REAL ESTATE – Sources of Capital

Mr. Hardeep Dayal MRICS

CEO - KAMALA GROUP
* Evolution of Private Equity in
Indian Real Estate
 * Journey in the Past 10 years

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* Fundamentally a strong economy
 * Demand for Finance

There has been an addition of approximately 100 Million sqft of office

space every 2 to 3 years since 2006 and approximately 500- 630 million
sft of residential space launched annually since 2010
* Conventional sources of Funding

Source: Brookfield Financial

 * Bank Credit- still a tip of iceberg as compared to
mature markets
§ As of December 2013, banks have
an outstanding credit of USD ~24
billion in the commercial real
estate sector and USD 97 billion
in the housing sector.
§ During Jan to Oct 2014, the
outstanding bank credit
increased by 16% and 15.6% in
the Commercial and Housing
sector respectively.
§ Due to the sensitive nature of the
commercial real estate, the
central bank has prescribed high
standard asset provisioning norm
for such loans.
§ RBI has discouraged advance
disbursal products such as 80:20
and 75:25 schemes that are likely
to expose the bank as well as
home loan borrowers to
additional risks.
* FDI in Real Estate- Journey so far
* Real Estate Private Equity
* FDI Framework for Real Estate (Press note 2)- 2005
Foreign Direct Investment

Automatic Route Approval Route

Offers single window

clearance for
proposals on FDI in
Greenfield/brownfield Projects India that are not
allowed access
through the
automatic route
Hotels, resorts and
Commercial Office tourism

Retail Hospitals

Residential Housing Industrial Parks

SEZs

Educational Institutions
 * PE Landscape
§ Balance sheet/prop book approach of Investing
§ Large global Banks like Wachovia (Wells Fargo), JPM etc. followed this form of investing
resulting in a mix of structured finance and Equity in era of pre global meltdown.
§ Real Estate Private Equity Funds
§ FDI Compliant/Domestic Funds which invest in Real Estate Asset class. Investment done on
the basis of strength of local partner and the financer act as pure financial investors and
play little role in the development of the Asset. AIG, Kotak Realty, HDFC Property Fund,
Milestone, Indiareit, Red Fort Capital, Xander, Sun Apollo are some of the examples of India
focused Real Estate Private Equity Funds.
§ Some of the Global or Regional funds with India Allocation
§ Investments done by Goldman, Blackstone, Walton etc.
§ Real Estate Development
§ Built development capabilities locally Ascendas, Hines, Tishman
§ Sector Agnostic Funds

§ Investment of these funds is not restricted to a particular sector. These funds invest in a
sector or a company wherever there is an opportunity. These funds may invest in Real Estate
Projects whenever there is an opportunity available. Some of the sector agnostic funds are
Carlyle, Baring Private Equity, Citi Venture Capital etc.
 * PE Landscape
§ Sovereign Wealth Funds and Pension Funds
These are government backed funds are generally sector agnostic in nature. Some of the Sovereign
Wealth Funds are GIC, Temasek, ADIA and QIA, Some of these funds tie up with a regional PE Investor
whereas the others may invest directly into Projects

§ Real Estate Development Funds (Platform Deals)

These are platform deals signed between a Global Financial Investor and a regional marquee developer.
The funds received by the developer may be used to develop and acquire projects or may be used to
invest in third party projects. The advantage of these platform deals are that there are only 2 - 3 parties
involved with few restrictions and clarity on investment guidelines on the Fund manager.

Some of the platform deals which have been signed are –

a) Affiliates of Shapoorji Pallonji Group with CPPIB

b) Godrej Properties with APG

c) Mahindra Lifespaces with Standard Chartered

d) Piramal Group with CPPIB

From 2005 onwards, one of the biggest challenge has been that the focused funds providing secondary
markets exist never developed.
 * Private Equity in Indian real estate
§ Total Private Equity Investments into construction development sector in India through
FDI is USD 23.9 billion.
§ The sector ended the year attracting PE investment worth around $1.84 billion spread
across 68 deals, against $1.29 billion spread across 45 deals in 2013,
§ PE investment in the Indian Real Estate is the highest since 2008. , in the good old days
of 2007-08, close to 100 deals were struck two years in succession worth $4-5 billion
each.

Source: VC Circle and

Brookfield Financial
* PE Investment Spread

Source: Brookfield Financial

 * PE Exit in Indian Real Estate
§ Of the total institutional PE capital deployed until March 2014, nearly a fifth amounting
to USD 6.9 billion has been exited by PE funds.
§ As per JLL, returns from Indian Real Estate for Private Equity Investments with vintage
of 2006 stand at 1.1 times compared with the global average of 0.86 times.
§ Performance in the last six years is even better at 1.34x.
§ The residential sector accounted for over 58% of the exits and the office sector 24%.
§ 85% of the exits were through Promoter buybacks.
§ Some of the Challenges that were witnessed in Private Equity exit are –
• Partner Issues
• PN2 ambiguities
• Unenforceability of put/call options
• Litigation
 * Controls, evaluation and management
§ Changing mindset of all stake holders
§ Project Management
§ Addressing delivery bottlenecks
§ Preparation of annual business plan highlighting cash flows from various projects
§ Accessing different sources of finance to ensure sufficient liquidity and capital in the
Project
§ Improved transparency, reporting and Corporate Governance
 * Future landscape
§ Platform level deals with global Institutions- skin in the game
§ Enhanced involvement and controls in the decision making by Investors
§ Risk mitigation and controls
§ Commercial RE investments (core/core plus) - yield generating- Emerging asset class
§ Mezzanine finance- continue to be preferred
§ ‘Forward purchase’ transactions- largely by domestic funds- wholesaler approach
§ Hybrid structures- Debt with Equity kicker
§ Focused Funds- Rehab fund/ NCR Fund
§ Enhanced focus on asset management
§ Shorter cycles- investments in smaller projects
§ Research driven approach to investing
§ Investments with partners which have demonstrated exits
§ Leadership and teams with demonstrated track record
§ Emergence of Secondary markets -exits
* Alternate structures to PE and
what do global investors want
 * Type of Structures
* Private Equity: seeks to invest in high-quality assets in markets or
asset classes where it has a competitive or informational advantage.
* to invest in companies with favorable characteristics, such as businesses who are
low cost producers,
* businesses benefitting from high barriers to entry
* and businesses with tangible underlying assets
* to source transactions in favorable sectors
* In distressed assets and which require restructuring
* to leverage knowledge in a particular asset class and related operating platforms
up and down the value chain
* Debt Strategies: lending activities include event driven bridge loans
and other specialty debt finance solutions
* bridge loan capital and provide funding for acquisition and growth transactions,
buy-outs, leveraging of assets, recapitalizations and refinancing and interim capital
solutions.
 * Type of Structures

* Mezzanine Debt
* Investing in mezzanine debt that yields attractive risk-adjusted returns.

* Recapitalizations
* Recapitalization opportunities involving highly valued assets financed with
excessive leverage that require restructuring or recapitalization.

* Preferred Equity
* Investments in preferred equity investments associated with the acquisition,
development and recapitalization of real estate opportunities.
* Sources of Capital- various stages
* Changing sources of Institutional real estate finance

§
Financing channels for the real estate sector in India have become limited and expensive
§
Bank lending for end-use has been restricted and risk weightage increased by RBI
§
Advance Disbursal Facility and 80:20 schemes etc. have been discouraged by RBI
§
Developers/land owners are financially stressed due to stretched debt levels, delays in
project approvals, diversification in non-core areas etc.
 * What happened in PERE- Challenges
§ Approvals have taken a long time resulting in delay of Projects
§ Large projects have taken a long time to come to market
§ Money has been impatient- the time value of money
§ Delay has hurt the bottom line
§ Local Partners have valued their existing land bank in excess to the market
§ Cash-out to the landholder leaving no skin in the game
§ Restricted management bandwidth
§ Large Projects have not been very successful
§ Funds have been diverted from the project
§ Slow sales combined with large capital outlay and fund diversion have made some
project financial un-sustainable
§ Title insurance

Maturityhas emergedinthedeveloper/fundrelationship- Views mayvary

* Inefficiencies in the process of Project life cycle
What stage does PERE enter?
 * What prompted alternative structures in Private
Equity
1. Governance
Under pressure from regulators and investors the board of asset management companies and
funds have/ask for greater oversight responsibilities than ever. Firms are increasing by
responding by rethinking their governance models, increasing executives’ and directors’
responsibilities.

2. Risk
The financial crisis and its aftermath revealed the true extent of asset managers’ are beginning
to place more emphasis on emerging investment risk, additionally they are also taking
enterprise-wide approach to risk. There is enhanced requirement of Group level data
beyond the spv level.

3. Regulatory Complexity
Evaluate the issue of list of approvals required in a real estate project. This issue is further
compounded with the element of lack of clarity in certain aspects of FDI regulations.

New regulations are creating complex web of regulations around the globe, just as national
regulators step up their scrutiny and enforcement procedures. Firms will want to review the
operation, resources and effectiveness of compliance programmes, especially in key risk
areas
 * What prompted alternative structures in Private
Equity
4. Operations and Technology
Evolving regulatory regimes, combined with greater and more complex transaction
structures and volumes, and stretching front, middle and back office systems. Asset
managers are implementing a range of initiatives including outsourcing, workflow
management and improved data management. The knowledge and learning on the
concept of waterfall

5. Global information reporting

New tax and regulatory requirements, investor expectations, the globalization of
AM and mounting product complexity are all increasing information reporting needs.
The challenges around on-ground quality data remain, which make the task of AM
difficult.

6. Trust and Transparency

Asset managers are finding that greater transparency enhances trust. The change in mindset is
required by certain developer/project teams.

7. Strategic M&A
While M&A volumes have failed to meet expectations, asset managers have good strategic
reasons for making acquisitions. The M & A and secondary market is virtually non existent.
 * What prompted alternative structures in Private
Equity

8. Organic Growth
Growth is struggling against the headwinds of economic uncertainty and market
volatility. Future growth will depend largely on execution.

9. Human Capital
As signs of tentative market recovery continue, asset managers are investing in
recruiting and retaining talent

10. Regulations
With the markets becoming more, matured there was certain relaxation of FDI
policies. Also listed NCD as a finance option.
 * Mezzanine /Structured Debt Financing- An emerging
trend
§ Mezzanine finance typically is a structured debt-like instrument, earning mid/high
yields, through a combination of cash coupon and terminal yield and/or equity linked
components, such as warrants and convertibles.
§ It bridges the financing gap in a company’s capital structure and occupies a place
between senior debt and equity, both in security and total returns
§ Presently 8 out of 10 deals in real estate finance - through structured finance, as
compared to 5 – 6 deals in 2011-2012 and may be 1 out of 10 in 2006- 2007
§ The Mezzanine Finance done through CCDs in pre Lehman-era has been replaced with
NCDs which provide better security/charge creation. The CCD deals were done with a
call/put options where the coupon was serviced regularly and the exit was structured
through call option premium ( conversion at minimum DCF value).
§ Some of the PE players have set up an NBFC arm to undertake mezzanine finance and
debt deals.
§ Mezzanine funding generally provides for a coupon/preferred return of 19% to 22%.
Most transactions provide for a waterfall structure on the Equity component now.
§ The collateral backing where finance is done through NCD route is through collateral of
land and project receivables along with standard covenants of debt.
 * Non Convertible Debentures Issuance Procedures
and Regulations

§ NCDs are Rupee denominated instruments, hence ECB regulations won’t apply as ECB
regulations deal with foreign currency
§ Issuance of NCDs to any foreign person including an FII would not attract the provisions
of Deposit Rules
§ No prior approval of RBI is required to remit principal, coupon and redemption
premium payments to the FII or sub account which holds the NCDs
§ Prior approval of RBI may be required for making any payments pursuant to the
enforcement of the security by which the NCDs are secured

Investment structure
 * Non Convertible Debentures Issuance Procedures
and Regulations
§ FEMA Issue Regulations allows Permitted Investors* to subscribe to NCDs issued directly
by an Indian Company, provided such NCDs are committed to be listed in 15 days of
investment
§ Permitted Investor is required to immediately dispose of the NCDs by sale to a third
party or to the Issuer if the NCDs are not listed within 15 days of issuance
§ Issuer required to make certain disclosures in the Information Memorandum to be filed
with the stock – exchange along with listing application
§ The disclosures to be provided are MOA, AOA, necessary resolutions, audited financials,
resolutions related to security creation
§ Credit rating from at least one agency registered with SEBI to be obtained - ICRA,
CARE, Brickwork
§ In-principle and final approval for listing to be obtained from the Stock Exchange
§ Trust deed and security documents to be executed and the issuer to maintain 100% asset
cover sufficient to discharge the principal amount at all times for NCDs
§ Can include all types of securities including immovable properties, movable properties,
receivables, cash flows, pledge of shares and other securities
§ All such security to be created in favour of Debenture trustee
§ No SARFESI protection
* Non Convertible Debentures and Compulsory
Convertible Debentures
 * REIT- An idea whose time has come?

§ REITs invest in completed, revenue generating commercial properties and distribute a

major portion of the earnings among investors.
§ The latest release of draft regulations for setting up REITs in India is one major step by
market regulator SEBI to bring high level of maturity into Indian Real Estate
§ It is expected that with the opening up of the sector to REITs, there will be increased
capital inflows from overseas market
§ Of the 375 msf of Grade A office market across top six cities, 80-100 msf could be up
for REIT listing once it is introduced. It is also expected that the cap rates will
compress by 100 bps to 150 bps.
§ REIT has a potential market size of USD 10 -15 Bn in medium term
§ REITs bring in increased transparency in the sector by adopting better corporate
governance, disclosures and financial transparency practices.
§ Current expectations on tax-breaks from the government granting a pass-through tax
status for REIT, grey areas continue to exist in terms of stamp duty and capital gains
on transfer of asset to REIT, apart from whether DDT will also be waived off.
§ Currently most leased assets have LRDs on them, which leaves little for distribution as
dividend, and CMBS which is more appropriately suited for leverage in a REIT is still in
its infancy in India.
* REITs Confidence Index
* Future outlook- asset class and preferred
cities
 * Future landscape
§ Platform level deals with global Institutions- skin in the game
§ Enhanced say in the decision making by Investors at platform level
§ Risk mitigation and controls
§ Commercial real estate investments (core/core plus)
§ Mezzanine finance- won’t loose flavour
§ ‘Forward purchase’ transactions- largely by domestic funds- wholesaler
approach
§ Hybrid structures- Debt with Equity kicker
§ Focused Funds- Rehab fund/ NCR Fund
§ Enhanced focus on asset management
§ Shorter cycles- investments in smaller projects
§ Research driven approach to investing
§ Repeat deals-Investments with partners which have demonstrated exits
§ Leadership and teams with demonstrated track record– importance on years of
working together as a team
§ Emergence of Secondary markets –exits. Will it remain wishlist?
*Thank You