Guest Commentary: The Force reawakens

A long time ago in a galaxy far, far away…The Republic of India with strong aspirations was at the forefront of attracting capital. Investors hurled through galaxies, venturing into the grueling and notoriously dangerous game of real estate investing in India. The terrain was harsh and unfamiliar, and alliances were formed with local forces to acquire the best slice of real estate.

After a few years of high-octane investing, the Republic experienced a great disturbance in the Force, which tested investors’ resilience and challenged the trust with their local alliances. In a short time, many investors retreated and the Empire lay in ruins.

Since then, order has been restored using galactic proportions of monetary easing. The galaxies have rejoiced in the newfound stability and investors are seen heading back to India. However, there is a marked contrast to earlier investing trends.

The Indian real estate market is being shaped by new trends in capital formation, deal structures, partnerships and asset classes. The majority of the $5 billion invested in real estate over the last two years has come primarily from a few sovereign wealth funds, pension plans and a handful of very large global funds. These capital providers have taken a long-term view on India, and have put boots on the ground to stay closer to deal flow and be more selective in their approach. They have also been prudent to create a limited number of partnerships with some of India’s most astute developers to take on larger deal sizes, limiting management time and resource allocation.

However, there is a notable change in the deal structures, with capital being invested in the form of debt or debt-like structures. Banks are flooded with non-performing assets, coupled with stringent capital requirements and sector caps, which limits their ability to lend. The mismatch in demand and supply of credit, combined with the frustrations of dealing with equity joint ventures in development projects, has allowed the growth of non-banking finance companies lending to the real estate sector. This has created an opportunity for real estate investors to generate equity-type returns with debt-style security in India. Challenges still remain in executing this strategy on a pan-India basis, and margins get squeezed when taxes, fees, currency and the competitive landscape for larger deals are factored in.

India also has seen the emergence of new real estate asset classes as technology, infrastructure and shifting consumption trends create new demands. Modern industrial-logistics warehousing is gaining momentum with changing patterns in consumption supported by e-commerce. The affordable housing sector is on the cusp of accelerating with the potential implementation of the Real Estate Bill, Housing for All scheme, and projected improvement in the affordability index. Healthcare facilities and senior housing are a few years from gaining traction as urbanization levels begin to peak in some cities. There are several unique pockets of opportunity to acquire assets at bargain prices as prior vintage funds and poorly capitalized projects seek exits in the hospitality and retail sectors.

Another trend is the emerging breed of young entrepreneurs who have built some extraordinary businesses by staying true to the fundamentals and being transparent in their approach with capital partners. One such example is SAMHI, a pan-India hospitality company that has developed and acquired a pan-India portfolio of assets, an achievement few companies have successfully executed while keeping their balance sheet intact. Such platforms are well positioned today to capitalize on limited competition in their respective sectors and attract capital partners with the high level of governance and transparency that they operate with. This is very different compared to the earlier years when investors plowed money into companies purely based on IPO dreams, rather than focusing on the core principles that make companies institutional-grade and IPO-worthy.

On the policy front, much frustration remains that things are not moving quickly enough for the market to benefit from the huge demographic dividend. Several key legislations have not been passed or implemented, such as the GST, REIT and Land Acquisition bills.

However, there has been some positive improvement on the policy front with further relaxation in foreign direct investment norms for real estate and clarification on some relevant tax issues. Despite these challenges, however, it is hard for anyone in the private equity real estate universe to deny that India is a Force reawakened.