Developers opt to fund their
construction projects through pre-launch and pre-sale mechanisms, as by far,
these are the cheapest sources of finance available
Namrata Kohli Real estate finance
is a grey area. In reality, realty funding happens through pre launches. So, a
builder typically asks buyers to cough up, say, a third of the final cost of a
house even before the first piles are drilled into the ground. In effect, very
little of the builder's own capital is at risk. This has been the done thing -
an arrangement between builder and buyer, which has been successful owing to
scarcity of housing in the country.
Real estate development business
requires constant acquisition of land for future projects. According to Sharad
Jhingan, COO (private equity fund) at Lanco Infratech Limited, "Due to the
short supply of land and lack of habitable locations and urban infrastructure
outside established locations, a developer starts to sell even before
finalizing the development plans. This is more a reflection of supply-side
constraints. A developer wants to grow as fast as possible. All these methods
allow him to acquire - what to him is the key constraint - land banks."
Even though pre-launches are
illegal, a developer realizes that the penalty for transgression is very light,
and public memory is short. But as Jhingan adds, "The core issue needs to
be addressed - that of increasing the land supply and speedy development of
alternative urban centers, along with strict imposition of penalties similar to
what Sebi does."
In theory, the funding of
construction using advance money from buyers is "fading out" owing to
"competition and financial sophistication" and "foreign
investors are queuing up to bring in equity into our markets". But equity
financing is only a short-term option. Sachin Sandhir, MD and country head of
RICS India shares his perspective: "Yes, there has been a visible shift
towards equity financing for projects. Real
estate companies have been very ambitious in the past and most are
already highly leveraged. Although RBI allowed debt restructuring for a year,
there is an astounding Rs 75,000 crore of outstanding debt with one third of it
due by June 2010. Even as unit sales have picked up, developers have not booked
enough profit to repay their debts.
Consequently, other sources like
equity dilution and bulk selling to long-term investors at 30-40% discounts are
the present-day necessities. Developers are also trying to attract PE funds to
invest in short-term, small-format projects with completion schedules of 3-4
years. In fact, private equity has experienced a phenomenal growth over the
last two decades as institutional investors, seeking higher returns have
embraced this alternative to traditional asset classes." But, cut to
reality and equity is much costlier than debt, so no businessman wants to
dilute more than what is absolutely necessary. Experts feel that almost all
sectors in India witness high leveraging. Real estate is no exception.
According to Jhingan:
"Presently, the reason to raise more equity is lack of sufficient cash
flows to service the loans. The fundamental issue is of excessive leveraging in
anticipation of huge profits from fast growth in sales. This did not
materialize and hence developers now want to raise equity to repay loans. This
argument itself is absurd." How do private equity funds view Indian
property market? It seems PE funds are both keen and wary of India.
They are keen because of India's growth story, and they are wary because it is
difficult for them to operate in India.
They want ease of entry and exit
and faster court processes in case of disputes - lack of transparency and
corruption further increases their wariness.
Ritesh Vohra, MD of Real Estate -
Saffron Asset Advisors, feels that debt and equity will always have a role to
play in Indian real estate. He adds that while equity is required for land
purchase, debt would be required for financing construction, especially in case
of office or retail building, which have a build and lease model. Ankur Gupta,
of Ashiana Housing, agrees: "Both are critical for real estate funding.
Joint ventures with landowners are also part of equity financing, which we have
been doing regularly and find that the best way to get equity financing. Debt
in construction financing works to make sure you are achieving your speed of
construction." Ankur adds, "We do our funding mostly through customer
advances and internal accruals. Secondly, we look at bank lending as they are
the two cheapest form of project financing available."
Private equity funds are bullish
in all metropolitan cities as well as developed Tier II cities. The verticals
for investment include retail, and specifically affordable segments in
residential projects, which spell opportunity for most of these funds. Vohra's
fund is focusing on the residential space - especially the midmarket and
affordable housing segment. In the long term, retail will also emerge stronger
and so would commercial segments.
He says that both these segments
need to resolve a few issues to ensure their long-term attractiveness - for
retail it is about focusing on quality of shopping center management and
developing greater depth amongst the retailer community. For commercial, it is
largely about managing the present oversupply situation in many micromarkets
and gradually moving away from the over dependence on IT. Industrial space and
warehousing are some of the other interesting verticals.
There are many PE funds, which
have taken a long-term view on India and which remain committed to investing
here. Equally, there are some daunted by the unstructured nature of the
markets. Bank lending is a very important source of funding which has emerged and
is here to stay. Experts conclude that bank lending will be an important source
of funding for developers.
FOCAL POINT
In theory, the funding of
construction using advance money from buyers is "fading out" owing to
"competition and financial sophistication" and "foreign
investors are queuing up to bring in equity into our markets" Experts feel
that almost all sectors in India witness high leveraging. Real estate is no
exception.
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