India shining

2017 was a banner year for Indian real estate, with some marquee global institutional investors committing equity across office, logistics and retail sectors. Suresh Castellino, executive national director at Colliers International, and Rahul Rai, head of real estate at ICICI Prudential Asset Management, discuss what’s currently working in India’s favor

Suresh Castellino, executive national director for capital markets & investment services, Colliers International

Suresh Castellino has fifteen years of experience dealing with developers and institutional investors across Indian markets. He was responsible for setting up Colliers International in Pune in western India. Castellino has concluded a variety of transactions covering private equity investments in real estate at SPV levels as well as entity level investments, project finance, fund exits and institutional asset sales.


Rahul Rai, head of the real estate investment business, ICICI Prudential Asset Management

Rahul Rai has over two decades of experience spanning real estate investments, corporate finance and tax and regulatory assignments. Before joining ICICI Prudential’s real estate investment team in 2010, he worked with SUN-Apollo Real Estate Advisors as a principal.

In many ways, 2017 was a game changer for Indian real estate, both in terms of the rollout of significant regulations as well as the completion of large institutional investments in office, retail and logistics. Mumbai-based investment advisor Primary Real Estate Advisors, in its latest quarterly review, described the “triple tsunami” of reforms – demonetization, the Real Estate (Regulation and Development) Act, and the Goods and Services tax – as having re-shaped the contours of the industry like never before. Some of these reforms had been long-anticipated, even since Prime Minister Narendra Modi won the 2014 parliamentary elections on the back of an ‘India Shining’ campaign.

Some of the effects were immediate. The biggest victim was the residential sector, with rising inventories continuing to create pressure on developers’ cashflows even today. In terms of private equity investments, retail and logistics were the biggest beneficiaries. Over $724 million in private equity capital was invested in the retail sector in the first nine months of 2017, against $846 million invested over the two previous years combined, according to Primary Real Estate Advisors. Meanwhile, the logistics sector received big ticket investments by Canadian investors including CPPIB, Ivanhoe Cambridge and QuadReal Property Group.  In a wide-ranging discussion, Rahul Rai, head of the real estate investment business at ICICI Prudential Asset Management, and Suresh Castellino, executive national director for capital markets and investment services at Colliers International, talk about the policy initiatives propelling meaningful institutional investment back into Indian real estate, and whether the investment market will continue to remain skewed in favor of debt and in disfavor of the long-ailing residential sector.

PERE: 2017 was a year of policy changes in India, many of which have had a tangible impact, both positive and negative, on the real estate market. Are reforms the key reason why more global investors are being drawn to India?

Suresh Castellino: It is where India is poised right now. We have a stable government with a weak opposition, so it is easier to get bills passed. We have had a lot of reforms, which may have affected growth in the short term but will have a positive impact in the long term. For example, the Real Estate (Regulation and Development) Act has given comfort and confidence to international investors. India’s GDP is fluctuating but remains solid. The IIP [Index of Industrial Production] index has jumped up recently, with a 4 percent increase year-on-year. In the Ease of Doing Business rankings, India has moved to 100 from 130. All these factors are contributing to further money coming in.

Though rents have gone up in the commercial sector, it is going to continue attracting the IT sector and outsourcing firms – who are big takers of space – so the big pension funds are coming in. Then, the passage of GST has created a big push for the logistics and industrial sector. And in the retail sector, the likes of Blackstone, APG, Xander and Abu Dhabi Investment Authority have shown keen interest because of the inherent consumption demand from India’s large population.

PERE: Even with all the hype around investing in India, are international investors willing to pursue all kinds of investment strategies (equity versus debt for example), or are there still some no-go areas?

“Today, many investors are unlikely to take an approval risk. They would rather come in at a higher price, but with all approvals in place”

Suresh Castellino

Rahul Rai: From investors’ point of view, the Lehman impact is lingering. The Indian real estate market has moved on but for some investors, they continue with legacy investments and having to recover money. I think the Lehman impact is coming to a close for those investors only now. Because of this experience, investors are either investing with established developers or investing in assets with secured cashflows. I believe the appetite to take on risk through development and other investment strategies will come up more in 2018 and 2019. We didn’t see much of this in 2017.

SC: I believe international investors’ appetite to take on risk will be minimal in 2018 also. Foreign investors have an issue with approvals. Today, many investors are unlikely to take an approval risk. They would rather come in at a higher price, but with all approvals in place. Or, even if they are willing to take a risk, it will only be some procedural risk, where there is a clear visibility that approvals will be given eventually.

RR: And I don’t think we are seeing a binary between equity or debt. There is a place for both. Today, equity investments are likely to give mid-teens returns, with a healthy multiple, even if you have a good project and a good ride in the market. It is unlikely that equity investments will give 20 percent plus returns anymore. There is a possibility that mid-teens may also get down to low teens.

As opposed to that, structured debt investments are priced at high teens kind of returns. However, such high returns from projects are not sustainable for a four- to five-year kind of a timeframe. So, investors need to be comfortable investing with the duration of two-and-a-half to three years in mind, with the ability to reinvest the capital.

However, the market is no longer seeing a significant asset price increase. There is a kind of a contradiction currently where the developers believe that equity is the right money for them, without recognizing the fact that, whether it is equity or debt, both carry an obligation to be repaid. Moreover, equity is the costlier form of money.

SC: We have also seen developers’ view change over the years. Three years back, when equity capital at the land stage was readily available, developers only wanted debt. Fast forward to today, and the same developers are now saying they want payable when able equity money and are willing to pay high returns. Today a lot of developers are stuck because of their cashflow situation.

For 2018, I think developers will continue to look at equity money, but there are two things currently making it difficult for equity deals to happen. Equity investors want to come in at the land acquisition stage, not where the land is historically fair game. The second issue is that equity is chasing only big and reputed developers, who already have enough access to capital. There is limited equity available to the developers who really need it.

On the investor side, the shorter duration capital is the one considering structured deals at the moment, whereas patient capital is also looking at equity deals. It is all a question of the risk appetite.

PERE: Many of these policy changes have not augured well for India’s residential sector. Given residential has traditionally been one of the most attractive investment sectors for foreign investors, how different is the situation today?

RR: Last year was a good indicator of people broadening their asset classes and investing beyond residential, into retail, office and logistics. The residential sector has had a lower proportionate allocation of capital. I believe that the residential sector will make a comeback in a year or so.

“Today, equity investments are likely to give mid-teens returns, with a healthy multiple, even if you have a good project and a good ride in the market”

Rahul Rai 

SC: There has always been a herd mentality. Post the Lehman crisis, the entire commercial market in India went through a major slump. All the projects at the ground level stage got converted into residential assets and over the next few years we saw such an oversupply of residential units that the residential sector started suffering. Today, there is literally no yield on residential assets; one would be lucky to get a 2 percent yield. Similarly, in the past couple of years, the demand for commercial assets is beating supply, causing rental increases.Unfortunately, today the residential sector is suffering so much that people are again converting units for commercial use. In certain micro markets, there is almost 10 million square feet of construction coming up for commercial use. So, while the story is still good for one year, I think 2019 and 2020 may look tougher, if the offtake doesn’t match the supply.

PERE: Does that mean more distressed buying opportunities?

RR: On the distressed side, what is happening with the insolvency process under the new bankruptcy code is a landmark development. For non-real estate companies, people recover investments in projects or companies from the value of land or the underlying real estate, as against a running business. Now that the process is becoming smoother, these distressed opportunities will increase. Investors will be able to buy distressed companies more easily. Many more distressed funds and ARCs are being set up and 2018 will witness further velocity of these trends.

SC: Distress is a myth in India. Having said that, there are deals happening at more interesting valuations. I have been witness to land exits in which investors had offered a certain price a year back, and the developer or landowner did not sell, whereas today they have sold to the same buyer at a price lower than the earlier quote. More developers are selling land than buying land, which has never been the case in India. The land banking game in India is not solid anymore.