Palate of the India-focused Real Estate PE Investor: The Times … · 2017. 9. 27. · 2 Palate of...

November 2016

Palate of the India-focused Real Estate PE Investor: The Times They Are A-Changin’

Palate of the India-focused Real Estate PE Investor: The Times They Are A-Changin’ 3Palate of the India-focused Real Estate PE Investor: The Times They Are A-Changin’2

Equity and Debt, the two key alternatives to funding real estate, have always had their own fair share in the developer’s balance sheet, as well as in his mind-space. For a while now however, the Indian real estate developer has seen leverage costs ride up considerably. Fresh debt is being used to service old debt-a typical case of an endless debt trap. While the total debt liability of listed developers in FY 2007 was INR 252 billion, it has gone up to INR 832 billion in FY 2016. In this scenario, the paper presents a case for relooking at equity. From the developers’ perspective this has become imperative for healthier bottom lines and better looking books. From the investors’ point of view, there couldn’t be a better time. Earlier, lack of uniformity and transparency were the key challenges the real estate sector was plagued with and this had kept the equity investor at bay. In a post GFC world ‘caution’ had become the mainstay for any equity investor’s valuation model. Today, however, the change towards better corporate governance and higher transparency is being seen across all industries, specially real estate.

INTRODUCTION

The Real Estate Regulatory Act (RERA) is in place, the Benami Transactions bill is getting more teeth, Goods and Services Tax is set to be implemented and the recent demonetization move is ensuring that unaccounted for money gets driven out of the real estate markets. The paper puts forth the view that these immense changes will bring about a three- way consolidation in the sector. As the men get separated from the boys, it will considerably reduce the riskiness of long term equity investments.

Apart from the lower risks, attractive entry points are also being offered to equity investors and the paper envisions a return of capital to the real estate markets for all these reasons. What is interesting however, is that this time, the flight of equity will be to quality and not to IRR.

Palate of the India-focused Real Estate PE Investor: The Times They Are A-Changin’ 5Palate of the India-focused Real Estate PE Investor: The Times They Are A-Changin’4

2007

2015 - 3Q 2016

2011 - 2014

2008 - 2010

2005 - 2006

STORY SO FAR

5.2bnUSD

43 equity%Improved confidence; Equity

platforms created but deployment pending; Structured equity

continues to be higher

Post Global Financial Crisis (GFC), investors

shifted to debt options.

How has growing debt on balance sheet broken developer strength?

6.7bnUSD

48 equity%Improved economic scenario and later on election results lifted sentiment; equity rose

steadily

4.7bnUSD

48 equity%Shaken by GFC, investors reduced equity exposure

and shifted to safer option of structured equity

4.7bnUSD

65 equity%PE Investment

peaked; More than 350 developers raised

money

1.1bnUSD

76 equity%FDI opened up in fast

growing Indian real estate industry; Higher focus

on IRR

Palate of the India-focused Real Estate PE Investor: The Times They Are A-Changin’6

LEVERAGE RISING; PROFITABILITY REDUCING

The finance books have always said that debt is a very important factor for a good, financially managed system. Leverage is highly recommended for the growth of any growing business due to lesser cost funds (debt) instead of higher cost funds (equity). Inherently, real estate is a dynamic business and can grow at a fast pace and hence, leverage is highly recommended. However, it is beneficial only until the time:

It can be serviced comfortably

through business cash flows

The cost of debt is lesser than the opportunity cost

of equity

It can support the business growth

Palate of the India-focused Real Estate PE Investor: The Times They Are A-Changin’ 7

COMMERCIAL REAL ESTATE LENDING

Source: Reserve Bank of India April 07457

INR bn

April 09943

INR bn

April 111016

INR bn

April 131274

INR bn

April 15

1664INR bn

April 08610

INR bn

April 10940

INR bn

April 121143

INR bn

April 14

1526INR bn

April 16

1841INR bn

Indian real estate has been witnessing a contrary situation. The majority of developers have seen debt levels rising over the years without supporting business growth meaningfully. This has led to the fact that a considerable portion of this increase in debt is used to finance interest on the existing debt. The Commercial Real Estate loan book of Indian banks has increased consistently over the years and currently stands at INR 1,800 billion. Even the Non-Banking Financial Company (NBFC) book, which started growing post-2011, has reached close to a massive INR 1,000 billion.

A deep study of financial statements of all listed developers in India, which is a good indicator of the condition of Indian developers, reveals why the situation of debt-laden developers is not healthy. Revenue growth has reduced considerably (in fact, there was negative growth compared with 2007 levels) while leverage on the balance sheet has risen significantly along with construction costs. As a result, profitability margins have shrunk and many developers are currently struggling to show a positive bottom line.

LEVERAGE RISING; PROFITABILITY REDUCING

GROWING DEBT LIABILITY OF LISTED DEVELOPERS

INR

252bn

INR

832bn

FY 16FY 07


Developers’ ability to raise further debt is exhausted.

Are investors open to reconsidering equity?

50,000 60%

50%

35,000 40%

20,000

30%

5,000

45,000

30,000

15,000

40,000

25,000

10,000

20%

10%

FY 07 FY 08 FY 09 FY 11 FY 13 FY 15FY 10

INR

Cr

FY 12 FY 14 FY 160 0%

Net Revenue PBT Margin

PROFITABILITY ON DOWNWARD TREND

Source: JLL

20,000 180%

160%

140%

120%

100%

80%

60%

40%

20%

14,000

8,000

2,000

18,000

12,000

6,000

16,000

10,000

4,000

FY 07 FY 08 FY 09 FY 11 FY 13 FY 15FY 10

INR

Cr

FY 12 FY 14 FY 160 0%

Int cost / PBTPBTInt Cost

INTEREST COST EATING PROFITABILITY

Source: JLL

FY 07

DEBT25265

Net Revenue19,656

Int Cost984

PBT8018

FY 16

DEBT83216

Net Revenue44,891

Int Cost6565

PBT4487


RISKS EXISTING; RISKINESS REDUCING

As discussed, the balance sheets of Indian developers are highly leveraged. While there are investors willing to lend, it will worsen, in most cases, the financial health even further. Since the GFC in 2008, we have seen equity infusion largely restricted to office projects closer to completion. Equity investors have clearly shied away from investing in residential projects due to various reasons, such as:

CHANGING REAL

ESTATE LAWS

PROJECT DELAYS COST

INFLATIONLIMITED LEGAL

OPTIONS FOR INVESTORS

INADEQUATE CORPORATE

GOVERNANCE


EQUITY STAYING AWAY FROM RESIDENTIAL

IT & Commercial Residential & Township Source: JLL Capital Market Research

2009 201160

%34

%

40%

66%

2012201043

%

57%

23%

77%

2013 20152014 2016

10%

90%

20%

80%

12%

88%

15%

85%

20072005 2008200652

%

48%

10%

90%100

%

50%

50%


Attentive investors are convinced of the benefits

of shifting to equity.

Are investors focussed on IRR or the quality of partners?

Over the years, one of the major reasons for staying away from equity investments has been the lack of uniformity in rules and transparency in the sector. Since taking the centre stage, the current government has taken various steps for the real estate industry, which we believe are in the right direction and have the potential to address a majority of investor concerns.

• With the implementation of the Real Estate Regulatory Act (RERA), we expect irregularities in the system to reduce and corporate governance among developers to increase over the long term. This will reduce a few of the risks associated with investing in Indian residential assets. Although the RERA assigns more responsibilities to the equity partners, intensive due diligence while selecting a partner can remove such credibility related issues.

• The government is acting aggressively to curb black money. By withdrawing the INR 500 and INR 1,000 notes from the system, the parallel economy is expected to face a huge setback. The cash component has already been reduced in the primary market post-2007, and this move will further help developers to make their books even more transparent.

• With limited cash outflows allowed until completion of the project (thanks to the RERA) and lower demand for properties (thanks to demonetisation and the Benami Property Act), developers will remain under pressure. Money circulation will slow down and the new cash flow generation will reduce further. With limited scope for further leverage, developers will be open to providing good entry points to the long-term equity investors. While a few equity related risks would continue, attractive entry points will provide a higher margin of safety to equity investors.

Through the implementation of the RERA and demonetisation, the government has worked towards removing all major inconsistencies in the system. While the real estate business has currently taken a step back due to these, it will set a very strong foundation for long-term growth. Equity investments at such times can work extremely well for long-term investors.


ALREADY STARTED; GAINING MOMENTUM

While we are discussing the benefits of long-term equity funding, a few investors have already realised it and have taken steps accordingly. Over the past two to three years, India has seen various equity/debt platforms created. Such platforms are partnerships between investors and developers where they create a pool of money that is available for all projects matching a specific set of criteria without going through the time-consuming approval process. At the date of writing, more than USD 2.8 billion-worth of platforms was already in place, largely equity-based and focused on affordable and mid-housing projects. We are expecting the model to grow further.


Mid-segment Residential

Mid-segment Residential

Land acquisition for Residential & Mixed-use developments

Commercial - Investment assets

Warehousing / Industrial

Commercial - Largely Core assets

Residential

Affordable Housing

Warehousing / Industrial

Commercial

ALREADY STARTED; GAINING MOMENTUM

Source: JLL Capital Market Research

EQUITY PLATFORMS CREATED OVER THE PAST TWO TO THREE YEARS

2012 APG 197

2014 CPPIB 500

2015 GIC 240

2013 QIA 300

2014 Realterm Global 330

2015 CPPIB 220

2013 Standard Chartered 170

2015Standard Chartered,

IFC & Asian Development Bank

204

2015 Warburg Pincus 250

2016

Godrej Properties

Piramal enterprises Ltd

Brigade

RMZ

Everstone Group

Shapoorji Pallonji Group

Mahindra Life Spaces

Shapoorji Pallonji Group

Embassy

Tata Realty & InfrastructureStandard Chartered

Equity

Debt

Equity

Equity

Equity

Equity

Equity

Equity

Equity

Debt & Equity 454

INVESTOR

P A R T N E R

DEVELOPER

P A R T N E R

INVESTMENT

(USD MILLION)

MODESTRATEGYYEAR


Alignment of investment & operational

philosophy among the partners

Proven corporate track record

Potential for long-term partnership

Skin in the game (equity infusion by the developer)

High focus on corporate governance

Equity is returning with a focus on quality.

How will this contribute towards strengthening the composition of the Indian real estate industry?

INVESTORS’ TOP FIVE CRITERIA FOR

SELECTING PARTNERS FOR PLATFORMS

RETURN OF FOCUS ON RETAILAfter a lull of six to seven years, well managed Grade A retail malls have started enjoying better occupancy with rent escalation on the cards. Such well managed assets/entities will attract investor focus.

We have already witnessed a few such deals:

• GIC bought a 50% stake in Viviana Mall of Sheth Developers in Mumbai• Blackstone acquired the retail portfolio of Alpha G:Corp through an entity level deal• Blackstone has progressed well in acquiring a stake in the retail assets of L&T in

Navi Mumbai

WAREHOUSING / LOGISTICS GAINING ATTENTIONWith the implementation of the Goods and Service Tax (GST) Act, warehousing/logistics space will start to see the consolidation of assets. Unlike earlier (small assets in various states), developers will focus on the development of large-scale, technologically advanced warehouses. Such assets will attract private equity (PE) investors, since they can deploy a larger amount in fewer assets, making monitoring easier. If they performe well, such assets can even fetch a better valuation when monetising through REITs or other ways.

Apart from traditional investible asset classes, such as office and residential, we will also see focus towards alternative sectors, such as retail and warehousing.


A JOURNEY TOWARDS AN ORGANISED INDUSTRY

Within the first half of its term at the centre, the BJP government led by Mr. Narendra Modi has taken various steps to set the stage for a more transparent, better-governed real estate sector. These include smoothing the process of REITs, easing FDI norms for real estate, clearing the much-awaited RERA and the most recent step - the “Surgical Strike” on the parallel economy through demonetisation. The former two have a direct, positive impact on the real estate sector and will support developers instantly. Easier FDI norms will add to developers’ fundraising capacity and REIT launches will help investors and developers with better exit options. However, the latter two steps will initially make developers take two steps back as they prepare for a longer jump in the longer term. With the implementation of RERA, debt-laden developers will feel a further cash crunch and the pressure of added responsibility while demonetisation will affect demand for developers who preferred unaccounted money. However, in the longer term, these two steps have the potential to transform the overall image of the Indian real estate sector. In the process, the overcrowded Indian real estate industry will see consolidation activity picking up pace.


The first option is largely dependent on developer reputation and marketability. We have seen various such partnerships being created over the past few quarters.

Cash-starved developers monetising their land bank by selling it to cash-rich/opportunistic developers

Developers / landowners finding a

development/marketing partner in large, reputable

developers through the JD/JV/DM model

Smaller developers being absorbed by larger developers

01

02 03

THE THREE

MODES OF CONSOLIDATION

Godr

ej Pr

oper

ties

36 NCR

Ace Developers

IREO

Godrej PropertiesHines

100

10

NCR

NCR

Rohan LifescapesRadius Developers150,000 sq ft

Mumbai

Presti

ge G

roup

800,0

00 sq

ft

Pune

BU Bhan

dari B

uilde

rsVihang GroupGodrej Properties

15

Lotus GreenNe

ptune

Grou

p

Omkar Realtors Eros Group

Logix Group

Mumbai

Tata HousingTa

ta Re

alty

Shapoorji Pallonji

Real EstateBharti Realty

ATS Builders37

10

16 40

35NCR

Mumba

i

Mumbai

LANDOWNER

PARTNERDEVELOPMENT

AREA (ACRES)

CITYNCR

NCR

Lotus

Gre

en

PARTNERSHIP AMONG DEVELOPERS


SELLER

BUYER

AREA(ACRES)

CITY

AMOUNT (INR CRORE)

M3M India

25

NCR300

Supe

rtech

Limi

ted

140

NCR

1,211

Skyline

Group

Kanakia

Spaces

500,000 sq ft

TDR

Mumba

i400

Windsor Realty

Sahara Group

M3M India

185

NCR

665

Wadhwa Group

6.5

Mu mbai

Rampra

sth

a Group

Vatika

Group

75NCR

500

Parsv

nath

Deve

loper

s

Tata Realty-Standard Chartered JV

208

Mumbai

Windsor Realty

Kanakia Spaces

2.5

125

While the consolidation is undeniable, the pace of it will depend on the quantum of equity infusion by the larger PE investors and the strategy adopted by foreign developers who may enter. A few have already entered India and are in the process of setting up their base with a long-term view.

Fosun International, a Chinese conglomerate, has revealed its plans to invest up to USD 1 billion in India, whereas developers such as the Dalian Wanda Group (looking to invest USD 10 billion) and China Fortune Land Development Company (signed a Memorandum Of Understanding (MOU) with the Haryana Government to develop large-format industrial parks) are tying up with state governments to set a base for large-scale development. A few investors/developers may opt to take the plunge in this market straight away (like Macquarie and Fosun) and a few might prefer the wait-&-watch approach, but we believe the industry is set to consolidate in the next five years. By 2021, we will see larger players consolidating their positions even further while the number of smaller players will reduce considerably. In both cases, equity investment or the lack of it will play a deciding role.

The latter two would showcase the power of capital. The purchasing power of every Indian rupee/US dollar will increase and money will move in the direction of good quality land banks - Grade A locations, followed by Grade B locations. We have already witnessed a few instances of developers’ monetising their land parcels by selling them to their competitors.

FOOD FOR THOUGHT:

In first half of 2016, as many as 339 developers owned the overall completed office space in India. However, the top five owned a massive 30% of this space (each owning more than 10 million sq ft), while the bottom 275 owned just 25% - a clear case of overcrowding.

LAND MONETISATION


INVESTOR STRATEGY

• Equity investment on a return journey; this time, a flight to quality & not IRR• More than USD 2.8 billion-worth of platform-level partnerships already in

place; deployment awaited• Strong corporate track record and a focus on corporate governance to earn

investor backing for mid and larger scale developers

LOOKING THROUGH THE CRYSTAL BALL

CHANGING INDUSTRY COMPOSITION

• Consolidation on the cards; smaller developers to find it difficult to continue; cash-starved developers to look for asset monetisation

• Money will show its power; cash-rich/PE-backed developers to grow much faster than others

SECTOR FOCUS

• Tail-ending quality office assets supply to demand investor focus on portfolio deals• The RERA and demonetisation-affected residential sector to start seeing

selective equity investment, with an investor focus on corporate governance• Reviving retail and GST-supported warehousing/logistics sectors to attract

PE investments


Authors Profile

Strategic Inputs

Akshit ShahAVP - Capital Markets Research India+919819578866 [email protected]

Authors Profile

Niharika BisariaEditor+91 98337 [email protected]

Ashutosh LimayeHead, Research and REIS+91 22 3985 [email protected]

For research enquiries, please contact:

Log on to www.jll.co.in to read our wide range of thought leadership:

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October 2014

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Rebooting Indian Real Estate

A Twelve Month Realty Report Card of the NDA GovernmentJune 2015

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July 2015

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About JLLJLL (NYSE: JLL) is a professional services and investment management firm offering specialized real estate services to clients seeking increased value by owning, occupying and investing in real estate. JLL is a Fortune 500 company with, as of December 31, 2015, revenue of $6.0 billion and fee revenue of $5.2 billion, more than 280 corporate offices, operations in over 80 countries and a global workforce of more than 60,000. On behalf of its clients, the company provides management and real estate outsourcing services for a property portfolio of 4.0 billion square feet, or 372 million square meters, and completed $138 billion in sales, acquisitions and finance transactions in 2015. As of September 30, 2016, its investment management business, LaSalle Investment Management, has $59.7 billion of real estate assets under management. JLL is the brand name, and a registered trademark, of Jones Lang LaSalle Incorporated. For further information, visit www.jll.com

JLL has over 50 years of experience in Asia Pacific, with 36,000 employees operating in 94 offices in 16 countries across the region. The firm won 15 awards at the International Property Awards Asia Pacific in 2016 and was named number one real estate investment advisory firm in Asia Pacific for the fifth consecutive year by Real Capital Analytics. www.ap.jll.com

About JLL India

JLL is India’s premier and largest professional services firm specializing in real estate. With an extensive geographic footprint across 11 cities (Ahmedabad, Delhi, Mumbai, Bangalore, Pune, Chennai, Hyderabad, Kolkata, Kochi, Chandigarh and Coimbatore) and a staff strength of over 8500, the firm provides investors, developers, local corporates and multinational companies with a comprehensive range of services including research, analytics, consultancy, transactions, project and development services, integrated facility management, property and asset management, sustainability, industrial, capital markets, residential, hotels, health care, senior living, education and retail advisory. The firm was awarded the Property Consultant of the Decade at the 10th CNBC-Awaaz Real Estate Awards 2015 and the Best Property Consultancy in India at the International Property Awards Asia Pacific 2016-17.

For further information, please visit www.jll.co.in

Jones Lang LaSalle Property Consultants (India) Pvt Ltd © 2016. All rights reserved. All information contained herein is from sources deemed reliable; however, no representation or warranty is made to the accuracy thereof.

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Palate of the India-focused Real Estate PE Investor: The Times … · 2017. 9. 27. · 2 Palate of...

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