MUMBAI : Vivek Chandy, joint managing partner, and Archana Tewary, partner, J Sagar Associates, comment on private equity interest in real estate-focused lenders amid a liquidity crunch, new financing routes and structures for real estate developers, and the impact of the economic slowdown on commercial realty, which has been a favourite among PE investors. Edited excerpts of an interview:

Are PE investors looking at equity investments in realty-focused lenders?

Chandy: There does seem to be increasing interest in such investments. The investee lenders are also looking for ways to diversify their capital sources. So, the opportunities are interesting. However, the lenders will also have to take a relook at their portfolio, and think of ways to make it more secure and appealing to investors. If the lender’s portfolio appears too risky for the PE investor, structuring would focus on ring-fencing the risky investments, and restructuring the deal to protect the investor. Thus, the approach is one of cautious interest.

What are the funding sources for residential realty developers?

Chandy: The NBFC crisis, triggered by the collapse of IL&FS, and exacerbated by the troubles of DHFL, has led to a liquidity crunch for all NBFCs. Over the last four to five years, NBFCs had become a favoured source of funding for all real estate developers, including residential real estate developers. After the NBFC crisis, however, funding to residential real estate developers has almost dried up. We are now seeing almost a reversal of the earlier trend, with banks stepping into the shoes of the NBFCs as lenders. These transactions are, however, being conducted on much stricter terms, especially with respect to collateral, than the lending that we saw in previous years. Further, the banks are also more cautious about the quality of the projects to which loans are being provided. There may be possibilities for very interesting structures in real estate financing in the near future, with a mix of debt and equity investments.

Tewary: Good real estate developers are now looking at equity investors who will bring value to the brand as well, and we have seen some good platform deals being put together.

Commercial realty has been a favourite among investors over the last few years. What are the investment trends?

Chandy: We are still seeing increased activity in commercial real estate, since the returns from residential real estate projects do not seem to have lived up to expectations. Forward purchase transactions are becoming a popular model for investment in commercial real estate. In a forward purchase transaction, the investor provides a part of the investment upfront at the time of commencement of construction, instead of front-ending the entire investment. The investor holds back the remaining amount and pays it to the developer after the completion of the project. In exchange, the developer transfers the ownership of the completed project to the investor. This model ensures that the developer has an incentive to complete the construction of the project, since he has to recover the remaining part of the investment. It also ensures that the investor has less capital at risk than it would have, if it had invested the entire amount upfront. To persuade the developer to finish the project, an investor may also ask that the undivided interest in the land being developed is transferred to the SPV upfront.

Tewary: Additionally, we are still seeing some interest from banks in lending to the commercial real estate space. Such lending is, however, also on more onerous terms than the lending that developers received from NBFCs.

Will the slowdown hit demand in the commercial space, impacting returns for investors?

Chandy: We do expect that there will be an impact from the economic slowdown on the demand for commercial spaces. This impact is not likely to be as high as the impact on residential and retail spaces. We believe that there is still a market for good commercial real estate. We are seeing that a lot of end users of commercial real estate are migrating towards flexible spaces. Co-working spaces are one part of the commercial real estate market that are still on an upswing.

This, however, has an impact on the returns for investors who have invested in larger commercial projects, which are geared towards more traditional corporate tenants and are not aimed at operating as flexible spaces.