An overhaul in foreign investment regulations for real estate at the beginning of 2006 has caused a rapid influx of investors eager to participate in India's growth story
The real estate investment market has been heating up right across Asia, and nowhere is this more evident than in India. While the likes of China and Singapore boast real estate hot spots (resulting in some cooling-off efforts in China), India's real estate evolution is more widespread, and to investors is appearing inherently more sustainable.
If you build it, they will come
Driven by positive growth in the economy, real estate in India is booming. The year 2006 started on a promising note for prospective investors when India opened the construction and development sector in February 2006, allowing 100% foreign direct investment (FDI) under the 'automatic route' in order to spur investment in the nation's vitally needed infrastructure. The relaxed FDI rules have invited more foreign investment and real estate development in India, a sector proving a most lucrative proposition at present.
"The positive outlook of the Indian government is the key factor behind the sudden rise of the Indian real estate sector - the second-largest employer after agriculture in India," says J Sagar & Associates partner Shivpriya Nanda. "This budding sector is today witnessing development in all areas, such as residential, retail and commercial, in metros of India such as Mumbai, Delhi & NCR, Kolkata and Chennai," she says.
The revised policies allow foreigners to own property, and have dropped the minimum size for housing estates built with foreign capital to 25 acres (10 hectares) from 100 acres (40 hectares). Overseas firms can now build commercial buildings as long as the projects surpass 50,000mý (538,200ftý) of floor space. As a result, overseas funds of over $7bn have already been announced for investment in Indian real estate. FDI in real estate is estimated to reach $16bn by 2012 from just $600m last year.
The real estate boom is spurred on by India's growth story. With GDP growth of around 9% for 2005/06, the economic drivers are obvious. There is a requirement for 80 million units of housing over the next 15 years and 61 million square metres of office space over the next five years by IT and business process outsourcing industries alone. The real estate market is expected to be worth $50bn in 2010, up from $14bn this year.
The enthusiasm for Indian real estate was demonstrated in the recent IPO of DLF Limited (DLF), India's largest real estate development company. With an appropriate slogan "Building India", DLF now has US$2.25bn more with which to do it, after it received an overwhelming response to its 100% book-built offering, India's largest to date.
The result of the real estate boom is more work for law firms, acting on foreign direct investments, private equity, funding, project finance, and joint development projects. The deals are spread across residential, commercial, institutional and hospitality sectors, and for both local and international clients including corporate/private equity funds.
"From a sector which typically involved only conveyancing and leases, the law firms are increasingly engaged in structuring and advising on complex deals involving different types of project interests," Nanda says. "The real estate practice groups in most law firms have been significantly strengthened by the addition of experienced lawyers from the transactions and banking & finance practice."
Know your acronyms: REITs, REMFs and REOCs
Although there are yet no Real Estate Investment Trusts (REITs) listed in India, some India-referencing REITs are reportedly considering listing offshore in established REIT jurisdictions. "As India's real estate market grows and opens up, REITs could play a major part in its development," Nanda says.
According to sources, the Securities Exchange Board of India (SEBI) has recently finalised guidelines for the introduction of Real Estate Mutual Funds (REMFs), and is considering framing guidelines for REITs going forward. SEBI's guidelines should also make it easier to invest in the sector through listed Real Estate Operating Companies (REOCs) and increasingly through foreign direct investment (FDI).
The real estate industry is eager for the introduction of REITS, with players feeling this could be a big step forward for the market and economy. Nanda says REITs can boost capital access and reduce capital costs for property owners, managers and developers, and have also successfully helped the commercial property business in other markets to better access the four quadrants of capital: debt and equity, public and private.
"However, the road to establishing an Indian REIT sector could be challenging," Nanda says. "Not least, the authorities will need to change parts of India's legal and tax frameworks. Furthermore, the real estate transaction process is cumbersome, and the property industry's transparency and disclosure levels must be improved," she says.
In regards to REMFs, although these are present they are essentially available only to high net-worth individuals, and institutional and global investors. "Catering to them are players like ICICI Venture, HDFC, Kotak Mahindra and Kshitij Venture Capital (Pantaloon), all of which have floated real estate funds," says Amarchand & Mangaldas & Suresh A Shroff & Co managing partner Shardul Shroff. "According to SEBI regulations, an individual investor in an REMF must put in at least $11,500. The current players, however, have set minimum contributions at far higher levels: ICICI and HDFC look for a minimum investment of $500,000, while Fire Capital asks for $1m. Obviously, it's not for small players," Shroff says. The funds operating in the industry today look more like real estate venture capital funds than mutual funds, and although SEBI has allowed the funds, there is no mention of retail participation in them.
Aiming for London
Since its launch in 1995, over 2,600 companies from various industrial sectors across the globe have joined London's AIM exchange. So far, about 25 Indian companies have listed, including Eros International, Hardy Oil & Gas, Hirco, Unitech Corporate Parks, Promethian India, Trinity Capital, KSK Power Venture and Ishaan Real Estate.
"Indian real estate companies, seeking piles of cash to fund their projects, and foreign investors, eager to get their fingers in the pie, have a common meeting point on the Alternate Investment Market of the London Stock Exchange," Shroff says.
It has become a favoured destination for listing because of its not so strict compliance requirements. Companies looking to raise capital on AIM do not need a three-year track record. As a result, real estate companies can form special purpose vehicles (SPVs) to execute the various projects, and can list and raise capital from foreign investors. Shroff says AIM also allows overseas investors to pick exposures in projects where 100% FDI is allowed. FII holdings in real estate companies are capped at 26%, though some companies have raised it with permission from Reserve Bank of India.
"The SPV route seems to be the preferred approach for Indian construction companies. It enables them to raise cash without diluting equity in the main company. Moreover, many foreign investors may not be comfortable taking an exposure to the balance sheet of Indian developers, according to investment banking sources," Shroff says.
"International investors stand to gain the best of both worlds: the booming Indian real estate market, and the security and transparency of a regulated stock in London," Nanda says. AIM is also filling a gap missing domestically. "There has been a strong need for an alternative trading platform for SMEs domestically but lack of it is prompting more and more to opt for foreign listing. Policy makers should look into the Indian alternative."
In the zone
The approval and subsequent creation of special economic zones (SEZs) in India is contributing significantly to the growth of the real estate market. As part of an attempt to grow an export-oriented manufacturing economy to augment its successful services-based economy, the Indian SEZ Act of 2005 was followed by the approval of 150 SEZ proposals within six months of the Act coming into force in 2006. The proposals submitted by both Indian and foreign companies to set up businesses in these SEZs account for $6bn worth of commitments. SEZs require large upfront investments to acquire large tracts of land and develop the basic infrastructure. However, 65% of this land area is available for commercial, residential and retail real estate development.
"Recent concessions such as the liberalisation of foreign direct investment in real estate, the rush of builders and developers to acquire SEZ land, the fact that only half of the area under a SEZ has to be dedicated to a broad definition of processing or industrial activities, the fact that industrialists are all too often being granted land well in excess of their production requirements, all point to an engineered real-estate boom through SEZ growth," Nanda says. "Huge amounts of capital are pouring into the market, from both within India and overseas. Returns of 30%, 40% or higher are becoming common."