Banking on private equity funds

Funding is an essential component of the real estate world. Formerly, builders would pre-sell apartments and homes in order to raise capital for a project. This ensured that they did not lock in too much of their funds in one project alone.

As time progressed, real estate companies and the process of funding gained a more corporate perspective, private debt and loans for banks became a favoured option. The real estate fraternity right now is blessed with a number of funding options, one being the real estate private equity funds more commonly known as PE funds.
 
This of course, begs the question on whether PE funds have helped shift the focus from debt based funding to that of equity based. Says Om Chaudhry, CEO Fire Capital, “The year 2008-09 saw a number of market corrections and stringent lending norms set by financial institutions.

As a result, a high percentage of developers were forced to explore financing through PE funds. However, today the real estate industry recognies that investment through PE funds, though acquired at a higher cost helps them achieve their growth ambitions.” 

Speaking of alternate asset management, as Archana Hingorani, CEO of IL&FS says, “In our business, fund raising takes a long period of time - anywhere between nine and 18 months. Then, deploying it into the right project takes time and of course exiting is critical so that you can raise more funds and be able to continue the business.

In real estate, most of our funds are largely FDI. So, many of them are locked in, and this is the reason why we need to be very sensitive about providing exits. For all practical purposes, India as an investment destination for real estate has not seen exits that can give confidence to investors to put in more money, so the focus has to be more on an exit strategy on the real estate side.”

Investment scale

Private equity funds are all about financial investments that are used as funding for the base capital needed to create large scale projects. Providing an idea on the investment scale in the PE model, Gautam Hora, Senior Vice President, Capital Markets, Jones Lang Lasalle, India says, “Currently, the proportion is heavily skewed towards residential. This can be attributed to the fact that the residential sector is correctly seen as a self-liquidating asset class, while commercial and retail real estate have exit-related concerns due to unavailability of REIT/REMF vehicles in India.”

Elaborating further, Om Chaudhry says, “As per the government’s estimate, India will face a deficit of over 26.5 million houses by 2012. Considering the same, PE Funds are attracted by the residential developments, though sizable PE investments have been made in commercial developments too. As a strategy we have been actively investing in projects in Tier 2 and 3 cities as the demand for residential space is far outstripping the supply in these cities.”

In the end, it is all about your return on investment. With fund management fees in the area of 2% of the fund, there is also the fact that PE funds have to deal with raised expectations each year despite a higher valuation being presented to the investor. In such cases, the onus falls on the PE fund to ensure good enough returns to the investor.  
Archana Hingorani says, “What is important here is that you make sure that the valuations that you get into are reasonable. Real estate has always been an expensive market. The key to ensuring that you have investments that are healthy and optimal from an investor perspective is of course that you need to have reasonable valuation.”

So what does all of this spell for the funding aspect of real estate? Are we witnessing a complete change in realty funding dynamics?

Elaborating on this Om Chaudhry says, “According to a recent report, PE investments in India are sharply rising. In just six months of 2010, about $4.03 billion worth of PE investments came to Indian companies through 155 deals. In the first quarter of 2010, out of the total investments by private equity firms about 10.2% were made in the real estate sector.

The players of the real estate sector have recognised the scalability challenges, financial as well as delivery related and are increasingly looking at investments from private equity funds to ensure their sustainability and growth in this fast expanding and competitive sector. With such clear benefits in addition to capital per se, PE funding has emerged as the preferred option for the development companies.”

Another viewpoint on the matter however is that of Gautam Hora when he says that there has not been much of a change in the realty funding scenario.  “The industry,” he says, “still depends heavily on bank debt, NBFC funding and end-user advances. Bank debt is a cheaper option with flexible tenures. Moreover, it is easily available domestically. NBFC funding is also available at cheaper rates and can be repaid early. Thus, this route is also more flexible. Finally, end-user advances represent interest-free finance.”  

The beneficiary

While all of this may be great from the investor-builder point of view, the consumer too should be looked at. To what advantage does a PE fund work for him?

Om says, “The stringent commercial due diligence procedures followed by PE funds ensures that customers are provided transparent and safe offerings.

“The investments by PE funds are made in form of equity capital therefore there is limited risk of the projects running out of funds, thereby ensuring that the customer gets timely delivery and good quality of constructions. In cases where the PE fund is following an activist model of investment, the customer also gets many other benefits including international quality of housing with world class facilities.”