India’s shallow pool

A second wave of private equity real estate capital seems destined for developed, leased-out commercial property in India. But there might not be enough of the stuff to go around.

That there is a second wave of international institutional interest in Indian real estate is hardly news. But it is interesting to note how this wave is characteristically different to the first. A fund poised to be launched by Mumbai-based Infrastructure Development Finance Company (IDFC) offers a telling case study.

In 2013 some investors will find a freshly drafted Private Placement Memorandum on their desk from IDFC for the fund. They’ll read the firm wants $500 million for a 10-year vehicle aimed at making investments in places like IT Parks or Special Economic Zones (SEZs).

As India’s high interest rates (the Indian Central Bank interest rate is currently 8 percent) persist and with struggling developers currently willing to trade 100 percent of the equity in their projects, the firm sees a window of opportunity of between 18 months and 2 years to put meaningful capital to work.

Cognisant of how varied the performances by the country’s first internationally capitalised funds were after India’s government opened its doors to foreign direct investments in 2006 IDFC is already making provision for a challenging capital raising venture. MK Sinha, chief executive officer of IDFC Alternatives, the recently revamped division responsible for the real estate fund, told PERE it would buy its pipelined investments regardless of whether it raised external capital, such is its belief in the opportunity at hand.

Nonetheless, IDFC and a handful of other India-focused real estate investment managers have adopted a strategy that they hope will, once again, attract dollars. And, opposite to the strategy at the heart of the first wave, the marginalisation of development risk has become very important.

One major reason why many investors became disinterested in Indian real estate after the advent of the global financial crisis is because it was far harder to trust valuations in the country than to trust cash flow. And firms like IDFC evidently understand this. Hence, a central tenant of its strategy is to buy developed properties already mostly or fully leased. That is also the thematic lynchpin underlining Blackstone’s investment this year and last into a joint venture with Bangalore-based Embassy Property Development. Since getting comfortable with the thesis, Blackstone has deployed $480 million into the country in little more than year.

Sinha said: “Development risk is the deep end of the pool in India. In the past 5 years to 7 years there have been a lot of bodies floating in the deep end of the pool. So we’re treading in really shallow waters.”

That is a sound message. However, by implication, while asset performance does indeed become more visible, the issue with the shallow end of the pool is that it doesn’t have much water. India’s first wave of private equity real estate investment created institutional grade property. But will there be enough to sustain a second wave, particularly when more managers cotton on to this approach?

According to Jones Lang LaSalle, more than $14 billion was invested by private equity in Indian property since 2006. It would be bold to assume there’ll be enough developed, leased-out property in the FDI-friendly places of the country to herald similar activity in the next 6 years. Perhaps it is correct to suggest there is an 18 month to 2 year window of opportunity in India to buy attractive commercial real estate. But not just because of India’s economic situation. Developed, leased-out property in IT Parks and SEZs could be snapped up pretty quick.

Message to investors thinking about joining India’s second wave of private equity real estate investment: if the “deep end of the pool” of development is not your thing, then do be careful with the shallow end, too. It won’t necessarily accommodate everyone either.