COMMENT: Asia’s inbetweeners

Development in India and China rapidly is becoming attractive for private equity real estate firms dexterous enough to offer funding that sits somewhere between equity and debt.

Sometime in the next few weeks, a European private equity real estate firm will be launching a mezzanine finance property fund for Indian developments. Aware of growing shortfalls in the funding behind some of the country’s projects, the firm in question is convinced it has a role to play in plugging the gaps with its own capital.

By the time the news of that fund breaks, however, the theme will likely be old hat. This week alone, it emerged that numerous similar strategies are underway. On Wednesday, a $500 million joint venture was announced between Canada’s largest non-state institutional investor, Canada Pension Plan Investment Board, and Mumbai conglomerate Piramal Group, to provide debt to residential developers. And today, PERE revealed that Chennai-based financial house IDFC is launching a fund with a view to doing likewise.

Bridge lending ventures are not just the soup du jour in India. As you’ll read in the forthcoming March issue of PERE magazine, China too is experiencing something of a paradigm shift among private property investment managers as they come to realize the potential of buying into developments via side-door avenues like preferred equity, mezzanine finance or, as you’ll read, via funding solutions you couldn’t really classify as one thing nor another. Featured in our analysis are InfraRed Capital and Harvest Real Estate Investments (HREI) – both of which have innovative ideas for positioning their capital somewhere in between straight equity and senior debt.

It was only a matter of time before debt became the new equity in Asia’s growth economies. Just like their counterparts elsewhere before them, Asian banks have pulled back from the market. Consequently, all but the most solvent of developers today are forced to accept debt from sources, and on terms, that previously they would not have entertained. Invariably, this means private equity real estate firms are increasingly finding themselves at the negotiating table with the upper hand.

Developers borrowing their ‘last-mile completion financing’, as one source put it, from CPPIB and Indiareit can expect to be charged between 18 percent and 22 percent – almost twice a typical bank rate of 13 percent. For that, they can expect various flexibilities not offered by the banks, such as permission to use the debt for a wider array of purposes or to pay it back at wider intervals than the banks expect. Not exactly compensation for paying so much more for your financing, but the borrowers are faced with little choice as the need to churn their debt intensifies.

Obtain credit from InfraRed and you might be asked to share the development profits in addition to paying back your debt. HREI, meanwhile, has introduced a debt-like addition to its equity outlays: developers engaging the Hong Kong-based firm that do not successful let their properties upon completion can expect to pay it rent for a period. Again, it’s a high price to pay to get to get your funding problem resolved.

The early movers in this incoming wave of private equity financiers say opportunistic returns of 20 percent-plus still are possible for their investors, even though they’ve moved off-piste from predominantly making straight equity outlays. How long that remains the case will be interesting to monitor. In Europe, mezzanine lenders have seen their return expectations dwindle in recent years to low-teen IRRs as the marketplace became more competitive.

That is not a concern for the Asia ‘inbetweeners’ just yet. If PERE is to sound a cautious note in the face of this compelling opportunity, which undoubtedly should be explored by the dexterous capital we write about, it would be this: be careful not to take the last dollar off the negotiating table. In Asia, more so than in any other region, reputation is a currency not traded twice. Your LPs will not benefit in the long haul if you breed resentment among operating partners. Remember too that a wider theme than hybrid funding opportunities is investors looking for excuses to exclude the middle man and work directly with operating partners. 

Notwithstanding that warning, the opportunity in the private real estate investing markets of emerging Asia is rapidly taking on a finance-themed complexion. Opportunistic capital should be getting stuck in before the window closes.



Hear from CPPIB, HREI, InfraRed Captial Partners and other active investors at this month's PERE Summit: Asia on 26-27 February in Hong Kong.