Securing funds is an essential requirement for developing real estate projects. However, unlike other sectors, the funds required to develop real estate projects are considerably large. Further, the cashflow requirements vary depending upon the size, nature, and stage of the real estate projects. These multidimensional intricacies pose unique funding challenges that many developers and promoters find hard to navigate.
Conventionally, real estate projects were funded primarily through a combination of debt and equity instruments. The choice was rather simple with promoters employing equity at the onset of the project followed by the infusion of debt money towards the advanced stages of the development. However, the investing scenario has undergone massive transformation lately with developers starting experimenting with other financing tools as well. So what are these tools and how one should use them, here's a complete lowdown:
a) Equity Financing: Counted among the most common methods of financing, equity allows real-estate developers to meet the large requirements of the funds for their projects. It?s considered a preferred method to start the projects with the money raised from the equity is used primarily for buying the land, starting the development activities, and building basic structures underpinning projects. As the funding requirement at the initial stage is relatively high, many developers choose the private equity route for raising the money. The method is more time consuming in contrast to public equity although it offers a more friendly plan for the repayment of the money. Overall, equity financing is a very dependable method and although it weighs a bit higher on the risk factor, it?s very popular among the promoters for developing real estate projects.
b) Debt Financing: Another popular method of raising the money for developing real estate projects is debt financing. Majority of real-estate developers use the instrument of debt to meet their funding requirements at different stages of the development activities. However, it?s ideal to rely on debt once the initial development is complete and cash inflows begin from sales or leasing activities. Banks are primary lenders in debt financing and with the growing interest of the non-banking financial corporations (NBFCs) in real-estate, promoters today have plenty of options to choose the lender for their projects. That said, one needs to be careful of the repayment terms and interest rates as these can vary considerably between banks and NBFCs.
c) Real Estate Funds: Growing exponentially, the use of real-estate funds are increasingly becoming the preferred choice of developers in both India and abroad. There are many prominent funds in the Indian market and the best thing is their focus on the specific needs of development projects. In fact, this discrete nature of real estate funds make them one of the best financing instruments for developers. Generally, these funds invest through the route of non-convertible debentures (NCDs), thereby offering desired levels of flexibility and versatility to developers. Going forward, the popularity of real estate funds are likely to surge even further as the method strikes a perfect balance between risk, convenience, and affordability factors.
d) Joint Ventures: Specifically suitable for developing large-size projects, joint ventures is the preferred route for many financial Institutions which join hands with leading promoters to leverage development opportunities in attractive land pockets. The sharing of the risk is the biggest advantage of joint ventures and by combining the financial prowess of institutions with operational excellence of developers, amazing results can be achieved in the real-estate sector. The key to success here is that both parties must bring their own competencies to the table and integrate them in a manner that will help in delivering superior value to end consumers. Joint ventures are an important aspect of real estate and with growing possibilities, this mechanism will help the sector to grow exponentially in the future.
e) Crowdfunding: Using the power of web and social media, developers can utilize crowdfunding to raise the money for their development projects. Unlike other mechanisms, there is no need for direct interactions with potential investors as the funding can be sourced online through social media platforms or official websites of promoters. The method involves combining small portions of money from a large number of investors and then investing the cumulative amount in the development activities. The method of crowdfunding for sourcing money is undoubtedly attractive although developers need to be careful regarding the regulations associated with the process. Nations across the globe vary in terms of crowdfunding requirements and hence, it?s essential to fully understand the laws before adopting this instrument for securing the funds for real estate development projects.
f) Foreign Direct Investment (FDI): The route of FDI is an excellent source of funds although their limited access only to the mega projects make it out of bounds for most of the developers. The funds through the FDI route come with low interest rates although can be explored by a limited number of promoters who are involved in large-scale development activities. The association with government projects or being part of the Public-Private-Partnership (PPP) can come in handy in receiving funds through the FDI. Given the higher threshold for entry, the FDI route is not very popular among the real-estate developers. That said, its prominence is quite apparent in the projects related to infrastructure development.
g) External Commercial Borrowings (ECB): A less-taken route by real estate developers is ECB as it entails fulfilling stringent conditions laid under the Foreign Exchange Management Act. The restrictive nature of this instrument makes it less popular among the developers, especially among the ones who are primarily involved in the development activities domestically. On the flip side, the ECB offers developers a chance to raise huge amounts of funds for accomplishing considerably large projects in an affordable manner.
Selection Criterion There is no one-size-fits-all approach when it comes to funding real estate development projects. For new developers who have just ventured into the domain, the use of debt instruments is recommended. In stark contrast to this category are developers who have already delivered a few projects in the past and are coming up with new development plans. For such realtors, the use of equity and real estate funds are the ideal options. Especially the use of real estate funds are advantageous as these are specifically constituted keeping in mind the current realities and needs of the market. As far as Joint Ventures, FDI, and ECB are concerned, these financial instruments are largely used by the seasoned developers who have big infrastructure development projects to their credit.
Conclusion Choosing an appropriate instrument of financing is critical for getting success in real estate development projects. While options are many, developers must align their priorities with available instruments to choose the best method of financing. All methods mentioned above have their merits and demerits and it's only after taking into consideration all the factors, one should pick the most appropriate method for developing their projects. In sum, there are many methods to secure funds and choosing the most feasible one must depend upon the nature, scope, and specific requirements of the project.
Authored By: Ankur Jalan, Chief Executive Officer (CEO) at Golden Growth Fund (GGF)
