Sahil Vora is the Founder and Managing Director of SILA.
From bullish in 2007 to sluggish in 2017-19, the Indian real-estate sector has been quite a conundrum. Taking a look at cash flow from that time to now will tell us where the industry is headed in the coming decade.
A sea captain knows that in order to go where you want to go, you need to know where you’ve been. Anyone who has been a stakeholder in the Indian real-estate sector in the last decade or so has set the path to where we will go from here. The way capital in the industry flowed, in terms of who benefited and who lost, it has been a roller coaster ride. The forecast for the next couple of years depends on the overview of the past decade.
Bullish run from 2007-11
These initial years saw the global financial crisis, with the collapse of the investment bank Lehman Brothers. Real estate in India then was quite the exception. It decoupled itself and attracted considerable equity interest. Capital was raised in 2005-06 and deployed in these years.
Large global real-estate funds invested in this sector and took equity risks. Developers used multiples on their land banks (some of which were not fully acquired) and raised money from public markets at an incredibly rich valuation. With Congress coming back to power in 2009 with a thumping majority, the bull found more legs to run.
The non-institutional investors aggressively bought under-construction stock in projects. Developers were using this capital as equity to buy more land and using debt, which they believed was relatively cheap, to complete the projects.
Riding the high, 2013 onwards
If the period of 2007-11 was about taking risks and aggressive buying, the sector saw a slight shift after toughing it out. With their learning from equity risk, the funds started using debt structures to invest in Indian real estate.
These structures have been the most favoured form of deploying capital into real estate since the last five to seven years. Since there were historical annual returns of 20 percent since 1991 to 2014 on real estate, and the investment growing by 600 percent since 2012 to reach over $2 billion in 2017, it never looked better for the sector. Funds became smarter in monitoring the uses of this capital.
They were making 16-20 percent internal rate of return (IRR) lending in this strategy and wrote cheque after large cheque. Who in their right mind wouldn’t, with the high-teens IRR and twice the cash flow cover on the spreadsheet?
Non-institutional investors started lending at 24 percent rates to developers, they thought this was bridge financing and that the markets/sales would significantly pick up. They were riding the optimism high.
The early asset yield
Residential real estate was the favoured property asset class during the bull run.
A contrarian bet and investment by Blackstone and a handful of Private Equity Funds saw a pick up in the commercial real estate asset class. They have reaped the benefits of their smart investment today.
Other real estate funds have followed this strategy since. With REIT legislation getting cleared every year, the exit from their investments via listing of REITS is becoming a reality.
The companies holding capital funded the larger and more reputable developers by taking equity in their holding companies as a platform deal. Piramal, Embassy, RMZ and more received large equity cheques from global funds to build their realty businesses.
Rise of the asset reconstruction companies
Refinancing projects with the help of PSUs and banks became harder. Asset Reconstruction Companies (ARC) found their way into this market in the last couple of years and have become aggressive in restructuring real estate assets.
An ARC is a specialised financial institution that buys non-performing assets or bad assets from banks and financial institutions so that the latter can clean up their balance sheets. ARCs business is buying bad loans from banks.
Instead of wasting time chasing defaulters, banks sell the bad assets to the ARCs at a mutually agreed value.
Several steps were taken by the RBI and the government to help the asset reconstruction activities. In one such step, the government raised FDI in the sector to 100 percent.
About 28 ARCs have been set up in India under a 2002 law passed to help re-organise non-performing credit but many of these have not been active due to lack of funds.
Overseas investors including KKR & Co, Blackstone Group LP and SSG Capital Management have either set up their own asset reconstruction companies in India or bought into existing ones. Others like Bank of America and SC Lowy have structured deals through such firms by paying them a fee.
Edelweiss Group has emerged as the largest stressed asset investor of the day. Edelweiss, along with Canadian pension investor CDPQ, is ready to deploy over Rs. 10,000 crore over the next three-four years, and the markets are watching them very closely.
The country’s banking system, which has a huge pile of stressed assets, has provided a big business opportunity to ARCs. They are now poised to scale up operations in Indian banks and see good times in the era of bad debts.
The next few years
Bank financing dried up post-2008 and NBFCs deployed large cash flows into real estate via equity. Developers raised capital in the equity market but the PSU’s stopped coming in for land purchase from 2011.
Indian real-estate developers’ debt burden has more-than-trebled over the past decade to Rs 4 trillion in 2018, from Rs 1.2 trillion in 2009, according to a study by Liases Foras Research & Rating.
Even though NBFCs have been investing since, the liquidity in this sector has begun to dry up. Investment in public equity and income priority units (IPUs) will be challenging in the coming year.
"While debt has grown in a monumental manner, so has inventory. Sales did not go up in the same proportion. Having borrowed money from different sources, developers kept adding housing stock into the market without productivity. Since sales remained abysmal all this while, developers are finding it difficult to meet their debt obligation at this point,” the study said.
Only Grade A developers will have access to credit as NBFC books will tighten up, to be squeezed only to fund established developers. Capital in real estate will only go to big players.
According to a survey conducted by KPMG, it revealed that the sector is estimated to grow to $650 billion by 2025, cross $850 billion by 2028 and touch $1 trillion by 2030. Will this actually come true in the next 10 years? What will be the sources of capital that fund this growth? Only time will tell.
The author is Founder and Managing Director of SILA.