PE investments in real estate see a quantum jump

In the current decade, apart from finance from banks / Non-Banking Financial Companies (NBFCs), private equity (PE) investments have been an important source of funds for the Indian real estate sector. Private equity capital comes primarily from institutional investors and accredited investors, who can dedicate substantial sums of money for extended time periods. These include Sovereign Funds, Pension Funds, Pure Private Equity Funds and Real Estate Funds.

PE investments into real estate across debt and equity

Private equity investments into Indian real estate did not show any upward trend between 2011 and 2013, in fact, the investments had declined compared to 2011.  However, with the new government assuming office in 2014 and the subsequent roll out of a battery of reforms, there has been a paradigm shift in investors’ interest. Post 2014, the PE investments grew at a CAGR of around 36 per cent from $2.5 billion in 2014 to $8.6 billion in 2017.

The Indian real estate sector was perceived by investors globally as developing in terms of quality assets across segments. However, some of the biggest path-breaking reforms of independent India became a reality in the past few years. Some of them include – the Real Estate (Regulation and Development) Act, 2016 (RERA), the Benami Transactions (Prohibition) Amendment Act, 2016, infrastructure status to affordable housing projects, demonetisation, interest subvention schemes, relaxation of norms to encourage Real Estate Investment Trust (REIT) listings and the Goods and Services Tax. These reforms have collectively set a new order and changed the perception global investors had of India.

The cumulative fund flow in the Indian real estate sector from 2011 to 2017 was recorded at $29 billion. Twothirds of this was invested over the past three years, i.e. 2015–17. Even for the first half of 2018, the run rate is very encouraging with around $4.9 billion being invested in the first six months of the current calendar year.

The years 2016 and 2017 witnessed several big ticket transactions of large mature assets such as the $1 billion Hiranandani-Brookfield deal in 2016 and $1.4 billion DLF-GIC deal in 2017. In the first quarter of 2018, a similar big ticket transaction was closed between Indiabulls and Blackstone.

In the coming years, there is a greater probability that we may witness a blip in the annual PE investments. This is because the assets that were transacted between January 2016 and March 2018 in the big ticket deals (indicated above) have a long gestation period and would take more than a decade to mature and become operationally efficient. Alth-ough these deals significantly elevated the annual investments for those years, currently there are very few large mature assets available in the country for investors. Hence, whenever a blip occurs, it should not necessarily be interpreted as the sector is facing headwinds.

Since 2011, nearly 660 deals have been done via the PE route. The average investment per deal across debt and equity has increased almost 2.5 times from $40 million per deal in 2011 to $102 million per deal in 2017. In the first half of 2018, average investment was $158 million per deal, which was nearly four times the corresponding figure in 2011.

This increase in average deal size was due to increase in number of large ticket size (large mature assets) transactions in the recent years. The number of deals has also gone up by 57 per cent from 180 deals in 2012–14 to 282 deals in 2015–17 period. Private equity (PE) by virtue, is risk capital, which generally goes in purchasing equity in a company or project and making maximum returns from the upside.

Traditionally, the PE funding route in Indian real estate was via entity-level equity as well as project-level equity. However, since the beginning of the current decade, the completions of a large number of residential projects were delayed and many are now nothing but abandoned sites. As a result, investors who had taken up equity in the projects burned their fingers terribly. There was no reprieve for their anguish. Many investors were not able to recover their initial investment, leave alone expect any gains. These factors forced the PE investors to shun the risk associated with investing equity into development projects and invest via debt or structured debt instruments. However, for ready-to-move-in, rent-yielding assets, the development and occupancy risks are largely mitigated. Hence, the investors took up equity positions in rent yield assets.

As a consequence, despite the overall investments increasing each year since 2014, the share of debt in total investments increased in the 2014–16 period. Particularly, for under-construction projects, the investors were not ready to take on any equity risk and preferred to invest via debt and significant proportion of the equity investments went into ready assets. In the past few years, particularly between January 2016 and March 2018, there were several big ticket equity investments that went into the acquisition of rent-yielding commercial assets, e.g. the $1.4 billion DLF-GIC deal, $1 billion Hiranandani-Brookfield deal and $730 million Indiabulls-Blackstone deal. Such large deals significantly increased the proportion of equity investments as a part of total PE investments in those years.

Source: Knight Frank