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Real estate: PE funds go where banks fear to tread

About 80% of the real estate deals are debt-based and the trend is expected to continue as banks stay away from a fresh exposure to this sector
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First Published: Sat, Jan 26 2013. 12 32 AM IST
Banks had total outstanding loans of about `1.2 trillion to commercial real estate companies as of November. Photo: Ramesh Pathania/Mint
Banks had total outstanding loans of about Rs.1.2 trillion to commercial real estate companies as of November. Photo: Ramesh Pathania/Mint
Updated: Sat, Jan 26 2013. 12 36 AM IST
Mumbai: Motilal Oswal Private Equity Advisors Pvt. Ltd is in the process of raising Rs.500 crore, its second real estate-focused fund, to invest in residential projects. The investment firm has fully deployed its first fund of Rs.165 crore.
The two funds, however, have different investment strategies. While the first fund was for equity funding of residential projects, the second fund will offer high-yield structured debt to real estate companies.
Motilal Oswal is not alone in favouring debt financing for the realty sector. Close to 80% of the deals these days in the real estate space are debt-based and the trend is expected to continue and even intensify with banks staying away from taking a fresh exposure to this sector.
After the boom of 2006-08, when developers promised 20-25% returns, not many private equity (PE) firms have been able to return money to investors. As a result, investors now prefer to either offer pure debt finance or structure deals, combining high-return, high-risk equity with modest assured returns of debt.
“Of our second fund, 70% will be for high-yield structured debt. We feel the market is ripe for this,” said Vishal Tulsyan, chief executive and managing director of Motilal Oswal Private Equity.
The Rs.674 crore IIFL real estate fund is offering money by way of debt to the sector, ensuring security by taking land as mortgage and securing development rights.
The investments are also turned into specific special purpose vehicles, the shares of which are pledged with them, said Abdeali Tambawala, director-investment advisory, real estate practice, IIFL Private Wealth.
“We also hold charge over an escrow account where the cash from the real estate project being funded flows in to ensure that we can monitor the project cash flows. We tend to keep a security cover of two times the amount invested and also ask for personal guarantees,” he said.
Also, IIFL prefers investing in residential projects as these generate cash flows. “We are also focusing on specific areas within cities where such projects have demand and are fast moving,” Tambawala said. “We are not looking too far into the suburbs.”
“In a pure debt situation, when one is getting returns of over 22%, is it worth taking equity risk for a delta, which could be smaller?” asked Vikas Chimakurthy, director at Kotak Realty Fund. The fund invests its entire corpus of Rs.523 crore in debt.
Equity deals are not taking place because there isn’t enough capital available for developers to acquire land and start property development, he added.
“As long as people get returns of over 20%, they won’t go beyond debt unless there are real good equity opportunities,” Chimakurthy said. “People will focus on debt and do equity deals in distress assets or acquisitions at right valuations.”
Bangalore-based real estate-focused fund Azure Capital has been investing both in equity and debt through its maiden Rs.75 crore fund. It is in the process of raising the second fund for a corpus of Rs.500 crore.
According to audit and consulting firm KPMG, PE firms invested nearly $31.5 billion (around Rs.1.7 trillion today) between 2006 and 2008, but exited less than 10% as of the end of 2011. Typically, PE firms have an investment horizon of three-five years.
Investors prefer debt deals as the structure offers them security on the capital invested through control over the property, the option to be the first one out through sales and escrow accounts as well as returns of 20-25%—in line with typical equity transactions. In equity deals, post-delivery, there are taxes that need to be paid by the investor and there’s no control over the property or the pace of its construction.
Experts say equity deals are a function of the capital available and right now the sector is fund starved. In 2007-08, domestic fund managers had $5-6 billion in capital, said Chimakurthy, adding that now domestic funds have not more than $1 billion. “Global funds are no longer putting money; capital is shrinking with PE firms,” he said.
Yet another reason for developers raising debt finance from PE firms is that banks are shying away from lending to them. Banks had total outstanding loans of about Rs.1.2 trillion to commercial real estate companies as of November, but their lending to the sector in the first 11 months of 2012 rose by just 1.7% over the previous year, according to India Ratings and Research, part of the Fitch Group.
Banks “are not hesitant in giving small loans of Rs.30-50 crore, but are averse to lending big money for massive projects”, said an official of a private sector lender. He declined to be identified.
Sanjay Dutt, executive managing director (South Asia) of Cushman and Wakefield, a real estate consultancy firm, said PE firms are asking two to two-and-a-half times collateral and are only lending to projects that have secured the necessary approvals for construction, and are not overpriced.
“Most of the money raised by the developers in 2012-13 has been used to retire expensive debts from private lenders or meet construction finance needs,” Dutt said.
Experts say most debt finance deals are for mid-segment developers. Also, debt and structured deals, where returns are assured, are expected to continue till large equity returns are seen.
Desirable returns are being seen in debt, said Sunil Goyal, managing director and chief executive of Ladderup Corporate Advisory Pvt. Ltd, a Mumbai-based investment bank working on four such deals.
“Real estate is not perpetual. Investors can’t gauge what returns they can generate in 10 years. In debt, one gets returns in three to four years,” he said.
Khushboo Narayan contributed to this story.
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First Published: Sat, Jan 26 2013. 12 32 AM IST
More Topics: real esate | PE funds | debt | returns |
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