A new world for Indian developers

The personality-driven construction sector in India has been undergoing a period of profound change. The net beneficiaries of this change may be foreign private equity real estate firms, who bring with them badly needed capital. But partnering with an Indian developer is not a straightforward affair. By Dave Keating

Construction in India is big business. After all, it stands to reason that in one of the fastest growing economies in the world, companies that build things would be among the most successful.

Construction has accounted for around 40 percent of the development investment in India over the past half century, and today around 16 percent of the country's workforce depends on the sector. As its importance has increased, foreign investors have flocked into the area. In fact, construction projects in India have come to increasingly rely on foreign capital as well as domestic lenders and the public markets as a source of funding.

“The degree to which developers have come to rely on foreign funding may put many of these ambitious projects in jeopardy as Western financial institutions experience turmoil.”

For this reason, the global economic turmoil seen over the past several months has affected the Indian construction sector more than most. And the timing couldn't be worse. As Western investors start to reel back and become more conservative with their investments, the Indian real estate sector is experiencing price slumps and vacancies that threaten to drive many of the smaller developers out of business.

But for Western private equity firms, the timing could be an ideal opportunity as they seek to expand – albeit cautiously – the relationships they've already built with domestic Indian construction companies. As funding from banks and the public markets dries up, Indian developers will have no choice but to give away larger equity stakes of their projects as private equity becomes their only source of available funding.

A complicated industry
Partnering with Indian developers is by no means a straightforward task, however. The industry, like the rest of Indian society, is traditionally family-driven. This is, at its heart, a personality business.

The largest private Indian developers are run almost as mini-kingdoms, having been set up from the amassed fortunes of wealthy families and run by colourful characters. The industry was originally state-run, and as it was privatised it was the wealthy families who had the capital to start enterprises and expand existing businesses into real estate. Anuj Puri, an analyst with Jones Lang LaSalle Meghraj in Mumbai, notes that the result is an industry that is largely based on personal relationships. “Many development and construction concerns were driven by single individuals who included only their immediate families in the key positions of their operations,” he says. Details on some of those important families can be found in the company profiles on pp. 42-45.

The fact that the industry is so driven by personalities makes sense not only because India is still a developing market, but also because investing in the sector requires a great deal of trust. “In Indian real estate, there are some typical drawbacks to contend with – lack of title insurance, bureaucratic red tape and opaqueness in regulations concerning real estate ventures are just some of these,” says Puri. “It takes development companies of considerable reach, financial strength and stature to bring their projects to completion in the face of such stumbling blocks.”

Those developers who appear to have the size, scope and available capital to reassure investors' fears have been the most likely to benefit from private equity funding. Because there are so many uncertainties, investors want to make sure that the developers they invest with have the resources to bring a project to completion regardless of what may happen along the way. But even some of the most successful families may find it tough to weather the upcoming storm.

Lehman panic
A preview of how directly the Indian real estate market could be affected by the failure of Western financial institutions was seen in September following the collapse of Lehman Brothers. Lehman had made numerous investments in some of India's largest developers. The firm had invested $200 million in India's largest real estate company DLF, and over the summer the firm had paid $175 million for a 50 percent stake in a project in Mumbai being developed by Unitech, India's second largest developer. Lehman was also in the process of investing in the two Mumbai-based property companies, Peninsula Land and Housing Development & Infrastructure.

So when news reached India that Lehman had collapsed, there was massive fear that all of these projects would be abandoned. Unitech quickly claimed that all of the funding for its Mumbai project had already been received, but there has been continued speculation that it still might not go forward.

At the same time, the collapse made many public market investors panic after it was realised that many Indian developers have raised money from foreign hedge funds, banks and private equity firms through structured deals in which assurances have been given of 18 percent returns on capital and where promoters' holding has been pledged as collateral. Under these arrangements, the foreign investors can sell their shares in the secondary market if prices fall below a certain level.

There has been talk of a firesale of Lehman's Indian investments in other real estate companies – such as IVRCL Infrastructure, Consolidated Constructions, Orbit Corporation and Vijay Shanti Builders – but it is unclear whether Indian law will allow that owing to the county's three-year lock-in period for foreign direct investment in real estate. If the government rules that such a sale is impossible under FDI rules, it may give people increased confidence that these development projects are safe.

The only option
In the same way that private equity has been picky about which families it will partner with for projects in order to ensure their completion, developers have in the past been picky about where they get their financing, often finding the terms of private equity deals unattractive.

In the past, Indian developers have been hesitant to give up equity stakes in their projects. Traditionally, developers have raised money from debt funds via corporate deposits and commercial papers. However, this is rapidly changing in light of the global economic turmoil. Because it was real estate which unwittingly initiated the current troubles, debt funds have become increasingly hesitant to add exposure to real estate. Even if the negative economic factors plaguing the West are not present in the growing Indian real estate

market, the fact remains that the head offices of these foreign funds and banks are still based in the US or Europe, and this will affect their investment decisions in India.

At the same time, real estate stocks on the public markets in India have taken a dramatic hit over the past several months, making the public markets an almost impossible place for developers to raise capital in the current environment. On September 15, for example, when the Bombay Stock Exchange Sensitive Index (Sensex) fell 3.35 percent, the worst-affected sector was the realty index, which dropped 7.6 percent. Stock prices of major real estate players have tumbled more than 60 percent in the last year.

“Debt has now become even costlier and the readiness of banks to sanction more debt is at its lowest ebb,” says Puri. “Because of the lack of success in the IPO market, public equity is not a very viable option either. Developers know that they will face increasing problems with completing ongoing projects and launching new ones. In the face of the ongoing liquidity crunch, internal accrual is no longer an option for all developers. While equity dilutes a developer's stake to the extent to which equity is raised, it's now the only option.”

This change has completely shifted the landscape for real estate investing in India. A recent FICCI Ernst & Young report concluded that with banks reducing their exposure to real estate, volatile stock markets and rising interest rates: “Private equity investments have emerged as one of the most important sources of capital for real estate developers,” says Puri.

Now these developers, some of whom were halfway through projects, have had to reassess private equity offers that they had previously rejected. “There were develpers who did not find the terms of private equity attractive enough last year,” says S Sriniwasan, chief executive officer of Kotak Private Equity Realty Fund. “Now it's a different world. Everybody welcomes private equity.”

However, for some of the smaller developers in India, such a route may not be an option. “Smaller developers with more modest expansion plans would not wish to avail of the [private equity] route since it would dilute their stakes and also raise commitment levels,” says Puri. But with many of these small companies having launched ambitious projects, particularly in the retail sector, the only option available to them now in order to complete these project may be buyouts. There have been increasing reports of small Indian developers approaching their larger rivals, as well as foreign investors, proposing to sell off projects, enter into joint ventures or even be bought out.

These are without doubt uncertain times for Indian developers. The degree to which developers have come to rely on foreign funding may put many of these ambitious projects in jeopardy as Western financial institutions experience turmoil. At the same time, the current conditions will have the effect of drastically changing the relationship between private equity firms and Indian developers.

Though they may have been hesitant in the past to accept private equity terms, these companies will now be much more open to the possibility.

So who are these developers? On the following pages we profile six of the country's largest developers, looking at the powerful families and personalities that run them as well as the deals they've done with private equity firms in the past. These are names which may become increasingly familiar to Western funds.

Developer profile: DLF
Name: DLF Universal Limited
Founder: Chadhury Raghuvendra Singh
Current Head: KP Singh
Headquarters: Delhi
Founded: 1946

As India's largest real estate developer, DLF is a giant in the Indian construction industry. The company is run by the powerful Singh family, founded in 1946 by the clan's patriarch Chaudhury Raghuvendra Singh. The elder Singh developed some of the first residential colonies in Delhi such as Krishna Nagar, South Extension, Greater Kailash and Hauz Khas. When the Indian government took over all National Capital Region real estate development activities in 1957, DLF switched to acquiring land outside the Delhi Development Authority, particularly in Gurgaon. It was in Gurgaon that DLF made its name, transforming what was once a small farming village into a major commercial hub. Today the company is headed by Kushal Pal Singh, 77, who inherited the company from Chaudhury in 1979. KP Singh has led the company's push to diversify, extending into markets beyond the Delhi area. He also led the company in its $2 billion IPO in July 2007, the largest in India's history. According to the Forbes 2008 ranking of the world's billionaires, Singh is now the eighth richest man in the world. DLF is now overseeing many development projects across the country, including a $2.1 billion investment in Tamil Nadu and a $1.7 billion investment in Madhya Pradesh. The company has partnered with private equity in the past. In November 2007, Merrill Lynch's private equity real estate fund invested $377 million in DLF for a 49 percent interest in seven of the firm's mid-income housing township developments in Chennai, Banglore, Kochi and Indore. The development company is now reportedly raising more than $1 billion of private equity and debt for its subsidiary DLF Assets. However, part of that capital came from Lehman Brothers, which collapsed in September. In May, the company received an investment of $450 million from London-based private equity firm, Symphony Capital, and it has also reportedly received an investment of $400 million from investment and technology development company, DE Shaw.

Developer profile: Unitech
Name: Unitech Limited
Founder: Ramesh Chandra
Current Head: Ajay Chandra and Sanjay Chandra
Headquarters: Gurgaon
Founded: 1974

Unitech, India's second largest development company, began life as a civil engineering company in 1974. Since then the company has built some of the tallest buildings in the national capital region and has developed residential and commercial buildings throughout India, from Delhi to Bangalore.

The company was founded by Ramesh Chandra, 68, a structural engineer from Delhi. The son of a banker, Chandra studied structural engineering in the UK and then returned to India to start a consulting firm. In 1985, he moved the company into residential real estate by starting to build middle-class homes in Gurgaon and later in southern and eastern India. With an estimated net worth of $11.6 billion, he is the eighth wealthiest Indian.

Today Unitech, which is publicly traded, is also run by his two sons Sanjay and Ajay Chandra. Sanjay oversees the finances of the group and heads the new telecoms businesses, while Ajay deals specifically with land acquisition and real estate in the South Indian market. The company has a market cap of $6.7 billion, developing luxury residential, commercial, leisure and retail properties, as well as hotels. The Chandra family is planning to invest its wealth and reputation into new areas. They have already moved into the telecom sector and are now planning a foray into the insurance sector. The family is among the richest in India, with a near 75 percent holding in publicly-traded Unitech, worth over $4.5 billion. In July, Unitech raised $300 million for a real estate fund which will be managed by its investment unit, Unitech Realty Investors. That venture currently manages $467 million worth of funds through CIG Realty Fund I, II, III and IV. In June, that unit sold a 50 percent stake in its Santacruz project in Mumbai to Lehman Brothers for $175 million. It was in talks with Lehman Brothers to raise funds for other commercial projects before the bank's collapse.

Developer profile: Sobha Developers
Name: Sobha Developers
Founder: PNC Menon
Current Head: PNC Menon, Ravi Menon
Headquarters: Bangalore
Founded: 1995

A relatively new entrant to the Indian construction sector, Sobha Developers was founded in 1995 by billionaire PNC Menon, 58.

Born in India but a citizen of Oman, Menon had already made a name for himself in the Middle East, where he had been an interior decorator since 1977. His 85 percent interest in Sobha made him a billionaire after its 2006 IPO.

Today Sobha Developers is a Rs 12 billion-plus ($248 million; €183 million) company, and is one of the only backward-integrated construction companies in India, in that it has its own wood-working and metal-glazing factories and can build its own concrete products. Over the past several years the company has been the recipient of a great deal of attention and enthusiasm from the Indian market. Sobha's IPO in 2006 was oversubscribed 126 times. As of July 2008, the firm had completed 26 million square feet of development area. Sobha, named after Menon's wife, began life by constructing residential apartments in Bangalore, a project which involved relocating professionals across the Arabian Sea to ensure that quality standards were met. One of the company's main clients thus far has been Infosys. The company currently has 28 projects under way, including a mall with an Olympic-size skating rink. Sobha is very much run as a family affair. Menon's wife sits on the board and his son Ravi, an engineer from Purdue University, is vice chairman. In July, Sobha sold a 40 percent stake in a Bangalore project to Dubai investment firm Pan Atlantic for Rs 433 million ($10 million). The development is a planned 1.7-million square foot residential township in South Bangalore. The company reportedly values the property at Rs 1 billion, and expects a realisation on the development of around Rs 6 billion. The company also has a joint venture with QVC Realty and Chintels to build integrated townships in Kochi on 400 acres, in Thrissur on 55 acres and in Gurgaon, Haryana, on 192 acres.

Developer profile: Parsvnath
Name: Parsvnath Developers Limited
Founder: Pradeep Jain
Current Head: Pradeep Jain
Headquarters: New Delhi
Founded: 1990

As he often likes to recount, Parsvnath's founder Pradeep Jain, 43, came to Delhi in 1984 with no capital in hand and started working as a real estate broker. Having assisted with many land parcel transactions, by 1990 he was well-known enough regionally to launch his own company, initially targeting land acquisition in small towns in Northern India.

Jain soon shifted his focus to Delhi though and today Parsvnath has a presence in 51 cities and 18 states across the country, with 114 ongoing projects. After the company listed in 2007, Jain became a billionaire through his 80 percent ownership stake and he is now India's 47th richest man.

The company's first big flagship project, however, didn't come until 2000. The Parsvnath Estate in Greater Noida was launched at that time with 277 home units and 20 shops. Recently Jain has been generating headlines from his latest tie-up with Hotmail founder Sabeer Bhatia to develop a hi-tech city spread over nearly 11,200 acres in Panchkula, near Chandigarh. The project, announced in July, will be under the branding Nanocity Haryana Infrastructure. Early this year, Parsvnath tied up with two Saffron Group funds for its first Mumbai project, the development of BEST bus depot near the Bandra Kurla. Jain told Indian news outlets that the company was speaking to at least five other private equity firms about buying projects in its special economic zone (SEZ) developments. The company has such developments in 15 SEZs in 10 states throughout India. Seven of the SEZs are in the IT & IT-enabled service sectors, two are in gems and jewellery, and the rest are in multi-product, food processing, leather and leather products, handicraft, automotive and biotechnology.

Developer profile: Hiranandani
Name: Hiranandani Developers Private
Founder: Navin, Niranjan and Surendra Hiranandani
Current Head: Niranjan and Surendra Hiranandani
Headquarters: Mumbai
Founded: 1980

Hiranandani's founders Niranjan and Surendra Hiranandani are the sons of a famous Indian ENT surgeon, Lakhumal Hiranand Hiranandani. The elder Hiranandani is famous in India for devising a treatment for throat cancer, and in 1972 for his efforts he was awarded the Padma Bhushan award by Indian president VV Giri. Capitalising on the family's reputation, Hiranandani's three sons set up the Hiranandani construction business in 1980. Today the firm has over 100 million square feet in developments across India, particularly in mixed-use townships, with 6,000 employees including 1,000 engineers, developing hospitals, hotels, retail space, schools and entertainment complexes. In 2006, Hiranandanu Hirco, the London AIM-listed investment vehicle for Hiranandani, co-invested in a large scale mixed-use township developments in suburban areas outside of India's city centers. The company's most famous project to date has been the Hiranandani Gardens, built in the hills of Powai, Mumbai, and dotted with tall skyscrapers. That development even includes a large hospital, which the two sons named after their father. The elder Hiranandani presides over the hospital himself.

Developer profile: K Raheja
Name: K Raheja Corp.
Founder: CL Raheja
Current Head: CL, Ravi and Neel Raheja
Headquarters: Mumbai
Founded: 1956

K Raheja is one of the oldest names in Indian real estate, having been established in 1956 as a real estate developer and since then expanding into retailing and hospitality. Concentrated on Mumbai and Pune, the group entered the hospitality sector in 1981, launching the K Raheja Group of Hotels, which owns the Resort and Renaissance hotels in Mumbai.

In 1991, the group launched the Shopper's Stop brand, the first organised department store of its type in India, which now has 12 locations across the country. The company also develops office and residential property, with clients including IBM, Morgan Stanley, HSBC, Nokia, Accenture, Oracle, and Citigroup.

The group is run by the Raheja family, whose patriarch, 65-year-old Chandru L Raheja, founded the company and today serves as chairman. His two sons Ravi and Neel serve as group presidents, with Ravi, 35, directing Shoppers' Stop and the hotels, and Neel, 32, running real estate development.

The group has been one of the most active in partnering with foreign investors. In April this year, Denver-based ProLogis entered into a 50-50 development joint venture agreement with K Raheja. The JV will acquire land, develop properties and manage the assets acquired, according to the firm, as it gears up for a $575 million investment spree, creating approximately 7.5 million square feet of commercial space.

In October 2007, JP Morgan's $360 million India-focused investment vehicle reportedly committed $25 million to a Raheja IT park development in Navi Mumbai, a planned city founded in 1972 east of Mumbai.