Homecoming

 Sarika Malhotra        Print Edition: Feb 17, 2013

Mukesh Ambani confidante Anand Jain's realty funds made news recently for all the wrong reasons. The two funds - Urban Infrastructure Opportunities Fund and Urban Infrastructure Real Estate Fund - have both underperformed. Nor are they the only ones. Most of the news coming from the real estate sector lately has been depressing for investors. Many projects are stuck because of high interest rates, mounting debt and the economic slowdown. A number of deals have failed to yield promised returns.

And yet there is renewed private equity (PE) investor interest in realty. A clutch of funds have quietly raised almost a billion dollars for investments in the sector in the past one year, and plan to raise another billion in the next six months.

Among them are HDFC Property Fund, which is raising $500 million, US-based realty developer-cum-investor Portman Holdings putting up $300 million, Motilal Oswal Private Equity raising a Rs 500-crore real estate fund and property consultancy firm Jones Lang LaSalle creating its first fund of Rs 300 crore.

So what has prompted this renewed interest? A few highly profitable exits by funds in the last two years, say experts. The PE involvement in Indian real estate really begins around 2005. Since then, HDFC India Real Estate Funds' Griha Investments, for instance, exited its 2006 investment of $46.62 million in Manyata Promoters Ltd at $119 million in 2011. In the same year Kotak Real Estate Fund I exited Peepul Tree Properties Ltd at $115.36 million, a huge premium over its initial investment of $21.13 million in 2006. In 2012, HDFC International Real Estate Fund exited Embassy Golflinks at $51.65 million, more than a four-fold jump over its 2006 investment of $11.41 million. "Since 2005, some funds have been able to complete the full investment cycle," says S. Sriniwasan, CEO, Kotak Realty Fund. In other words, some PE investors have not only raised and deployed funds but also exited and achieved targeted returns.


There is also the growing realisation that the funds which underperformed did so due to their lack of a well thought out investment strategy. Many early investors lost money as they entered projects at excessively high valuations. For instance, real estate PE fund Trinity Capital lost 70 per cent on its investment in DB Realty. Trinity had invested $51.61 million in 2007, but had to exit at a mere $14.97 million in 2012. Some funds also made the mistake of paying the entire investment amount upfront - this often resulted in the developer either losing interest in the project or using the proceeds to fund other projects.

"In 2005, understanding of the market was limited. No one knew how to enter and exit the market," says Sriniwasan. That has changed considerably since.

Funds have also realised that investors in real estate have to involve themselves in asset management - essentially, actively monitor the progress of the projects they have invested in. "We pursued the strategy of partnering with the same developer on multiple projects as against different developers for each project. This results in significant efficiencies and synergies for asset management work and teams get comfortable working with each other," says Parry Singh, co-founder and Managing Director, Red Fort Capital, a real estate-focused PE investor.

Red Fort has pursued this model with a few chosen developers such as Prestige Group (three projects in Bangalore), The 3C Company (eight projects in Noida) , Parsvnath Developers (three projects in Delhi) and Ansal Group (two projects in Gurgaon).

Wiser from the experience, funds are now developing fresh strategies too. Red Fort now has a different payoff model for developers - it staggers payment, linking it to construction targets. "This ensures a strong alignment of interest between the developer and the investor. The idea is to incentivise the developer," says Singh. Investors of Red Fort Capital have given it the thumbs up too - Red Fort raised a second offshore fund of $500 million in 2012 with several repeat investors from its $375-million first fund of 2007.

Then, several PE firm s are now raising funds from domestic investors. For instance, Kotak India Real Estate Fund IV and V raised capital from domestic institutional investors and ultra-high networth individuals who can invest Rs 2 crore and above. "Domestic investors have a sharper appreciation of the economy and the sector," says Sriniwasan. "They are closer to the ground and hence understand the highs and lows of the real estate market. International investors, on the other hand, look at India from a distance and are more affected by what they read and hear," Indeed, the new real estate funding is primarily driven by domestic investors. "In 2005, the split was 75:25 for foreign and domestic.

Today the split will be the other way around," says Sachin Sandhir, Managing Director, South Asia, Royal Institute of Chartered Surveyors, adding that local investors still see real estate and gold as the best asset classes.

Funds are now much smarter in crafting their investment structure in projects as well. For its first fund, Motilal Oswal Private Equity had made pure equity investments, and also invested in projects at the land acquisition stage. For the second fund, Somak Ghosh, Co-CEO, Motilal Oswal, is clear there will be a mix of structured equity and mezzanine debt. "Change from equity to a combination of debt and equity has to do with the learnings we had from the first fund," he says. "We realised that early returns are only possible through mezzanine debt. Domestic investors are looking for early and regular returns."

It is a sentiment also echoed by Balaji Raghavan, CEO and Chief Information Officer, IIFL Alternate Asset Advisors Ltd. "Pure equity investments did not work well, generating limited returns," he says.

"Today most funds work with 33 per cent debt and 67 per cent equity. A debt equity combination also works well with conservative investors looking at hedging risk." With plans to raise a Rs 500-crore fund, IIFL Real Estate Fund (Domestic) Series 1 closed at Rs 700 crore in two and half months flat in 2012.

Residential Market Focus
Residential properties are likely to remain the most sought-after segment for PE funds in the coming decade, according to industry insiders. Last mile financing and projects which have got land approvals will remain the sweet spots for investments. Most of the top funds, including Kotak Realty Fund, Red Fort Capital and HDFC Property Fund, have a majority of their investments in residential projects - in most cases the ratio of residential and other assets  is 4:1. Estimates by JLL show that of the total $3.2 billion real estate exits over 80 deals in the last four years, about half have been focused on residential. With most funds ploughing capital into residential properties, will there be an oversupply of housing units? "There will not be a glut of supply since demand for housing is growing faster than supply and will continue to outstrip supply," says Sriniwasan.

It could mean a turnaround for the market in the new year.

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