Mumbai: Investments into the real estate sector by local and foreign private equity (PE) funds saw a big jump of 80% last year to around $2.4 billion, but with investors wary of putting in equity, much of it — an estimated 75-80% — is understood to have been injected in the form of structured debt.
That’s not surprising given real estate players are over-leveraged and can’t raise loans from banks. As Sumeet Abrol, partner at Grant Thornton, points out, “Structured debt has the advantage that developers do not have to attach projects as a collateral to raise capital.” Approximately 30% of the infusion has been made by foreign players, shows data from the department of industrial policy and promotion.
More important, unlike in the case of equity, it allows the investor to exit the investment with a pre-determined return. While companies would need to fork out 13-14% as interest on loans, PE funds demand a return of between 16% and 18%, which are lower than the returns of 27-30% they can make from equity investments in residential properties. But the risks of buying an equity stake are too high now given the real estate companies are not in the best of financial health; “The sector has underperformed in recent years and returns from an equity investment have dropped to as low as 15-18%. So, funds have become a lot more cautious,” Abrol explains.
The Ajay Piramal-owned Piramal Fund Management, for instance, doubled investments to R4,400 crore, but 85% of that was made via structured debt. Khushru Jijina, managing director at Piramal Fund Management, says PE funds refinanced existing loans of developers last year which was one reason for the rise in investments.
Foreign funds too have preferred to invest via structured debt and have routed their investments through NBFCs. “RBI does not restrict NBFCs from investing via such mezzanine structures,” Kumar Sourabh Singh, associate partner at Khaitan & Co, pointed out.
In the past, the Reserve Bank of India has frowned upon structured finance from foreign sources, pointing out the money is debt disguised as equity.
While structured debt may be the preferred mode of investment, there are real estate players that are able to attract equity; these are typically those whose assets have started generating cash flows and have a sound execution track record. The ASK Group, which has made a number of equity transactions, has done so in companies like Godrej Properties, Shriram Properties and Paranjape Schemes. Each of these developers has partnerships with reputed funds like APG, HDFC and TPG. ASK Group’s Sunil Rohokale points out that once there is an equity stake in a project, the fund has a say in the strategy and business plans. “If a project is not selling well or there are delays, fund managers will sit with developers and come up with a gameplan,” he observed. Abrol adds that where deals adopt a more equity structure, funds add clauses such as preferential access to cash flows.
“The terms of sharing in case a fund decides not to exit after the stipulated period or if the project earns
more than anticipated returns,” are negotiated, he said.