Real estate PE funds move to include more equity capital

Bengaluru: More than three years after private equity funds (PE) moved to debt and debt-structured transactions in real estate, they are again willing to infuse equity capital into projects to get better returns and invest with a long-term commitment, instead of looking for short-term profits.

A number of PE investors, who are in the process of raising fresh funds, are increasing the equity component or introducing equity in the new fund—a high-risk, high-return model—at a time of weak sales, high inventories and soaring leverage.

What this means for the sector is simple. Funds willing to take more long-term equity risks by investing in early-stage projects will not push developers to go on a refinancing spree, and will limit the burden of regular loan servicing on the project, letting the developer concentrate on execution. More often than not, this may also translate into a higher price realization per square foot at a later date.

In recent years, with banks turning wary of developers, non-banking financial companies (NBFCs) and PEs flooded the market with debt-like capital for all purposes and to every class of developers, at relatively high lending rates.

HDFC Property Fund and Motilal Oswal Real Estate Fund are looking to put out more equity from their soon-to-be launched funds, executives from the two funds confirmed.

Motilal Oswal is planning to launch its largest property fund of around ₹ 1,000 crore in the next couple of months or so. From its current fund, which has done 20% pure equity deals and the rest in the form of mezzanine (debt with an equity component), the new fund will do about 50% pure equity deals.

“Yields in debt transactions are coming off and investors need to take more risk in investments,” said Sharad Mittal, director and head, real estate investment, Motilal Oswal Real Estate Fund.

HDFC Property Fund, which will start a new $500 million offshore fund soon, will significantly bolster the equity component from the 9-10% it currently allocates from its current fund.

“It will be a fund that is strategically a long-term one, where the fund tries to stay till the end to share the profits. While returns may be the predominant reason, equity deals will help leverage levels come off, as investors will then look at primarily mid-segment housing which make business sense and will also bring in supply into the market,” said a fund executive, who didn’t want to be named.

Indiabulls Real Estate Fund, which is deploying its first debt fund of ₹ 500 crore, will introduce equity capital in a new fund it plans to raise later this year, said a person familiar with the development, who didn’t and to be named.

“This will ensure better returns of 20-22% than the average returns of 16-17% on debt offering. In such transactions, while there is a cap on downside, there is none on the upside,” he said.

Many funds that were unable to return money to investors after pure equity investments during the 2005-07 property boom opted for these deals that offered low but guaranteed returns. While this in a way solved the immediate liquidity concerns of realty firms, it also led to leverage levels rising high, as lack of cash flows pushed developers to keep borrowing afresh to repay older loans.

Among domestic funds which stayed with the equity model when most moved towards debt deal is ASK Property Investment Advisors Ltd. The fund has always backed early-stage, mid-income or affordable residential projects within city limits, and ensure steady sales owing to the massive housing demand in that price segment.

“I think the market is certainly returning to equity albeit extremely selectively—that is, equity is available only for a combination of both the right developer counterpart and the right project,” said Khushru Jijina, managing director, Piramal Fund Management.

Jijina said Piramal does individual equity transactions under a discretionary project management services route and has recently launched a couple of deals under this format—one is an early-stage redevelopment transaction in Mumbai and the second is a plotted development in Bengaluru.

“We are also in conversations with a couple of larger offshore investors for a longer tenure, programmatic equity platform but it is perhaps slightly early to comment,” he said.

“With too many debt instruments in the market, the fear is if sales don’t pick up, what happens to borrowers? If funds return to committing equity, there is no cash flow pressure in the short term or the stress to repay loans on a periodic basis. One is only looking at investors making money on the merit of the project,” said Shashank Jain, partner, transaction services at PricewaterhouseCoopers India, a consultancy firm.