PE Inflows In Indian Retail Double To $1.2 bn In 2 Years

Shobhit Agarwal, MD & CEO – ANAROCK Capital

  • From USD 600 mn from 2015-2016, private equity inflows in retail jumped to over USD 1.2 bn between 2017 and 2018
  • Of total USD 1.84 bn inflows in retail in last 4 yrs (2015-2018), Tier 2 & 3 cities attracted nearly 48% funds (of USD 880 mn) against USD 960 mn in Tier 1 cities
  • Top favoured Tier 2 & 3 cities included Amritsar, Ahmedabad, Bhubaneshwar, Chandigarh, Indore & Mohali
  • US-based funds like Blackstone & Goldman Sachs invested more than USD 1 bn between 2015-2018; UAE, Singapore, Canada & Netherlands funds also active
  • Q1 2019 saw only UAE-based Lakeshore invest USD 110 mn in Indian retail

Further liberalization in FDI policies – 51% FDI in multi-brand retail and 100% FDI in single-brand retail under the automatic route (against the previous 49%) – has attracted major global PE funds to double their investments in the Indian retail sector.

As per ANAROCK’s Private Equity in Indian Real Estate report, the total private equity inflows in the Indian retail sector between 2015 to 2018 stood at USD 1.84 bn. Of this, nearly USD 1.2 bn were pumped in between 2017-2018 alone.

US and Canada-based PE funds together invested more than USD 1.13 bn into the retail sector, bestowing their faith on an industry riding on increasing consumerism which is pegged to rise to USD 3,600 bn by 2020.

Tier 2 & 3 cities were high on the radar of the PE investors, who in the last four years infused almost half of their total investments into the retail sector in cities like Amritsar, Ahmedabad, Bhubaneshwar, Chandigarh, Indore and Mohali.

Our report highlights the fact that unlike the commercial office sector, retail is to some extent geography-agnostic because its success depends on the spending power of its target audience.

As a result, shopping malls in Tier 2 & 3 cities have performed as well as, if not better than, their Tier 1 counterparts. This also led to an increase in rentals and profitability and caused PE investors to start considering investment options outside their accustomed Tier 1 geographies.

US-based funds like Blackstone and Goldman Sachs invested more than USD 1 bn funds into the Indian retail sector between 2015 and 2018. Of this, more than USD 700 mn went into Tier 2 & 3 citiesjust USD 300 mn came to cities like Pune and MMR.

Evidently, large PE funds have recognized the potential of smaller cities which continue to have a shortage of organized retail despite the rising disposable income and aspiration-driven consumption appetite being generated there.

PE investors from UAESingapore and Netherland also showed interest in Indian retail during the period and invested close to USD 800 mn into it.

Top 5 Retail PE Deals in Tier 2 & 3 Cities – 2015 – 2018

Investor Investee Deal Size in USDmn Cities
Blackstone Carnival Group 340 Chandigarh
Blackstone Kalani Group 190 Indore
Blackstone Alpha G: Corp 150 Amritsar & Ahmedabad
Xander (VRSA) & APG Sun Apollo &Gumberg Retails 110 Mohali
Blackstone Forum Group 40 Bhubaneshwar

Source: ANAROCK Research

The opportunity that the Indian retail sector holds in store for PE investors is more than evident – as are the geographies they must focus on for optimum returns.

ANAROCK data reveals that around 39 mn sq. ft. of organized retail space is expected to enter the market between 2019-2022. Of this supply, approximately 71% is expected to come up in Tier I cities, and the remaining 29% in Tier 2 & 3 cities.

Ahmedabad, Bhubaneshwar, Ranchi, Kochi, Lucknow, Surat and Amritsar, among others, are the new retail growth hubs where the next chapter of the Indian retail story will play out in the coming years.

In fact, global retailers are now also eyeing cities like Chandigarh, Lucknow and Jaipur, to name a few. There is every reason to expect increasing funding infusions into the retail sector of these cities in the future.

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Entity-Level PE Inflows In Indian Realty Up 17% In Last 2 Years

Shobhit Agarwal, MD & CEO – ANAROCK Capital

Previously, private equity (PE) funds focused on Indian real estate were content with investments at the project level. Now, investors’ preference is now gradually tilting towards entity-level investments.

Data trends from ANAROCK’s recent report Private Equity in Indian Real Estate indicate that the share of entity-level investments is on the rise.

Project Vs Entity-Level – What’s the Difference?

Entity-level investment is an efficient strategy to get a firmer foothold in the real estate market. It allows a private equity investment firm to not only deploy its capital but also gain synergetic skills in the real estate marketplace.

PE firms invariably look for high levels of corporate governance in a real estate development company before deciding to invest in it at an entity level.

Project-level investments take a shorter-term view of capital deployment as they do not necessarily involve partnering with the developer over the long haul.

Rather, a PE firm will invest in a developer’s project, which involves a lower commitment and is, for that reason, a less risky approach to investing in real estate.

Entity-level investments, on the other hand, involve multiple projects and require the forging long-term business alliances.

They require thorough due diligence of the entity’s financials, as opposed to project-level investments where the PE fund will primarily seek to understand the financials of an individual project.

There are well-established benefits to entity-level investments. Once a PE firm and its developer partner have established synergy, more options to deploy further funding opens up.

In the current cash-crunch scenario of the Indian real estate industry, this is significant as longer-term funding can help the developer address long-term issues rather than merely seek short-term solutions.

While entity-level investments by PE players come at the cost of lower returns and higher due diligence requirements, they are of greater overall value for the real estate market in general and developers and PE players in particular.

An increase in entity-level investment alliances implies increasing confidence in developers with high corporate governance scores. As such, they bode well for a market which is making determined strides towards a deeper organization.

Entity-Level Investments Surge

From an overall 22% share in 2015 and 2016, entity-level investments increased to a share of over 39% during 2017 and 2018. In actual value terms:

  • During 2015 and 2016, nearly USD 1.1 bn funds were pumped into Indian real estate at the entity-level
  • In the 2017-2018 period, it was nearly USD 3.3 bn.

Back in 2007, investors were investing all across – largely at the project level – as the picture looked fairly rosy then.

However, post the Lehman Brothers crisis in 2008 and up to 2014, they became more selective. They refocused on select developers with good past track records, and with whom they felt ‘comfortable’.

As in any relationship, a comfort level comprises of various dynamics. With private equity players, it primarily hinges on a developer delivering consistently and factoring in their funding partners’ expectations – not just their own requirements.

Despite this new focus on comfort and credibility, PE investments remained limited largely to the individual project-level. This approach was very much in evidence in the 2015 to 2018 period, wherein approx.

2/3rd of PE investments in Indian real estate was at the project level. Of the total USD 14.01 bn PE funds in Indian real estate over the last four years, more than USD 4.4 bn were infused at the entity level.

A deep dive into data reveals that the focus on the portfolio or entity-level investments picked up momentum in the latter half of the period between 2017 and 2018.

In this period, entity-level private equity inflows almost tripled compared to the previous two years.

Top 3 Entity-level deals between 2015-2018

Investor Investee Deal Size in USD mn
GIC DLF 1,390
Blackstone Indiabulls Real Estate 730
CPPIB Indospace 500

Source: ANAROCK Research

For these plays, institutional investors used a combination of ‘vanilla’ and structured equity for investments into projects.

That said, they found greater comfort with vanilla equity while investing at the entity level, considering the longer-term focus at the entity level, and also the limited availability of structural options while investing at this level.

The major reason for this change is that institutional investors are now looking at long-term partnerships with fruitful returns over a long period, rather than the earlier focus on short-term gains.

Commercial Real Estate Retains the Winning Hand

As anticipated, the commercial office segment accounted for the maximum share with 59% of entity-level investments over the last four years.

  • Entity-level investments in commercial real estate accounted for a mere 13% share in 2015-2016
  • Such investments increased to a share of nearly 74% during 2017 and 2018 (approx. USD 2.5 bn.)
Sectors % share of total USD 1.1 bn entity-level inflows in 2015-16 % share of total USD 3.3 bn entity-level inflows in 2017-18
Commercial 13% 74%
Logistics & Warehousing 0% 17%
Mixed Use 25% 0%
Residential 62% 4%
Retail 0% 5%

Source: ANAROCK Research

What Changed the Game?

The constant talk of these factors has, perhaps, become something of a cliché. Nevertheless, it was primarily the improved transparency brought on by a completely new regulatory approach and policy regime that turned the tide for Indian real estate.

There were also far more favourable macro-economic indicators, including IMF’s forecast of India’s GDP growth rate, at play.

Thanks to these positive market signals, private equity investors once again reposed their faith in the Indian real estate sector -, particularly in commercial real estate.

In fact, the new sunshine sectors of logistics & warehousing, as well as retail real estate, attracted entity-level PE investments.

The residential sector, on the other hand, witnessed a massive decline in entity-level PE inflows – here, investors favoured investments at the project level as this mitigated their risk exposure in a very uncertain market segment.

Other Key Takeaways:

  • In the past four years, out of total USD 4.4 bn entity-level investments in real estate, the commercial segment received a 59% share, followed by residential with an 18% share, logistics & warehousing at 13%, mixed-use projects at 6% and retail at 4%.
  • Massive growth in the commercial sector – from just 13% of a total of USD 1.1 bn funds at the entity level in 2015-2016 to 74% of a total of USD 3.3 bn in 2017-2018.
  • The period between 2017-2018 saw meaningful entity-level investments in the logistics & warehousing sector; entity-level investments in retail also picked up in this period (after a lull in 2015 – 2016).
  • Entity-level investments in residential real estate witnessed a sharp drop – from a 62% share to just 4%.

 Download the full report here –  Private Equity in Indian Real Estate

 

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Singapore Private Equity into Indian Real Estate Triples in Last 2 Years

Shobhit Agarwal, MD & CEO – ANAROCK Capital

  • Singapore funds, over 2 years, comprise 41% share of total PE inflows into Indian real estate at USD 3.5 bn (against USD 1.15 bn in 2015 and 2016 combined)
  • The US and Canada-based PE investors come next with a collective contribution of USD 3.8 bn PE funds in the last 2 years
  • Singapore’s GIC, Ascendas and Xander top PE investors; largely eye southern cities of Bengaluru, Hyderabad and Chennai

Singapore investors are betting big on Indian commercial real estate and other new sunshine sectors, including logistics and warehousing.

Major Singapore-based private equity firms are funnelling billions of dollars into the country’s real estate sector, particularly in South Indian cities.

As per ANAROCK’s recent report Private Equity in Indian Real Estateof the total USD 14.01 bn PE funds into Indian realty between 2015 to 2018, approx. 1/3rd were pumped in by Singapore-based firms alone during the period – the highest among both domestic and foreign investors.

However, of the total PE inflow of USD 1.1 bn in Q1 2019, there were no investments from any of the Singapore-based PE investors such as GIC, Ascendas and Xander.

With funding from banks and NBFCs drying up over the last few years, Indian developers were being forced to explore debt and equity funding from various private equity players.

Singapore investors were on top of the list, followed by PE players from the US and Canada. After establishing a strong base in China, India was their logical next destination of preference.

In fact, with their more patient and long-term outlook, Singapore-based investors and developers have gained a substantial foothold in India’s property market over the last four years.

In in 2015 and 2016, Singapore-based PE players pumped USD 1.15 bn into Indian real estate. This saw a three-fold jump in 2017 and 2018 – to nearly USD 3.5 bn.

Major players including GIC, Ascendas-Singbridge and Xander have been making steady investments into India. However, in recent years they have scaled up their investments and developments across segments.

Besides commercial spaces including office and retail, players like Ascendas are also diversifying their portfolios and eyeing sunshine sectors like logistics and warehousing.

Singapore-based Top PE Investors Approx. PE Funds in India

USD (2015-2018)

GIC 2.5 bn
Ascendas 830 mn
Xander 910 mn

Source: ANAROCK Research

Over the past four years, GIC has invested close to USD 2.5 bn in Indian real estate, mainly in cities like Mumbai, Chennai, Bangalore, Hyderabad and NCR. For Ascendas, the preferred cities have largely been Hyderabad, followed by Chennai and MMR.

Meanwhile, US-based investors pumped in nearly USD 4.0 bn in the same period (2015 to 2018) and more than USD 700 mn in the first three months of 2019.

From the leading US-based private equity players including Blackstone, Goldman Sachs, Hines, Warburg Pincus and Proprium Capital, Blackstone alone infused nearly USD 2.9 bn across Indian cities over the last four years.

A further deep-dive reveals that US-based investors, led by Blackstone, have largely invested in West Indian markets, including Mumbai and Pune.

On the other hand, Singapore-based investors have focused on strengthening their foothold in the South Indian markets of Bengaluru, Hyderabad and Chennai.

PE players from Canada, led by Brookefield, were the third-largest investors into Indian real estate over the last four years, with PE infusions close to USD 2.3 bn. The other major PE player active in India is Canada-based pension fund CPPIB.

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PE Inflows In Residential At 4-Year Low, Commercial At 4-Year High – ANAROCK Report

  • Total private equity inflows in residential at USD 266 mn in 2018 – an 82% decline since 2015
  • Commercial real estate drew the lion’s share with USD 2.8 bn PE funds
  • Average deal size increased by over 170% in 4 years – from USD 47 mn in 2015 to USD 128 mn in 2018
  • Overall real estate sector attracted over USD 4 bn of PE funds in 2018; a decline of 9% against 2017
  • In less than 3 months into 2019, PE equity investment into real estate is close to USD 1 bn

Institutional investors invested more than USD 4 bn funds across the country’s real estate segments in 2018, states ANAROCK Property Consultants‘ latest report ‘Private Equity in Indian Real Estate‘.

The commercial office segment saw the highest inflows, accounting for a massive 70% share of the total institutional investments into the industry in 2018.

Retail real estate came in a distant second with 7%, and the residential sector drew the least private equity among the three sectors, with less than 7% of the overall share.

The report says that out of the total PE inflow of USD 14 bn into the sector in the last four years, 2017 and 2018 collectively saw the maximum investments to the tune of USD 8.6 bn.

Currently, funding is a major hurdle for the Indian real estate’s growth prospects – especially post the NBFC crisis. Private equity funding is the best alternative for developers who qualify for it.

Despite a decline of 9% in PE inflows in 2018 against the preceding year, 2019 will bring a marked increase in private equity funding because of India’s first REIT listing.

From this point onward, commercial real estate – especially Grade A office spaces – will attract considerable investments. Nevertheless, much of the industry’s prospects also hinge on the outcome of the upcoming general elections.

Institutional investors will continue to pump in funds into the real estate industry if they can rely on political stability, proactive policies and a favourable microeconomic environment.

The report further states that despite deal numbers declining since 2015, the average deal size has increased by nearly 172% in the last four years – from USD 47 mn in 2015 to USD 128 mn in 2018.

Interestingly, the top 5 deals in 2018 alone contributed almost 50% of the total investments during the year. PE investors have become more cautious about selecting and associating with developers; however, once confident, they are making larger investments.

Top 5 PE Deals of 2018
Company Investors Amount (US$M) Date City Sector
Shapoorji Pallonji Group Mapletree Investments Pte Ltd.            352 Nov-18 Chennai Commercial
Phoenix Group Xander            350 Oct-18 Hyderabad Commercial
Indiabulls Real Estate Blackstone            730 Mar-18 Mumbai Commercial
Equinox Business Park Brookfield            386 Jan-18 Mumbai Commercial
Phoenix Group Ascendas            204 Jul-18 Hyderabad Commercial

Source: ANAROCK Research

A segment-wise breakdown indicates that commercial realty saw an annual increase of 27% in PE investments – from nearly USD 2.2 bn in 2017 to over USD 2.8 billion in 2018.

High occupancy levels, relatively lower rentals in dollar terms, quality Grade A assets and high-quality tenants are the key reasons for commercial space to draw around 70% of the overall share of the total private equity investments in 2018.

Considering high demand, fund exits have been relatively easier in commercial real estate – and with REITs being launched, they will become even easier.

Q1 2019 PE Update

In less than 3 months into 2019, we have already seen PE equity investment touching almost USD 1 bn, the majority of it coming through a single deal when Brookfield acquired a portfolio of hotel assets of Leela Ventures for USD 570 mn recently.

Also, investors’ interest in long-term real estate plays with preferred developers continues to be visible with more than USD 500 mn of additional platforms getting created in just 2.5 months.

As we speak, the REIT offering by the Blackstone – Embassy Group is ongoing. If the interest for this new investment platform is as expected, it will open a new chapter in the country’s real estate space.

Key Deals in Q1 2019

Investor Investee Asset Class Amt (USD Mn)
Brookfield Hotel Leela Ventures Hotel 573
Hines DLF Office 127
LOGOS India

 

Casagrand Distripark

 

Logistics & Warehousing 98

Source: ANAROCK Research

Other Report Highlights:

  • Between 2016 and 2017, the main Southern cities cumulatively saw just 18% (in 2016) and 17% (in 2017) of the total PE investments. This share increased to 54% in 2018 through a series of investments.
  • The retail real estate sector is riding high on India’s growing consumerism – not just in metros and tier 1 cities but also in tier 2 & 3 cities. Nearly 46% of institutional investments in retail spaces between 2015 and 2018 were made in non-metro cities like Bhubaneshwar, Chandigarh, Indore, Amritsar and Ahmedabad.
  • Due to multiple issues like stalled/delayed projects, the liquidity crunchhigh property values and low sales, the residential real estate sector has been shedding PE investors’ interest. Between 2015 and 2018, equity investments into the sector reduced from 47% to a mere 3%.
  • However, the affordable housing segment is gaining momentum and investors will seek to secure a slice of this increasingly lucrative pie.

Best-performing Cities:

  • At the city-level, Mumbai continued to be the most preferred destination for overall PE investments, seeing nearly 38% of the total capital inflows in 2018
  • Hyderabad witnessed a sudden burst in investments in 2018, attracting more than USD 1.1 bn of private equity – a more than three-fold increase in investments compared to the collective previous three-year period. This growth spurt was largely led by commercial real estate, with the Phoenix Group receiving vast PE infusions through multiple deals.
  • Hyderabad surpassed Bangalore and Chennai, the other two major South Indian cities, in investment inflows.

Going forward in 2019, institutional investors are likely to continue infusing investments into the maturing Indian real estate market, which offers more scope for growth than developed countries with matured real estate markets.

Moreover, strategic policy relaxations to boost the ease of doing business, coupled with the rapidly transformed business environment, will continue to attract private equity to Indian real estate.

Click here to download the report

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What ROI Can One Expect From REITs?

Shobhit Agarwal, MD & CEO – ANAROCK Capital

  • About 50% of India’s total office stock is REITable – up from 30% in 2 years
  • Projected 5-year returns on commercial assets is 14%
  • REITs could further percolate down to other asset classes like retail and logistics

The listing of India’s first REIT by Blackstone-backed Embassy Group has been in the offing for quite some time, but it now it will finally be listed and open for investment on 18 March 2019.

As REITs get officially deployed in India, investors hoping to cash on this new avenue for generous ROI growth seek to understand what exactly is in store for them – and for the real estate market.

As with any other investment platform, REITs have their own nuances and also issues, especially in the Indian context.

Obviously, the industry at large has a lot of skin in the game as REITs promise to be a major inward-facing funnel not only for foreign institutional investments but also considerable individual investments.

Given that the industry is still caught in the prongs of an unrelenting liquidity crunch, there couldn’t be a better time than this for foreign and domestic investors to pump funds into the real estate market via REITs.

Besides perfect timing, the listing will enable India to join the ranks of all mature markets because only such markets have a proper REIT structure in place.

It will open avenues for global investors who have been bullish on Indian commercial real estate but have been waiting for an opportune time. The total of 33 mn. sq. ft. area to be listed by Blackstone-Embassy group is just a fraction of the massive portfolio held by the US firm in India.

If successful, it will help them list more properties under REITs in the future. This will eventually send across a positive signal to all global investors. As for several retail investors back in India, the listing will unveil more robust investment avenues.

Also, depending on its success, REITs could further percolate down to other asset classes namely retail, logistics etc. which will not only bode well for the overall real estate sector in the country but also entice investors to penetrate into other niche segments.

FIIs Gear Up for the REIT Plunge

2018 saw large foreign institutional investors like Japan’s NikkoAm-Straits Trading Asia and US’ North Carolina Fund, among others, receive SEBI approval to invest in India under REITs.

Several FIIs had already ‘conquered’ India’s equity markets in the past, and now it is the turn of the real estate market via REITs.

It is not only the timing that is right, but also the stance that FIIs have assumed for real estate plays in India. Most of them are patient investors focused on stable long-term returns which will hopefully exceed those they could expect in their own countries.

Nevertheless, whether Indian REITs will indeed be an unequivocal blessing to foreign and domestic investors still remains to be seen. As things stand now, India’s REIT environment is not really a faithful emulation of that of developed international markets like Singapore, UK, Canada and Australia.

How India REITs Compare Globally

In those countries, REITs are a market-proven model that has withstood the test of time and produced very attractive returns for their investors.

Globally, REITs have responded quite favourably to the evolving market dynamics. Indian REITs hope to take a cue from their western counterparts by bringing in regulations in line with the globally recognized norms so as to maximize profits for REIT investors here.

In Canada, the average return for REIT investors was around 10% in 2017, while in the UK, it hovered between 8-10%. This average return is on all REITable assets including commercial and residential projects together.

In India, the projected five-year returns on commercial assets is an optimistic 14%, largely because Grade A commercial real estate has been on a protracted winning streak since 2017. Commercial real estate withstood the vagaries of the various reforms much better than the residential asset class.

In the US, smaller investors account for between 25-30% of REIT participation from the previous 50% about a decade ago. In India, we can reasonably start with at least 15-20% of participation by smaller individual investors.

All of this certainly bodes well for both FIIs and smaller investors focused on REITable commercial real estate – a space which has also benefited from the incumbent government’s efforts to improve the ease of doing business in India.

Expected ROI – REITs vs other asset classes

REITs

Source: ANAROCK Research

What Disqualified Residential from India REITs

However, residential real estate, the sector that is in greatest need of institutional funding, is not included under REITs while in developed global markets, residential assets are included under REITs.

This is obviously not without good reasons. Lack of a sound and inclusive rental policy in India is one of the major hurdles for REITs in the residential segment. Countries like Singapore and US have a defined rental policy which makes it easier for them to host residential REITs.

Also, the yields on residential projects in India hover between mere 2-3% in the prime locales here – nowhere near those of developed countries.

In short, low returns coupled with the overall negative hype that has followed the Indian residential sector in recent years have thus clearly negated its candidature for Indian REITs – at least in the foreseeable future.

Another area of difference is the taxation structure currently being proposed for Indian REITs. Like in the more developed countries with successful REIT platforms, India too must offer a logical tax regime with a single point of taxation if they are to rise to globally comparable stature.

Commercial Spaces – Primed and Ready

From a pure industry viewpoint, India’s Grade A commercial real estate sector has certainly proven its resilience and ability to generate attractive returns. This is why NRIs and domestic HNIs have shifted their erstwhile focus from residential properties to commercial real estate.

Nor is this a passing ‘phase’ – commercial leased assets across cities such as Bengaluru, Mumbai, Pune and NCR are seeing steadily mounting interest from occupiers, and therefore also from investors. Demand for Grade A office space has been growing and vacancy levels have been sliding south in prime locales.

ANAROCK data also indicates that while commercial real estate supply across the top 7 cities in 2017 (post the disruptive reformatory changes of DeMo, RERA and GST) declined by 24% over the preceding year, 2018 saw a 21% jump in new commercial supply as against 2017. Office space absorption remained steady with top 7 cities, witnessing an increase of almost 5% in 2017 as against 2016, and a 19% increase in 2018 as compared to 2017.

Data currently suggests that approximately 50% of the total office stock in India can qualify for REITs – a definite improvement over the 30% two years ago. Clearly, the market is gearing up for the launch of REITs by developing investable commercial assets.

At the end of the day, the success of Indian REITs will be basis growth prospects of a market that is still maturing, unlike developed countries (including in the Asia Pacific region) which are already mature. India is currently seeing a lot of new construction, so the average age of office buildings is lower than in cities in Australia or even Hong Kong.

Endnote – Cause for Caution

Once REITs become an on-ground reality, the market must remain vigilant. There could be a major issue for Indian REITs if the supply of investment-grade office spaces does not keep pace with demand. If it doesn’t, we will see an asset bubble form in the short-to-mid-term.

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50% of Indian Office Stock Qualifies for REITs

Shobhit Agarwal, MD & CEO – ANAROCK Capital

  • About 50% of India’s total office stock is REITable – up from 30% in 2 years
  • Low returns, lack of sound rental policy eliminated residential’s REITs candidature
  • Projected 5-year returns on commercial assets are 14%

The listing of India’s first REIT by Blackstone-backed Embassy Group has been in the offing for quite some time, but it now finally appears that it will be listed within the first half of 2019.

As REITs await their official deployment in India, investors hoping to cash on this new avenue for generous ROI growth seek to understand what exactly is in store for them – and for the real estate market.

As with any other investment platform, REITs have their own nuances and also issues, especially in the Indian context. Obviously, the industry at large has a lot of skin in the game as REITs promise to be a major inward-facing funnel not only for foreign institutional investments but also considerable individual investments.

If the first REITs are indeed announced in H1 2019, it would certainly not happen too soon for an industry still caught in the prongs of an unrelenting liquidity crunch.

There could not be a better time than this for foreign and domestic investors to pump funds into the real estate market via REITs.

FIIs Gear Up for the REIT Plunge

2018 saw large foreign institutional investors like Japan’s NikkoAm-Straits Trading Asia and US’ North Carolina Fund, among others, receive SEBI approval to invest in India under REITs.

Several FIIs had already ‘conquered’ India’s equity markets in the past, and now it is the turn of the real estate market via REITs.

It is not only the timing that is right, but also the stance that FIIs have assumed for real estate plays in India. Most of them are patient investors focused on stable long-term returns which will hopefully exceed those they could expect in their own countries.

Nevertheless, whether Indian REITs will indeed be an unequivocal blessing to foreign and domestic investors still remains to be seen.

As things stand now, India’s REIT environment is not really a faithful emulation of that of developed international markets like Singapore, UK, Canada and Australia.

How India REITs Compare Globally

In those countries, REITs are a market-proven model that has withstood the test of time and produced very attractive returns for their investors. Globally, REITs have responded quite favourably to the evolving market dynamics.

Indian REITs hope to take a cue from their western counterparts by bringing in regulations in line with the globally recognized norms so as to maximize profits for REIT investors here.

In Canada, the average return for REIT investors was around 10% in 2017, while in the UK, it hovered between 8-10%. This average return is on all REITable assets including commercial and residential projects together.

In India, the projected five-year returns on commercial assets is an optimistic 14%, largely because Grade A commercial real estate has been on a protracted winning streak since 2017. Commercial real estate withstood the vagaries of the various reforms much better than the residential asset class.

In the US, smaller investors account for between 25-30% of REIT participation from the previous 50% about a decade ago. In India, we can reasonably start with at least 15-20% of participation by smaller individual investors.

All of this certainly bodes well for both FIIs and smaller investors focused on REITable commercial real estate – a space which has also benefited from the incumbent government’s efforts to improve the ease of doing business in India.

What Disqualified Residential from India REITs

However, residential real estate, the sector that is in greatest need of institutional funding, is not included under REITs while in developed global markets, residential assets are included under REITs.

This is obviously not without good reasons. Lack of a sound and inclusive rental policy in India is one of the major hurdles for REITs in the residential segment. Countries like Singapore and the US have a defined rental policy which makes it easier for them to host residential REITs.

Also, the yields on residential projects in India are nowhere near those of developed countries and mostly hover between mere 2-3% in the prime locales here.

In short, low returns coupled with the overall negative hype that has followed the Indian residential sector in recent years have thus clearly negated its candidature for Indian REITs – at least in the foreseeable future.

Another area of difference is the taxation structure currently being proposed for Indian REITs. Like in the more developed countries with successful REIT platforms, India too must offer a logical tax regime with a single point of taxation if they are to rise to globally comparable stature.

Commercial Spaces – Primed and Ready

From a pure industry viewpoint, India’s Grade A commercial real estate sector has certainly proven its resilience and ability to generate attractive returns. This is why NRIs and domestic HNIs have shifted their erstwhile focus from residential properties to commercial real estate.

Nor is this a passing ‘phase’ – commercial leased assets across cities such as Bengaluru, Mumbai, Pune and NCR are seeing steadily mounting interest from occupiers, and therefore also from investors. Demand for Grade A office space has been growing and vacancy levels have been sliding south in prime locales.

ANAROCK data also indicates that while commercial real estate supply across the top 7 cities in 2017 (post the disruptive reformatory changes of DeMo, RERA and GST) declined by 24% over the preceding year, 2018 saw a 21% jump in new commercial supply as against 2017.

Office space absorption remained steady with top 7 cities, witnessing an increase of almost 5% in 2017 as against 2016, and a 19% increase in 2018 as compared to 2017.

Data currently suggests that approximately 50% of the total office stock in India can qualify for REITs – a definite improvement over the 30% two years ago. Clearly, the market is gearing up for the launch of REITs by developing investable commercial assets.

At the end of the day, the success of Indian REITs will be basis growth prospects of a market that is still maturing, unlike developed countries (including in the Asia Pacific region) which are already mature.

India is currently seeing a lot of new construction, so the average age of office buildings is lower than in cities in Australia or even Hong Kong.

Endnote – Cause for Caution

Once REITs become an on-ground reality, the market must remain vigilant. There could be a major issue for Indian REITs if the supply of investment-grade office spaces does not keep pace with demand. If it doesn’t, we will see an asset bubble form in the short-to-mid-term.

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The NBFC Real Estate Crisis – What, Why and What Next?

Shobhit Agarwal, MD & CEO – ANAROCK Capital

  • NBFCs account for over 50% of total developer financing – close to INR 4 trillion in FY2018
  • Real estate has already exhausted over 75% of available credit
  • Consolidation of not only developers but also NBFCs on the cards

As an alternative to the main banking sector, Non-Banking Finance Companies or NBFCs have had few peers, which makes the perfect storm that has gathered around them now all the more worrisome.

What ARE NBFCs anyway?

NBFCs are financial institutions that are essentially engaged in the business of providing loans and advances primarily to retail customers. Unlike the formal banking sector, they cannot accept deposits from the public; they depend solely on wholesale lending and banks for their operations.

Two-wheeler loans, consumer durable loans, gold loans, vehicle finance and loan against property are the segments where NBFCs have a very strong presence across the country and enjoy a much larger share than the public sector banks.

Which Sectors Do They Fund?

After agriculture, the MSME sector is heavily dependent on NBFCs for loans and working capital.

Since banks cannot be present in every nook and corner of the country, NBFCs have capitalized on their highly localized presence to grow their business on the back of strong rural demand and the thriving SME and MSME sectors.

Their local network and understanding of customer profiles at a local level give them an edge over the banks when it comes to lending at the micro level. Due to these advantages, NBFCs could rapidly scale their businesses where the formal banking system was slow in lending.

Also, the rising Non-Performing Assets (NPA) crisis in the overall banking sector made banks reluctant to lend to the perceived riskier sectors like SME and MSME, thus helping NBFCs to gain market share. Real estate, also considered a high-risk sector, depended heavily on NBFC funding as well.

How Did The Current Crisis Play Out?

The ongoing liquidity crisis in the NBFC industry is the result of asset-liability mismatch (ALM). Since the NBFCs cannot raise retail deposits from the general public, they depend on wholesale lending for their capital requirements. As a result, the cost of funds for NBFCs is higher than that of banks.

The biggest error that the majority of NBFCs and HFCs committed with regards to the real estate sector is that they ventured into long-term lending to builders and also into underwriting loans with very long-term repayment tenures.

As a result, the NBFCs short-term borrowing was channelized towards financing long-term loans. They were heavily dependent on banks, mutual funds and private placements to meet their capital requirement as well as for refinancing of loans.

However, post the IL&FS default, banks and mutual funds have stopped refinancing the loans of NBFCs and also stopped the disbursal of sanctioned loans to them, since there is still no clarity regarding the spill-over impact of the IL&FS default.

How Bad Is The Situation For Real Estate?

NBFC loans to developers have seen a phenomenal rise since 2014, particularly due to the slowdown in bank loan disbursals. Interestingly, as per the current fiscal, NBFCs alone account for more than 50% of the total developer financing, which is somewhere close to INR 4 trillion in FY2018 as on date.

However, the recent NBFC crisis has clearly spelt intense gloom – if not outright doom – for Indian real estate. Nearly USD 34 billion of mutual funds debt in NBFCs and HFCs is maturing between Oct 2018 and March 2019.

Prior to the crisis, the sector was already dealing with a massive cash crunch and subdued demand, due to which more than 75% of the available credit facility was already exhausted.

With the rise in banks’ NPAs to INR 10 lakh crore (as on March ’18), up INR 1.39 lakh crore in a quarter, further funding from banks to NBFCs and HFCs (currently have an exposure to bank lending of more than 40%) seems extremely difficult.

The liquidity crunch has been a major pain-point for Indian real estate over the last two to three years owing to tepid sales, banks’ refusal to disburse loans due to rising NPAs and the widening debt-equity ratio even with the biggest developers. The recent NBFC crisis in September has only exacerbated the pain for the real estate sector and its major stakeholders – the developers.

Post the IL&FS crisis, some NBFCs even halted the disbursal of earlier sanctioned loan amounts to developers for fear of widening the funding crisis even further. The worst phase came when some NBFCs urged developers to return the money that was disbursed to them so that they can repay their dues.

As per the S&P BSE realty index data, the debt-equity ratio of the top 10 listed players (on a stand-alone basis) in FY 2014 ranged anywhere between 0.10 to 0.85 which has increased in the current fiscal to range anywhere between 0.17 to more than 1.

This may not seem overly alarming, but the situation is worse in the case of small and mid-size developers whose debt-equity ratio is much higher.

The major bailout option for most of these small developers is to possibly consolidate. It also needs to be highlighted that out of the approximately 10,000 developers in the country today, only 35-36 are listed. Hence, the financial numbers could be even worse.

What Next?

The Government’s consistent assurance of ensuring credit to NBFCs is some sort of a relief, particularly for skittish investors who started panic selling in the equity market post the IL&FS default.

Sensing trouble, even the RBI came forward to aid NBFCs by relaxing liquidity norms and allowing banks to lend more. Vey recently, the apex bank relaxed asset securitisation norms for the NBFCs in a bid to ease the persistent stress on the sector.

Thus, even while the RBI and the Government have taken steps to ring-fence the NBFC crisis and support its financing needs by providing additional liquidity to banks and credit enhancement for refinancing needs, there are speculations over spill-over concerns in the market in the near-term.

Only time will tell whether or not we feel this heat in the near term. However, one major outcome visible in the coming year will be the consolidation of several small NBFCs.

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ANAROCK Report Underscores Gujarat’s Thriving Economy, Housing Opportunities

  • Compact homes (area less than 646 sq. ft)see maximum traction in Vadodara
  • Surat’s residential market set to boom on the back of DREAM City

Ahmedabad, 26 October 2018: Gujarat’s real estate market presents a mixed bag of highs and lows, according to ANAROCK Property Consultants’ report ‘Gujarat – Land of Innumerable Possibilities.

As knowledge partner for the event, ANAROCK launched the report at the CII Realty & Infrastructure Conclave 2018 in Ahmedabad today.

Shobhit Agarwal, MD & CEO – ANAROCK Capital said, “Gujarat has attracted over ₹65,432 crores of FDI over the last 5 years, accounting for 5% of the total investments in the country. The state’s major real estate markets are largely stable, barring a minor price correction in early 2017 due to demonetisation. Smaller-sized housing units appear to attract the maximum demand overall, though Surat is a notable exception. While there has been fairly constant housing price growth in all segments since 2016, the maximum price rise in major cities of the state has been in the mid-segment.”

 

Housing Price Trends

Dinesh J. Yadav, Chairman – CII Gujarat State Council said, “We at CII are organizing the 1st Edition of Realty & Infrastructure Conclave 2018 for developers and builders based out in Gujarat. Understanding the current scenario, there are sufficient reasons to remain bullish on Gujarat’s real estate market, not least of all the state’s brilliant macroeconomic indicators. Gujarat contributes a massive 18.4% share to India’s industrial output, and the per capita income has increased from Rs. 87,481 in 2011-12 to Rs 1,56,691 in 2017-18. This accounts for an impressive annualized growth of over 12% during the period. Gujarat currently ranks 3rd in India in terms of per capita income. This bodes very well for its real estate growth story.”

Report Highlights:

  • Gujarat has 419 industrial clusters, which employ more than 17 lakh people. South Gujarat alone has 132 clusters employing more than 10 lakh people.
  • Ahmedabad is witnessing significant infrastructure growth. The main factors fuelling growth of the city are its proximity to DMIC & GIFT City and the proposed Ahmedabad-Dholera Special Investment Region.
  • In Vadodara, smaller homes (with area less than 646 sq. ft) are witnessing maximum price appreciation. Vadodara will also gain from DMIC passing through its borders.
  • Surat has seen a rapid increase in population, resulting in severe pressure on existing infrastructure and services. Nevertheless, the Diamond Research and Mercantile City (DREAM City) in Surat will fuel further residential development in and around Surat

Click here to download the report ‘Gujarat – Land of Innumerable Possibilities’

Image By Srikeit at en.wikipedia, CC BY-SA 3.0

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NBFC Crisis – Real Estate on Tenterhooks!

Shobhit Agarwal, MD & CEO – ANAROCK Capital

It may be true that ‘when the going gets tough, the tough gets going,’ but this doesn’t hold true for the Indian real estate sector currently. The ongoing NBFC crisis post IL&FS default has made things even more difficult for developers.

Post the banking system’s freeze on real estate funding due to rising non-performing assets, NBFCs and HFCs were the sole sources of funds for the cash-strapped developers. Now, however, NBFCs themselves are struggling and their loan disbursals to developers have slowed down significantly.

A source of broad-spectrum dismay and despair, the NBFC crisis needs to be resolved as soon as possible or the real estate sector’s much-anticipated recovery will be postponed by a couple of quarters more.

As a Credit Suisse report reiterates, NBFCs and housing finance companies (HFCs) have played a major role in credit supply in recent years, accounting for nearly 25-35% of the incremental overall credit.

While bank credit growth in the last two years averaged at a mere 7%, strong 20%-plus growth in NBFC credit aided overall credit expansion beyond 10%.

Free Falling

What began as a singular event with one of the biggies – IL&FS – failing to repay its commercial dues has blown up into a liquidity crisis for the entire NBFC spectrum.

As an immediate aftermath, NBFCs’ stocks went into free fall. The top 15 NBFC companies cumulatively lost over ₹75,000 Crore in just two initial trading sessions.

To say that this rattled investors would be a gross understatement, and the Government and regulators’ immediate efforts to rein in the panic failed to curb the sell-off tidal wave. Since 20 September, NBFC stocks have tumbled by more than 50% for DHFL.

The current NBFC crisis can have a cascading effect on the real estate sector’s growth forecasts, which were already nebulous on the back of the liquidity crisis created by rising defaults and non-performing assets in banks.

Deep Impact

  • The liquidity crisis plaguing NBFCs is likely to hit stake sale and fund-raising plans for these lenders in the near term. With real estate having a strong correlation to credit availability, it could be worse for already cash-starved developers. As per ANAROCK data, more than 5.75 lakh residential units are running behind schedule across the top 7 cities since their launch in 2013 or before. The major factor contributing to this delay is the liquidity crunch developers are experiencing to the backdrop of tepid sales.
  • Despite residential sales gradually picking up q-o-q, they are nowhere near their peak levels. With a substantial number of residential projects running behind schedule, the crisis could further exacerbate liquidity woes and impact project delivery timelines even more.
  • Some NBFCs like Indiabulls also provide home loans to individual homebuyers. With banks tightening their norms for lending to individual homebuyers in recent times, NBFCs were seen as the best alternative. Therefore, the ongoing NBFC liquidity crunch will also impact home loan approvals and disbursements, inevitably reducing residential property demand in the short-to-mid-term.

Apart from weak residential sales, increasing input costs and promotion expenses coupled with the high compliance costs will result in decreased earnings before interest, tax, depreciation and amortization margins.

Advantage Heavyweights

With most things being unequal in Indian real estate, the impact of this crisis will not be the same across the board.

Many listed realty developers such as Puravankara, DLF, Prestige Group, Oberoi Realty and Godrej Properties have well-diversified portfolios, including commercial and retail.

Many of these players have also reduced their debts and ventured into affordable or mid-income housing, where growth is currently the highest.

In the highly competitive real estate business environment, these players will, in fact, may emerge stronger as they are better equipped to ride the storm and continue to deliver while others can’t.

Large-scale consolidations are already ensuring that only the fittest will survive in the future, and this crisis will hasten the process.

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India REITs – Realty Gold Over Stock Market Blues?

The pros, cons and ho-hums about Indian REITs as they stand now

Shobhit Agarwal, MD & CEO – ANAROCK Capital

REITs are finally happening in India, and that’s good news. While real estate as an asset class has always attracted both small and big investors, other investment instruments – gold, stock markets, fixed deposits, mutual funds etc. – have also been a part of well-diversified investment portfolios.

However, most of these asset classes have come with not-inconsiderable risks in recent times. The value of gold has eroded visibly, mutual funds have responded sharply to the recent stock market downturns, and fixed deposit returns barely break even after taxation.

Investors are looking for investment avenues that provide them steady income with minimal risks and under professional management, ultimately ensuring a decent return on investment. It can safely be stated that REITs could not have made their appearance in India at a more opportune time.

Investment in commercial real estate is a highly capital-intensive affair. REITs are a very viable option addition to investment portfolios because they allow investors to participate in an asset class previously reserved only for the affluent few. Also, as is the case in developed nations, REITs provide very decent returns with minimal risks.

How REITs will Benefit Small Investors

Let’s look at what we have at the current time. The Blackstone-backed Embassy Group includes the income-generating SEZ and IT parks under its first REITs listing – potentially a highly lucrative proposition for small as well as big investors to get involved in.

Today, commercial real estate is doing exceptionally well in India, thanks to the aggressive expansion plans of both local and global businesses. Like mutual funds did for the stock market, REITs open a door to a potential treasure trove of returns to small investors – minus the downside of market downturns.

Stable rent-yielding Grade A commercial properties are high in demand with rentals seeing a steady increase. In sharp juxtaposition to the extremely volatile stock markets, Grade A office rentals will increase regardless of whether supply increases or decreases.

There just isn’t enough supply to meet all the demand for this type of real estate, because the locations that qualify Grade A office assets have limited growth capacities.

In short, demand will always outstrip supply – and as long as this remains so, returns from REITs can only be in the green. They are far less prone to risks and will deliver decent returns over the short-to-mid-term.

Some of REIT’s USPs

REITs offer various advantages to investors:

  • low entry point – as low as Rs. 2 lakh – effectively means that one can add real estate to one’s portfolio at a much lower investment.
  • The projected return on investments is anywhere between 8-14% in the short-to-medium term (post adjustment of the fund management fee), with minimum risks. REITs are far less volatile than the stock market, FDs, mutual funds and gold because regulations maintain that 80% of the REITs listings must be of rent-generating assets.
  • A lot of institutional capital is chasing the limited supply of investible Grade A office stock across top property markets. Therefore, the rents for these listed properties are very likely to rise steadily, and the contractual terms will be far more structured and transparent.
  • REITs guidelines maintain that at least 90% of the net distributable income after tax will be distributed to investors at least twice a year.

US, Canada, UK, Singapore and Australia are some of the countries with dynamic and flexible REITs markets that have proved to be highly lucrative for investors. For instance, in Canada, the average return was around 10% in 2017, while in the UK it hovered between 8-10%. The average return in these countries includes all REITable assets such as commercial and residential.

In India, REITs have currently been limited to commercial Grade A office spaces – however, the umbrella of ‘commercial spaces’ also covers retail. In other words, investors of varying investment appetites and capacities will actually be sharing in the profits of India’s best shopping malls.

Expected ROI – REITs vs other asset classes

Expected ROI - REITs vs other asset classes

Source: ANAROCK Research

On the Flipside

The success of REITs in India will largely depend on the benefits they offer to investors. Currently, there are a plethora of taxes that may make REITs unattractive for many. For instance, when a REIT sells shares of assets, the capital gains are taxable.

In contrast, in the UK where REITs have been operating for over a decade now, there is no taxation on income and gains from their property rental business. Instead, shareholders are taxed on REIT-related property income when it is distributed, and some investors may even be exempt from tax altogether.

Further, in other countries, there have been exemptions from the stamp duty, as well. If and when India provides these tax benefits to investors, REITs will become all the more functional and lucrative in the long run.

Also, if REITs are made more attractive for investors with such tax sops, the flood-gates of foreign funding into Indian real estate will open up in real earnest.

The Immediate Future

It will indeed be interesting to see the response to the first REIT listings in India. We do need to remember that, as is the case with any kind of real estate investment, the degree of their success depends heavily on a favourable macroeconomic environment backed by sound policy reforms.

To make the most of REITs in India and earn maximum returns, analyze the portfolio of projects included under the REIT. The analysis must include the stature and historic track record of the concerned entity, the developers’ portfolio, and the location advantages of the properties – including micro-market, IT Parks, and so on.

Effectively, a REIT will drive price appreciation at the lowest risk if it includes Grade A commercial spaces with minimal vacancy, located in the best business-centric micro markets, with established rentals and occupiers.

 

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