a Rs 500 crore fund focussed on financing affordable housing projects targetted for end-users across cities and fringe areas of metros. The fund will enable 50,000 homes for low-income families through sustainable development.'

Bright prospects for affordable housing loans
In time, a cascading impact on demand for housing loans in the country may also become visible.

We are addressing both the demand and supply side of developers' increasing impetus on affordable housing, by extending funding to developers who are building affordable homes across cities as well as creating tailor-made home loan products for this special category of homebuyers through our housing finance platform,' says Jijina.

Our base being low, we expect our affordable home loan portfolio sanctions to double in second half of the current financial year versus the first half. Our average ticket size of disbursement stands at Rs 12.3 lakh, so that's our emerging business landscape,' says Jaiswal.

Commercial realty poised for growth
Commercial realty has typically occupied the backseat to residential realty in realty funding, but it is now coming into its own. Currently, Maheshwari believes that commercial real estate offers a superior risk adjusted return (to residential realty) along with regular income to the investors.

At Indiabulls Asset Management Company, the preference is for commercial projects in the top seven cities. 'Our prime criteria for a completed rent yielding office project are location, quality of the completed building and the existing tenants, and we look for a return in the range of 16-18 per cent from a commercial completed asset fund,' says Maheshwari.

With the resolution of all the hurdles pertaining to REITs, ASK Property Investment Advisors has made a foray in this segment. 'We thought this is the right time to enter into commercial real estate, and have recently invested in two greenfield projects, one being a part of the mixed-used project and the other a city centric commercial office space,' explains Bhagat.

Historically, Piramal Finance and Piramal Housing Finance has had a bias for residential realty, which is why residences for sale (across the entire capital stack) still form a large part of its portfolio. However, the reforms have positively impacted its outlook on commercial realty as an asset class, so much so that the financier has gradually increased its exposure to both standing investments (through lease rental discounting) and under construction commercial assets (through structured debt and construction finance).

Lease rental discounting arrangements for commercial realty are financiers' preferred route for completed projects in markets which are not oversupplied with reputed tenant occupants who are perceived to be non defaulters,' observes Kannan. These arrangements work in favour of developers because they earn a small element of profit early on without selling the property. The money thus raised upfront is used by the promoter to start a new project. Banks also prefer this, as completed projects have no implementation risk and the security is also good.

With the first REIT listing expected to take place in 2018, Jijina expects a new asset class to emerge for retail and institutional investors to earn regular dividends with a relatively lower risk profile.'The developer, too, will benefit in the form of an additional exit route for their commercial portfolio and this should translate into increasingly, more greenfield developments taking place,' he notes.

Realty developers have a lot to look forward to as do realty financiers.


  • Funding for real estate up 40 per cent YoY between January-June 2017.
  • Quasi-equity funding: Financiers' preferred option for Large (Grade A) developers.
  • RERA is expected to meaningfully increase funding requirements for residential development.

Consolidating Times
In the preceding quarters, a strong trend has emerged towards consolidation in both, the developer community and the financing community. Khushru Jijina, Managing Director, Piramal Finance and Piramal Housing Finance, believes this is indicative of the increasing influence of policy initiatives. Smaller developers will no longer be competitive in the coming years as real estate development moves away from being a high return-minimum capital-low governance model,' he says.

Among financiers, given the need to achieve overall financial closure for a project will assume greater importance in a post-RERA world. Jijina expects the preference to grow for those who are capable of providing early stage equity, ongoing construction debt as well as late-stage completion finance. 'Those who focus on one or two verticals within the capital stack, risk seeing their market share erode further.'

Funds for Stuck Projects
In the last few years, most developers who have launched projects are facing a cash crunch as sales velocity is lesser than anticipated. Slow sales in leveraged projects have led to a mismatch in cash flows. Their problems are further aggravated as they have to focus on project completion as per the timeline committed to buyers and submitted to RERA at the time of registration. Bearing all this in mind, ASK Property Investment Advisors has recently launched ASK Real Estate Special Situations Fund-I (RESSF-I) with an objective to provide flexible and patient capital to developers in line with their current requirement in projects where absorption is slow, to ensure seamless project execution. Structured or preferred equity investments are being provided through this fund. The fund will continue to differentiate through quality of developer selection with projects in growth corridor, with focus on risk management and asset management for generating superior risk adjusted returns,' says Amit Bhagat, Managing Director & CEO, ASK Property Investment Advisors.

Brick Eagle has funded Sheltrex, a company that is developing an affordable housing project at Karjat. In 2015, Sheltrex acquired the Karjat site from another developer facing shareholder and legal disputes. 'Over 3,000 customers were stuck for over seven years,' notes Rajesh Krishnan, Founder & CEO, Brick Eagle. Since then, Sheltrex has already delivered 800 homes to these customers and plans to deliver the rest over the next two to three years.'


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