It was unexpected, unprecedented and, arguably, unwelcome for many employed in India’s cash-intensive sectors.
On the night of November 8, a week after the Hindu festival of Diwali, Indians were jolted out of their post-festive gloom by Prime Minister Narendra Modi. In an unscheduled televised address, Modi announced his government’s decision to demonetize all 500 rupee ($7.30; €6.80) and 1,000 rupee notes in a crackdown on unaccounted wealth and fake currency. In other words, 86 percent of the currency in circulation in the country was discontinued overnight.
Demonetization was the surprise policy of 2016, but it bookended a year in India full of regulatory reforms, often in quick succession. Many of these have directly impacted the real estate sector – most notably, the passage of the Real Estate Regulation & Development Bill, and the Goods and Services Tax.
Concerns of short-term distress inflicted by some of these reforms is palpable in the room where PERE’s annual India roundtable is being held in Singapore. The ensuing uncertainty and scarcity of cash in the days following the demonetization announcement, for instance, precipitated a drop in residential sales and footfall in regional shopping malls.
Even so, all four participants are convinced that the changes will eventually benefit a sector long marred by a lack of transparency and governance. A proactive government and a regulatory framework favorable to foreign investors, coupled with India’s sound macroeconomic fundamentals relative to other developing and developed economies, should augur well for capital raising, too.
“Right now, deals have stopped. Potential buyers are sitting on the fence and asking for a discount. For folks who don’t have a big legacy cost, they will just sit on the land for the time being. Residential sales are definitely getting impacted,” says Sanjeev Dasgupta, chief executive of Ascendas Property Fund Trustee at the Singapore-headquartered fund manager Ascendas-Singbridge. “We are waiting to see what will happen with land prices, if there is some correction. However, there has not been much impact of demonetization on the office sector because the sector did not have much of an influence from the cash economy.”
“The property market is going through a bit of dislocation, but you should see clarity emerge in six months’ time, especially in the residential sector,” adds Vishal Kumar, managing director for investment strategies at the emerging markets-focused manager Xander Group. “There will be two to three themes playing out this year which may include build-to-core commercial, operating office or special situations.”
Opportunity in uncertainty
A comparison of residential sales before and after November offers a telling analysis of the impact of the currency ban.
Global property consultancy Knight Frank, in its India real estate report for July to December, has predicted “2016 to be worse than 2015, which was one of the worse years itself” for residential sales. Sales volume dropped by 44 percent year-on-year in the fourth quarter, while new launches fell by 61 percent compared with the same period in 2015. In contrast, the first half of 2016 actually witnessed a 7 percent increase in sales volume compared with the first half of 2015.
The report further adds that the drop in sales volume during the fourth quarter has caused a notional revenue loss of more than 226 billion rupees to the real estate sector across the top eight cities.
Domestic uncertainty and global disruptions, including the potential aftermath of Brexit and new trade policies under President Donald Trump in the US, signal a subdued start for the residential sector in 2017. Knight Frank predicts the first two quarters will see a substantial slowdown in sales, prompting further pressure on prices.
For private real estate investors and their managers, however, the current market sentiment could create varied investment opportunities. As developers continue to struggle amid tepid sales, distress selling could pick up pace, roundtable participants say.
Dasgupta says there are developers which, until a year or two ago, were not keen to engage in a conversation on specific assets, but are now reaching out to engage. However, there is also unanimous agreement that the distressed market in India is limited in scope and unlike its counterparts in the West. Dasgupta says developers which are willing to sell still expect a reasonable value for a decent asset.
“The way distress situations are already playing out in India are either in the form of some structured funding transactions with the developer to ease his liquidity, or a developer selling an asset at a lower valuation,” he says. “But it is certainly not a huge discount of, say 40 percent. The next 12 months may see some pain becoming more visible.”
Anuj Ranjan, managing partner and regional head of Middle East and South Asia at Brookfield Asset Management, says he prefers to call India a stressed market instead of a typical distressed market.
Talking about the potential increase in the number of non-performing loan sales, he says: “We [Brookfield] have a $1 billion distressed joint venture with the State Bank of India. If you look at the majority of NPLs, they are in thermal power, steel or textiles. Today, any of the public sector banks will focus on the biggest problem areas. There may be some real estate assets on their books that they would like to clear out, but I’m sure they would rather prioritize a huge thermal power plant in which they have billions of dollars of exposure.”
Dasgupta concurs: “Banks are under pressure to clean their balance sheets. [However] the challenge for public sector banks, where most problem loans are sitting, is about taking a big book loss. The other challenge is banks will need to get recapitalized if they write-off these loans, which will need huge government capital infusion.”
Private debt lending is another route being explored by many domestic and international managers. Brookfield, for instance, currently provides loans to residential developers using structured finance or preferred equity type instruments, and Ranjan says the firm plans to do more such investments through a vehicle out of its global private equity business.
Revival of foreign money
With the exception of demonetization, the impact of which on investment volumes can only be judged once the country’s latest quarterly numbers are released, the property industry has been eagerly awaiting the announcement of other reforms passed last year (see table opposite).
The Real Estate Regulation and Development Bill (RERA), for instance, labelled as a transformational act by the real estate industry, seeks to curb unscrupulous practices by property builders and improve transparency. Every state will have its own real estate regulatory authority that will mandate the registration of all new and ongoing real estate projects – and impose heavy fines on project delays.
Data published by real estate consultancy JLL show total private equity inflows into the sector increased to 210 billion rupees in the second half of the year, reflecting increasing investor confidence following the passage of RERA and the Goods and Services Tax. In comparison, the second half of 2015 recorded 95 billion rupees in total inflows (see table on p. 50).
Brookfield Asset Management was one of the largest investors of private equity in India last year, closing two mega commercial real estate transactions. The firm agreed to acquire Indian developer Hiranandani Group’s office and retail space in Mumbai’s Powai area, reportedly for around $1 billion. It then went on to ink a deal with the telecom giant Reliance Communications to acquire a 51 percent stake in its nationwide tower assets for 110 billion rupees.
The North American investment manager set up shop in India in 2009, but has only expanded its investment exposure in the country in the last few years. Currently, the firm has
$5 billion of assets under management in the country, of which around $2 billion is real estate.
Ranjan agrees that the percentage of global funds currently deployed in India is higher than what it has been traditionally.
“On a comparative basis to the rest of the world, India is now a destination and a bright spot,” says Ranjan. “Brookfield is a bit contrarian as an investor; that is why we are active in emerging markets. If you look at all emerging markets, India is in a unique place. It has potential for strong domestic economic growth, and it affords you the opportunity for scale in the real estate sector.”
Ranjan says Indian investments now enjoy much greater visibility with the firm’s global investor base in comparison with some other markets. If Brookfield were to buy a building in New York, for example, he says it may not generate the same curiosity as the Indian investments.
“Since the real estate market opened up in India in 2005, many LPs had their fingers burned and so they are understandably nervous. However, they are all intrigued again. They are looking for competency on the ground through a combination of hiring their own people and working with managers who have a good track record and experience,” he says.
The interest appears to be coming from a varied basket of investors. Xander’s Kumar says a growing number of European family offices, as well as Chinese, Japanese and Korean investors, are gathering data and evaluating options to invest in India. He expects them to make a decision either this year or next. Xander manages $2.4 billion of commitments for India, currently across 50 deals, and is understood to be plotting the launch of its fifth opportunistic vehicle.
According to Johnny Adji, the Singapore-based senior investment director at global advisory firm Cambridge Associates, European investors are particularly drawn to Asian markets because of the opportunity to earn higher yields.
“Unlike in the US whereby debt has a positive yield, in the core European countries like Germany, the yields are negative. That is one reason why we are seeing more interest from European investors investing money into Asia in the core-yielding space – versus our US clients, like the endowment foundations, who tend to look at Asia as the higher-risk region and demand higher risk premium,” he explains.
“India is certainly more attractive relative to an export-oriented economy,” he says on the reasons behind the growing interest in the country.
“If you take China as an example, given what has happened in the US with potential trade issues, India seems to be less in the spotlight relatively speaking. India is an economy with a huge domestic demand and that gives investors some comfort.”
Additionally, the Indian currency has also been relatively stable in the last year. “When you look at India from a US-dollar based return, in the early-to-mid-2000s, investors were entering at an exchange rate of 40 rupees to the dollar; now it is more than 60 rupees. There has been lot of currency headwind in the past, but it is lesser now,” says Adji. “This is going to bring the potential return of the Indian real estate market more comparable or closer to a US dollar-based return.”
For investment managers like Xander, Kumar says foreign exchange is not an unknown risk and the firm has strategies in place to minimize the impact of a currency volatility.
“We monitor volatility and consider the forward curve in our return computations. Since we constantly think of the risk, our systems have become agile at managing it better,” he says.
“The other strategy for Xander is to take money out as soon as we can, especially from income-generating assets, and not to wait for last dollar to be earned. We remit earnings as soon as we can; we don’t wait for the forex to improve.”
Ascendas-Singbridge’s Dasgupta says that, in some sectors such as office, currency movements actually have a counterbalancing effect, which can ultimately benefit managers.
“Almost 75-80 percent of Indian office stock is in the IT business parks segment and the tenants earn dollar revenues. In a lot of markets over the last six years, office rents have doubled. For tenants who export IT services, however, it is probably a 30 percent increase in rents, plus they have the benefit of a falling wage bill, in dollar terms. So if you look at the medium term: while on one hand funds that invested in office probably took a knock because of the currency a few years ago, at the same time their propensity to raise rents has improved due to the currency depreciation.”
Global institutional investors are also adjusting the lens with which they view developing economies like India, a trend reflected in their choice of investment strategies.
“We have all heard that international investors look for over 20 percent returns from India, but return expectations from India have become more nuanced,” Kumar says, adding that lower-risk strategies are now gaining traction among investors.
However, not all types of investment vehicles are benefiting from these capital inflows.
Managers operating traditional, blind-pool, commingled vehicles are finding it challenging to raise equity, participants agree. According to multiple news reports, ASK Property Investment Advisors, which had been trying to raise a $200 million offshore fund, has recently suspended fundraising after raising just $82 million. Meanwhile, the Indiabulls Group was set to launch its maiden offshore fund last year, but, according to a report in LiveMint, the firm decided to defer plans until this year.
“Investors are more hesitant to invest in a closed-ended, blind-pool fund because they don’t want to get blindsided by a macroeconomic shock. If you recall what happened in
2008-09, investors had difficulty in meeting capital calls. Investors have learned from their earlier experience,” says Adji.
Consolidation, therefore, has emerged as a clear trend in the investment landscape in India.
“There are probably about 10 to 15 large LPs globally who seem to be dominating most of the allocation to private funds and a lot of them, at least in the Indian context, appear to be more keen to do some sort of a separate account or a JV structure as opposed to a blind-pool, so that they do have a reasonable amount of involvement in the investment and decision-making,” says Dasgupta.
Ranjan says this consolidation trend differs from when he first moved to India in 2009, when investment activity was split across many smaller and niche real estate funds.
“For the active investors, volumes have grown substantially but smaller investors seem to be less active. This is partly just a function of the confidence built up in these investors as they build out a platform and have boots on the ground,” he says.
“Also, the counterparties now look at more than the dollar-value of investment; they also look at the certainty of closure. We have seen examples of investors coming to India, exploring the market and doing diligence on opportunities, but not cutting a check. The credibility of the investor has channelled a lot of the opportunities towards the same handful of firms you keep reading about.”
He says a growing number of investors are now showing willingness to enter in co-investment deals wherein the ticket size is larger than a typical fund investment.
Last year was the year the retail sector in India attracted significant commitments from global investors as regulatory restrictions were eased. Before the relaxation of foreign direct investment rules in November 2015, international investors were not allowed to acquire standing retail assets and shopping malls. In October, Blackstone reportedly made its first retail deal in the country by setting up a fully-owned subsidiary called Nexus Malls.
According to local news reports, the entity would own and manage shopping malls, having acquired several in Ahmadabad and Amritsar. In December, the New York-based asset management giant also reportedly acquired a 50 percent stake in a Pune mall for six billion rupees.
APG Asset Management, the Dutch pension fund asset manager, has also dipped its toes in the sector. In November, the investor formed a $450 million retail platform with Virtuous Retail, an Indian developer and operator of lifestyle shopping centers sponsored by Xander. The Singapore-headquartered platform, called Virtuous Retail South Asia, will be the partners’ exclusive platform to build a retail presence in India.
Kumar says demonetization was only a temporary hindrance and the opportunities for retail investment will continue. According to him, cap rates for yielding properties – well-located and planned shopping malls – have come down from 10.5 percent to around 8.5 percent. Additionally, retailer sales growth also continues to range from 15 percent to 30 percent on a year-on-year basis for various categories of tenants.
“Footfalls in our malls in Surat and Bengaluru declined a bit but are now better than pre-demonetization. For retail, demonetization is a good thing for the bigger centers as people start using credit cards, [mobile payment provider] Paytm and other digital methods,” he says.
The logistics and warehousing sector, meanwhile, is also expected to attract institutional capital once the comprehensive national value-added tax is implemented starting in April. This, together with the increasing interest from foreign manufacturers to set up shop in India, the roundtable expects will spur the development of quality logistics facilities.
Dasgupta adds that there is an almost five to seven-fold jump in terms of the number of kilometers of roads being laid out daily by National Highway Authority of India, which will be a boost to the logistics sector. Ascendas-Singbridge currently owns mostly business park assets in its India portfolio, but the firm is understood to be looking at industrial development projects via a new private vehicle.
The demonetization shock has exemplified reform-filled 2016 and, with that, a mixed-picture for private real estate investment in India. Optimism prevails at PERE’s roundtable, and there is a shared belief that the country’s marketplace is due for a turnaround. However, that will be complete only when – and if – their optimism is reflected by greater commitments to the country from the capital they strive to serve.