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While India's real estate market is moving towards 'corporatisation', here's what it needs for its 'real' revival!

August 2018
There's been plenty of action in the Indian real-estate sector in the wake of policy moves like Real Estate Regulatory Authority (RERA), Goods and Services Tax (GST), Housing for All by 2022, foreign direct investment (FDI), the Benami Transactions Prohibitions Act, demonetisation, the Insolvency and Bankruptcy Code (IBC) and land title insurance, among others.

The market, which is expected to touch $180 billion by 2020, is undergoing a transformation, the results of which are becoming visible.

'Three powerful legislative reforms - RERA, IBC and GST - have put the sector on the path of transparency,' says Ramesh Nair, CEO and Country Head, JLL India. 'Grant of infrastructure status to affordable housing was among the most significant steps by the government in recent times. This opened up avenues for developers who were previously sceptical to take up these projects owing to lack of appropriate funding. It allowed them to gain funding from NBFCs, ECBs and, more recently, the National Housing Board (NHB).

The government is also setting up a dedicated Affordable Housing Fund (AHF) under the NHB, which will be a game-changer.'

FDI on the up
Overseas capital investment in Indian realty touched $2.6 billion in 2017, recording a 31 per cent growth over 2016, according to a Knight Frank report. 

While the number may not be too high, it signifies the renewed interest in Indian realty after four years of slowdown, according to Mudassir Zaidi, Executive
Director-North, Knight Frank India.
He believes the market is still in a bearish phase, considering a large part of it comprises the still bearish residential segment.
'Other segments such as commercial and retail are doing decently. FDI is flowing in largely in built assets, such as offices and malls for leasing.'

The visible shift is in terms of investment from global investors. 'This is where the new regulatory regime has played a major role in enhancing the safety and security factor global investors seek,' shares Dr Niranjan Hiranandani, National President, NAREDCO, and Chairman & Managing Director, Hiranandani Communities. 'Plus, the regime has made it easier for institutional investors. Another factor is the evolution of other segments of real estate as potential asset classes - commercial has been doing exceedingly well and is sought after by global investors.'

The reforms in FDI regulations have allowed direct investment by foreign funds into real-estate developments through the direct route with limited restrictions. This allows NRIs, PIO and smaller funds to invest in smaller projects. 'The opening up of commercial, retail and industrial assets has brought in the bulk of the FDI money to buy commercial and IT buildings,' adds Amit Goenka, Managing Director & CEO, Nisus Finance Services, 'Further, low mortgage interest rates, increased confidence of consumers and the push from PMAY have shown healthy growth in sales and offtake for branded developers. This is attracting investors and financiers to pour in more capital in finishing mid-income housing projects. The returns on debt and equity are also higher than most sectors with a strong underlying asset base.'

A number of key investors have taken a keen interest in projects related to affordable housing and opportunities for growth are immense, shares Mini Nair, Executive Director & CEO, Essel Finance Home Loans.

FDI in Indian real estate has touched a high point owing to RERA and good rental yielding asset, reasons Vijay Agrawal, Executive Director, Equirus Capital, adding that, last year, there have been multiple deals in IT parks and malls. Marquee deals include investment of $142 million by Blackstone in Dawn Retail (a Chandigarh mall and commercial project), CPPIB's $255 million in Phoenix Group's mall project and Brookfield's $378 million in Equinox Business Park, among others. 'We have also seen multiple deals in residential projects by various developers and are now witnessing more partnerships, wherein investors are committing to developers.'

Blackstone has partnered with Panchsheel Group, Embassy, Salarpuriya, Prestige and other developers. Similarly, ADIA has partnered with RMZ. Other funds are also looking for similar partnerships.

Funding scenario
While the industry continued to grow at about 20 per cent per annum, growth among real-estate lenders is at about 38 per cent.

This is evidenced by the large number of NBFCs starting shop.
'Most earlier project financing avenues have been shut,' says Goenka. 'Banks are facing a liquidity crisis, having already hit their real-estate limits. In fact, they are withdrawing commitments.

This has brought forth a new wave of opportunity to NBFCs, funds, HFCs and new banks. The high confidence of financiers and lenders is because of higher transparency, governance and reporting; greater caution and accountability owing to RERA and IBC; GST and accounting standards; higher risk-adjusted return with strong asset base; improved economics owing to revised development norms in most cities; and higher margins to projects under PMAY from tax breaks and low subvention cost.'

Almost 45 per cent of funds in real estate today are from non-bank institutions, up from 18 per cent a few years ago. 'There is an estimated $4 billion of liquidity available in the non-bank or fund space, which is looking to be deployed in real estate,' adds Goenka. 'A large number of international investors, global institutions and prominent Indian corporate houses have hence lined up to finance this sector. With the legal process of enforcement through IBC, SARFAESI, etc, becoming more robust and the pressure on the developer from RERA, there is comfort and safety to lenders.'

Mini Nair believes a timeframe of another six months to a year will bring out the positive effect of RERA and GST and the industry will regain faith from financial institutions and investors.

Private equity (PE) investment in real estate was recorded at close to $7 billion in 2017. According to estimates by JLL India, PE inflows from 2014-2017 in office and IT and ITES have risen by 150 per cent. 'Residential remained the highest invested sector; its rise in the same period was about 5 per cent of total investment flows in pure equity,' says Ramesh Nair. REITs is one of the most awaited development for the real estate sector in India. Significant changes in making REITs a reality, in his view, are allowing REITs and InvITs to raise debt capital by issuing debt securities; introducing the concept of 'strategic investor' for REITs on similar lines as InvITs; allowing single-asset REIT on similar lines as InvIT; allowing REITs to lend to underlying holding company or SPV; and amending the definition of valuer for both REITs and InvITs. The SEBI board has kept the minimum asset sizes for investment at Rs 5 billion.

What do sales figures say?
New housing launches have been up by 50 per cent in the top seven cities in Q2 2018; housing sales, too, rose by 24 per cent in Q2 compared to Q1 2018, according to a report by Anarock Property Consultants.

In its Q1 operational results of FY18-19, Bengaluru-headquartered real-estate developer Sobha achieved new sales volume of 960,085 sq ft valued at Rs 7,624 million.

'The sales volume and total sales value are up by 18 per cent and 22 per cent respectively vis-a-vis the corresponding quarter of last year,' shares JC Sharma, Vice Chairman and Managing Director, Sobha.

Although overall market sales have declined 30-40 per cent from peaks, there is a market share shift towards Tier-I developers, who remain the preferred choice for end-users.

Towards 'corporatisation'
The shift from unorganised to 'corporatised' is clearly visible.
The market share of India's top 10 developers improved from 13 per cent in 2015 to 19 per cent in 2017 and the consolidation pace has picked up over the past two years after the implementation of RERA, as per a report by JM Financial Institutional Securities.

The reforms have created an environment where several smaller developers have been compelled to look at corporatisation as they did not have the ability to manage challenges like raising funds, observes Zaidi. 'They realised the best way forward is to tie up with stronger, larger and corporatised developers with the management bandwidth capability to take larger projects, build and deliver them. Besides, the larger developers are also not interested in buying land as a large part of project capital is for land cost. They are mainly interested in JVs, through which they can build and lend their name. Larger developers are currently focusing on project delivery, quality and price. Corporatisation will happen over the long term.'

The sector is expected to experience long-term consolidation in the wake of RERA, with reputed developers poised to reap the benefits of enhanced brand recognition and loyalty, believes Sunil Sharma, Vice President-Marketing & CRM, Mahindra Lifespace Developers. 'Corporatisation augurs well for long-term growth, with lenders and financial institutions tending to prefer corporate players who can consistently demonstrate value creation for stakeholders.'

The implementation of the reforms are creating a level-playing field for organised players with a strong balance sheet, transparent dealings and a track record of timely delivery, says JC Sharma. 'These changing dynamics are likely to enhance the credibility of the sector with a focus on transparency, accountability and speedy execution, and bring about orderly growth.'

The new regulatory environment is good for 'branded developers'. 'As this segment is already working as per the new norms, land aggregators have been opting to work with them,' says Dr Hiranandani. 'Similarly, the unorganised segment finds it can learn the new rules easier by working on a couple of projects with those already working on these lines.'

Consolidation is expected to continue as unorganised developers partner with branded developers to improve return profiles and reduce regulatory risks. 'With changes in RERA, small players will also convert themselves into corporatised players,' says Agrawal. 'We will see more mergers and acquisitions (M&As) and joint developments.'
 
What's required for the big leap?

The industry has one loud cry: Single-window clearance! This will play an important role in helping developers reduce average project time.

For the big leap, growth drivers such as fast-tracked, single-window approvals can be a boon, says Sunil Sharma. JC Sharma agrees, saying: 'The tedious approval process can take up to 18-36 months before beginning construction. Similarly, a project requires 50 NOCs, with each taking four to six months. This delays delivery and increases costs by 10-30 per cent. Single-window clearance will speed up and simplify the approval process, enabling developers to bring down the cost and timelines by at least three years. Buyers, in return, will be able to see price correction in their markets.'

Dr Hiranandani further emphasises: 'Our demands for time-bound, single-window clearances is still pending. Another example is the taxation system, which was sought to be made better with GST but still remains a work in progress. Also, real estate has not seen stamp duty and registration as also various types of cess and levies being subsumed into a unified GST. Again, the affordable housing segment enjoys a lower GST rate for the works contract compared to other realty segments.'

There is great opportunity for developers to change the perception of stakeholders and we are already seeing signs of revival, avers Mini Nair. 'However, despite various reforms, the industry needs stronger thrust, viable private-public participation and faster project approvals to achieve full potential.'

Goenka believes the markets are too fragmented and shallow for serious investors to pour in large capital. 'There is still a disparity between affordability and price of assets.' Further, he suggests the following:
  • Rationalisaton of taxation: The total tax incidence on homebuyers is effectively 40 per cent of the purchase price including GST, stamp duty, etc.
  • Approvals and permissions: Nearly 15 per cent of the selling price is owing to cost of approvals and permissions.
  • In addition, the FAR sold by the state and municipal agencies add another 30 per cent to the price. Government charges and process should be rationalised.
  • Reduction in circle rates, land value: Government estimates on value of land and built-up areas are still too high, artificially pumping up prices.
  • Land bank: Government agencies are yet to provide land banks under the PPP model for PMAY. Private land banks are expensive.
  • Capital cost: The cost of capital is still a large concern for affordable housing. NHB needs a model for affordable capital to bring down the prices of stock, which will further stoke demand.

Enough measures have been taken on all fronts for regulation, avers Zaidi. 'What matters now is implementation, which is still not up to the mark.' He expects things to be healthier in the next three to five years.

NAREDCO, along with industry representatives and other stakeholders, recently met Minister for Housing and Urban Poverty Alleviation Hardeep Singh Puri. 'The emphasis was on measures, including effective implementation of RERA, to 'revive' the sector,' shares Dr Hiranandani. 'We discussed the creation of a 'stress assets fund' to enable completion of stalled projects, by providing last-mile funding. Another suggestion was allowing NBCC to take over and complete stalled projects.'

We hope for a positive resolution of all these aspects to bring about the 'real' revival for the sector!

What are Investors and Developers looking at?
Indian real estate has caught the fancy of investors and developers alike.
Nisus Finance operates through a SEBI registered Category II AIF Fund and, along with co-investors, capitalises projects through NCDs. 'We have been investing through the AIF route since 2012-13 and believe it is the most efficient and effective way of investing capital,' says Amit Goenka, Managing Director & CEO, Nisus Finance Services. The firm's recent investments through NCDs include an investment in affordable housing in Thane for $5 million, a mid-income residential project in Noida Extension for $8 million, and an affordable housing project in Bengaluru. 'We are looking at similar projects in Mumbai, Pune, Noida and Bengaluru for an additional investment of about $30 million.'

Sobha uses debt financing towards executing projects - residential, commercial and contractual - and finance the acquisition of land parcels for future development. 'Our debt-equity ratio has been in the range of 0.60-0.85 for the past six years, among the lowest in the sector,' says JC Sharma, Vice Chairman and Managing Director, Sobha, 'Every year, we are able to maintain and sustain this ratio by generating consistently operating cash flows.'

Mahindra Lifespace Developers has partnered with World Bank member International Finance Corporation to develop multiple industrial parks across Gujarat, Rajasthan and Maharashtra, with an investment commitment of $50 million, shares Sunil Sharma, Vice President-Marketing & CRM, Mahindra Lifespace Developers. Also, for the development of affordable homes, the firm has established a JV with HDFC Capital Affordable Real Estate Fund-1, a fund managed by HDFC Capital Advisors, with an investment commitment of Rs 5 billion.

Solutions amid Challenges

Vijay Agrawal, Executive Director, Equirus Capital,
shares the challenges faced and offers some solutions:

Challenges:
  • Defaulting developers: It is developers rather than home buyers who seem to be defaulting on payments. Competition led to massive accumulation of land. Borrowing for this purpose and land development made the interest burden accumulated huge, and in excess of what could be met by the development and marketing of house properties and commercial floor space. So, leading developers have also stopped servicing debt and become part of the NPA problem. The impact on construction is reflected in the deceleration and recent decline in cement production, which is a commonly used proxy for real-estate growth.
  • A fallout of the NPA problem is that banks are less willing to lend as they work on cleaning up balance sheets and finding funds to recapitalise themselves. This has hit the housing sector as well.
  • Thus, trapped between rising interest and other costs and faltering demand that affects prices, the real-estate sector is experiencing a severe version of the crisis stemming from the inability of the system to sustain growth driven by private debt-financed spending.
  • Regulatory pressure: Like in 2017, developers will have to confront the effect of RERA by concentrating on finishing ongoing projects.
  • As supply of ready-to-move-in properties expands, builders will confront the challenge of finishing the task on a specified due date.
  • Single-window clearance: Property clearance for a developer takes from 18 months to three years.
  • GST rate: 2018 has seen clarity on GST in the real-estate industry. There is no GST for completed, ready-to-move in properties, properties for which completion certificate has been issued, and for resale.
  • Rising input cost: The real estate industry is both capital and labour-intensive. Owing to lack of advanced technology and skilled manpower, overall project economics are not achieved and there are further delays. In fact, at present, 25 per cent of housing projects in India are delayed because of this.
  • Slow urban development: India is witnessing high urban population growth but per-capita urban infra spending is low, restricting realty growth.
  • Scarcity of land: Non-availability of land within city limits along with rising land and construction costs is leading to an increase in overall cost of projects, making them unviable.
  • Lack of adequate policy framework: There is a lack of coordination between Central and state ministries. Further, numerous Central and state level laws, rules, and regulations often result in a lengthy and cumbersome approval process.
  • Restrictive development norms: Low floor area ratio (FAR), density norms, ground coverage, parking provision, etc, also pose a challenge.
  • Unsold inventory: Owing to stagnancy in the market, unsold inventory  has increased considerably. According to Knight Frank, unsold inventory in India include 206,000 units in the NCR; 181,000 in Mumbai; 100,000 in Bengaluru; 63,000 in Pune; 41,000 in Ahmedabad; 36,000 in Chennai; 36,000 in Kolkata; and 31,000 in Hyderabad.

Solutions:
  • To deal with an inadequate policy framework and project delays, the government should decentralise decision-making and empower urban local bodies.
  • The approval process should be streamlined with a single-window clearance mechanism backed by technology.
  • Low FAR/FSI, density norms, etc, should be reconsidered.
  • Fees and taxes should be rationalised across project stages as they increase construction cost by 30-35 per cent.
  • PPP framework should be adopted to effectively address major issues.
  • A nodal agency to coordinate effort of various stakeholders should be formed.
  • More funds should be allocated; FDI should be promoted.
  • Cuts in interest rates should be announced to reduce the cost of borrowing, help clear unsold inventory, and support future demand.

- Seraphina D'souza

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