After foreign equity, realty industry needs funding reforms

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Vinod Behl | 10 Nov, 2014
The government's recent policy initiative to ease foreign equity norms in construction by reducing the minimum capital requirement from USD 10 million to USD 5 million and built-up area from 50,000 sq mts to 20,000 sq mts may well provide a lifeline for fund-starved, debt-ridden property developers. Yet, more reforms to boost credit flow are needed to provide a long-term solution to the funding crisis faced by the realty industry.

This development should be seen in the context that availability of funds at a good price has been a big challenge for the real estate sector, especially as banks and other financial institutions have restricted the flow and borrowing from other sources have been expensive.

But with the new move, the cost of funds is likely to become more competitive. It will boost investor sentiment and increase investment flow by specially providing a window to those foreign developers who earlier could not invest due to higher investment cap. It will also be a boon for small- and medium-size developers to access foreign capital, as these developers holding small land parcels were not eligible for such inflows earlier.

It will also make things easier for those developers who are constrained by the non-availability of bigger land parcels and high cost of land within the city limits. The relaxation in area and capital norms will provide a fillip to small office, residential and shopping centre projects -- much in demand in Tier-II and Tier-III cities. The exemption of the projects which commit 30 percent of their total cost to affordable housing will give further boost to this segment with highest demand.

Also, the government has done away with the condition of mandatory 50 percent development in five years from the date of approval and permitted investors to exit on the completion of a project, or after three years from the date of final investment, subject to development of trunk infrastructure.

This is quite an attractive proposition for both current and future investors. The latest foreign equity reform has further improved the investor sentiment, which has been on the upswing after the installation of corporate-friendly stable government of Prime Minister Narendra Modi that has taken a number of reform initiatives.

It is clearly evident from the foreign investment inflows, which has already jumped 34 percent to USD 7.23 billion, up from USD 5.3 billion in 2013-14. Private equity funding that rose from USD 670 million in 2013 to USD 855 million in 2014, during the January-September period, is also an indicator of this. According to an Assocham survey, there is also a one-third rise in enquiries from non-resident Indians for investment in Indian real estate.

Global investors are increasingly looking at property investment in India due to global economic improvement and better transparency and investment climate in India. They also find better investible assets especially in commercial real estate. Now, especially with India opening up the real estate investment trust (REITs) market, this interest has further grown.

According to a KPMG study, of the estimated 350 million sq ft of Grade-A office space, valued at around USD 65-70 billion across major urban centres, about 80-100 million sq ft, valued at USD 15-20 billion, will be REIT-friendly over the next three years. They are also looking at an immense opportunity thrown up by the Indian government's decision to develop 100 smart cities which need annual funding of Rs.35,000 crore.

Notwithstanding all this interest of foreign investors in Indian real estate, the big question is if the foreign equity alone is the answer to massive funding requirement? Considering the current shortage of 19 million homes -- and to achieve the goal of housing for all by 2022 -- one needs close to Rs.16.5 trillion (USD 275 billion) per year for the next eight years, whereas currently housing development is getting less than Rs.8 trillion (USD 135 billion) of annual investment.

The challenge becomes all the more enormous as the real estate sector has been facing a crisis on household savings, equity funding and bank credit -- the three main sources of real estate funding. Industry statistics reveal that close to USD 1 trillion was invested in the real estate sector between 2008 and 2014 and 72 percent of this funding was met by household savings that have now considerably gone down.

Equity market and private equity funding which accounted for 10 percent in 2008 has now halved. Even though real estate gets less than four percent of total bank advances, the Reserve Bank of India has raised concern over real estate exposure, up from Rs.600 billion (USD 10 billion) in 2007-08 to Rs.1,540 billion (USD 25 billion), and housing exposure, up from Rs.2,600 billion (USD 43 billion) to Rs.5,400 billion (USD 90 billion).

What is really reassuring is that the investment bucket is getting enlarged with large sovereign wealth funds and pension funds coming forward. But considering the enormity of the challenge, we need a lot more reform measures to boost funding. This includes widening the external commercial borrowing window by upping the USD 1 billion limit.

One is hopeful the government, which is reviewing foreign investment policies for limited liability partnerships, will soon lift curbs and provide automatic access to foreign investors via these entities in sectors like real estate where 100 percent foreign equity is permitted. The newer emerging investment vehicle of commercial mortgage-based securities also holds promise.

As home loan is a key to housing growth, the government is undertaking positive policy initiatives in this regard. It has already increased the home loan entitlement from 80-90 percent of property value and now it is planning to hike interest subsidy for low cost housing to five percent, besides lowering the interest rates.

By proposing to bring in amended Land Acquisition Act and Real Estate Regulatory Bill in the upcoming winter session of Parliament, the government will be further making the investment environment conducive for investors by cutting down delays in land acquisitions and building approvals and by making the real estate transactions more transparent.

(Vinod Behl is editor of Realty Plus, a leading real estate monthly. The views expressed are personal. He can be reached at vbehl2008@gmail.com)