Emerging Trends in Real Estate Finance

The global financial crisis of 2008 altered the landscape for real estate finance in India. “Return maximization” is no longer the fundamental investment strategy. Post the emergence of “risk-minimization” as a focus area, investment structure has drifted from unsecured equity deals towards debt deals. Furthermore, developers are scouting for fresh sources of financing to mitigate the liquidity crunch faced by them. This has accelerated the process of institutionalization in Indian Real Estate sector due to developers’ prompt willingness to leverage opportunities available in the financial market instruments like IPOs and QIPs.

Jones Lang LaSalle Meghraj’s latest research report, Emerging Trends in Real Estate Finance, explores the trends and challenges in different channels of financing real estate development in India. The report establishes the importance of real estate as an investment avenue and investigates the stakeholders’ strategy to obtain financing for continuing a high growth story of this sector in recent years. The report also articulates the need for clear policy guidelines for REMFs, REITs and FDI necessary for sustainable growth of the real estate sector in India.

The summary of the report:

  • Real estate has established itself as one of the high-growth sectors in the Indian economy. In 3Q09, investment grade real estate was valued at USD 768.28 billion*, which was equivalent to 63% of the total market capitalisation of the Indian equity market.
  • According to estimates, the Indian real estate sector will require additional USD 23.66 billion for the construction of undertaken commercial projects and to fulfill the unmet housing demand. While sources of funding have become scarce in the aftermath of the 2008 global financial crisis, there are some emerging channels of real estate financing in India, which are likely to help the sector continue its high-growth story.
  • Gross bank credit to the real estate sector surged to USD 19.7 billion in FY09 from USD 13.6 billion in FY08, registering a growth of 44.6%. Real estate still accounts for less than 4% of the total bank credit creation.
  • Contrary to the commonly held belief of capital flight occurring during 2008, the actual deployment of FDI into India’s real estate sector increased 29% y-o-y during FY09. During FY06–FY09, FDI into India’s real estate sector registered a CAGR of 193% and witnessed an increase from USD 38 million in FY06 to USD 2.8 billion in FY09.
  • However, new deal announcements for real estate significantly slowed down in 2008. This conforms to the overall trend of a slowdown in the private equity (PE) market and is not specific to the real estate sector.
  • Domestic PE players have been focusing on deal structures that are essentially debt but replicate an equity structure. Investors prefer mezzanine deals, which are structured debt-like instruments consisting of interest income and an equity-linked component.
  • To date, a total of USD 2.76 billion has been raised by the real estate sector in India through qualified institutional placements (QIPs), and at least another USD 2.45 billion is expected to be raised by many other real estate players in the future, for which these players have their shareholders’ approval.
  • In the coming months, USD 3.31 billion is expected to be raised through property IPOs. IPOs can be an attractive vehicle to tap domestic, as well as foreign institutional investment. Moreover, they provide a good exit option for most PE investors that have a finite fund life.
  • Issues related to valuation and taxation are holding back real estate mutual funds (REMFs) in India. It is expected that the government will soon clarify these uncertainties to enable better financing opportunities for real estate development in the country.
  • We believe that all channels for financing real estate developments will see enhanced activity in the coming quarters. However, there are issues related to the transparency of the sector that must be addressed beforehand to bring about a smooth improvement in the sources of funding.

* Assumed conversion rate of INR 46.5 per USD

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