New Delhi: Worried that real estate developers will not be able to complete projects in time in a market where demand is slowing and credit is becoming tighter, private equity firms that invest in such projects have increasingly started doing so in phases or instalments.
“The problem in investing at one time is that you don’t really have any link to progress in the project you have invested in,” says Aashish Kalra, managing director of the New York-based, India-focused real estate fund, Trikona Capital Ltd. “Funding should always be performance linked.”
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Private equity firms are a preferred source of funds for developers who are finding it increasingly difficult to raise money from banks or retail investors. And the cost of debt has increased to around 16-18% a year.
A typical transaction involves the real estate firm setting up a separate company, also called a special purpose vehicle or SPV, for a project and the private equity firm taking a stake in this.
Developers aren’t opposed to private equity firms investing in phases. “There are discussions in the market that deals will be based on project milestones,” says Ajay Mangal, chief financial officer of Uppal Group, a Delhi-based real estate company which is looking to raise money for projects through the private equity route. “If the terms are okay, I don’t see any problems in such a deal, as the market is getting tighter and tighter.”
According to Trikona, its investments in real estate projects have always been linked to performance or the progress of the project.
South Asia Real Estate Ltd, a private equity fund that has raised $400 million (Rs1,804 crore) to invest in the Indian real estate business also links investments to performance.
And while private equity money continues to flow into real estate, investors have become more cautious.
The euphoria has died down, says Amber Malhotra, executive director of Walton Street Capital, Llc, a real estate fund. “Funds are more watchful now and they want to ensure that their money is invested correctly.” In instances where private equity firms invest in phases, the total investment is broken up over the lifecycle of the project, typically two to three years.
“Investing in phases ensures that the developer completes a particular task, say obtaining government approval before he gets the next tranche of investment,” says Rajnish Changrani, vice-president of research and investments at Red Fort Capital Advisors Pvt. Ltd, a real estate fund. “It also minimizes risks. If you put in money in one go and if the project fails for some reason you stand to lose all the money that you have invested.”
Private equity firms say that by investing in phases they are encouraging developers to be more efficient.
According to Venture Intelligence, a firm that tracks private equity investment, in 2007, private equity firms invested around $9 billion in real estate industry. This includes investment at the Special Purpose Vehicle level and at the company level. According to Arun Natarajan, chief executive of Venture Intelligence, this is the amount that funds have committed but they have not yet been fully deployed.
In the first eight months of this year, they have invested around $6.8 billion in the real estate sector.