Real Estate Private Equity 3.0

November 2015

Real Estate Private Equity 3.0 Entering a new phase of mature investment decisions in India

Real Estate Private Equity 3.0 3Real Estate Private Equity 3.02

IntroductionAround the same time last year, we released a report titled “Horses for Courses” which encapsulated the various ways Indian real estate has been financed during times of transition. Taking cues from that research, this paper aims to offer readers a closer look at the fundraising activity and its deployment through various phases over the last 10 years in the local real estate market. It studies the variation in factors such as selection criteria for development partners, preference of investment modes, return expectations, focused investment approach, tenure of investment, ticket size and resultant investment style that are prominent during a particular phase.

Private equity (PE) investment in the real estate sector in India peaked in 2007–08 and then fell in 2009–10. Since then, a gradual and a steady growth in PE activity has been visible

The study should be able to offer readers an understanding of the changing style of investments that allow us to segregate the last 10 years into three broad phases. The ongoing phase, which we believe began in 2014, clearly presents an opportunity to look for new investment modes.

After a decade of ups and downs and with the formation of a new government following the 2014 general elections, PE activity in Indian real estate has picked up its pace. We believe that PE investments are entering a new phase of maturity as they experiment with their investment strategies and look for more stability in their new cycle of investments.

Source: JLL Capital Markets Research

9,0008,0007,0006,0005,0004,0003,0002,0001,000

2003 2007 2010 20132005 2008 2011 20142006 2009 2012 1H2015

0

PE Investment across years

USD

mn

http://www.asiapacific.joneslanglasalle.com/india/Gurgaon/Nov2014/JLL-Nov-2014_Horses-for-Courses-e_version.pdf

Real Estate Private Equity 3.04

The three broad investment phases within

Indian real estate The first phase, falling in the period of 2005-08, was the discovery of opportunities across multiple asset classes in real estate despite too many worries about the risk it carries. The second phase, falling in the period of 2009-13, exhibited bearishness across all markets

in India which made investors largely sceptical. The third phase involved a better understanding of the Indian real estate

scenario and regaining momentum that was lost during the first two phases.

Opportunistic investments

Phase1(2005-08)

Structured Equity

Investors

Phase2(2009-13)

Long-Term Partnership

Phase3(2014-ongoing)

Real Estate Private Equity 3.0 5

82%

6%12%

Sequence of events:

Through Press Note (PN) 3, the Department of Industrial Policy and Promotion (DIPP) allowed foreign direct investments (FDI) into Indian real estate in 2003. On the back of considerable underlying demand and huge scope, India started attracting a lot of PE investors-domestic and foreign. After years of moderate-level activity, the investment scene started an upward trajectory with the issue of PN 2 by the DIPP in 2005. The pace sped up significantly until the global financial crisis (GFC) hit the world economy in 2008. While the India-dedicated fundraising was happening at a fast pace, investment into real estate was keeping up. The cumulative single-country, India-dedicated fund-raising during this period was to the tune of USD 16 billion through more than 50 funds.


Phase1(2005-08)

Source: Preqin, JLL Capital Markets ResearchNote: Single country India specific funds are considered for fund raising data

India Focused Fund-raising

Fund characteristics:

The majority of funds raised (88 percent) during this phase was denominated in U.S. dollars and Singapore dollars, indicating the keen interest of foreign institutional investors in the Indian real estate sector. While few funds focused on residential and retail, the majority (66 percent) had diverse options, encouraging investors to find opportunities arising from different asset classes.

Source: Preqin, JLL Capital Markets Research

66%14%

8%11%

1%

Indian Rupee Singapore Dollar US DollarDiversified Hotels Residential Retail Others

6,000 18161412108642

5,000

4,000

3,000

2,000

1,000

2004 20072005 2008200600 0

USD

mn

Fund Raised (USD mn) No of Funds Raised


Phase1(2005-08)

Currency of Funds RaisedAsset Class Focus Fund-raising


On the other hand, India witnessed investments of USD 13.6 billion spread across 300 transactions in more than 30 cities in India. The phase can be broken down into two, two-year sub-phases: 2005-06 and 2007-08. While the investment activity remained moderate (64 deals in 12 cities) in the former period, it rose sharply (more than 230 deals in 30 cities) in the latter. It would be realistic to say that in the latter sub-phase, the investors left no stone unturned to participate in the ever-booming Indian economy and real estate growth story. Although the investors and their investment styles varied throughout the phase, the flavour was plain vanilla equity, contributing up to 60 percent of the total investments. This clearly indicates an investor focus on profit sharing, even at the cost of a higher risk.

Wrap-up:

This phase, which saw investment activity peak in India, witnessed various eye-catching deals. While many investors gained multiple returns, a few suffered losses due to the GFC in the latter half of 2008. The profits and losses were caused by the cumulative effect of various factors, the most important of which were the entry price point, developer credibility and intensity of due diligence.

Quick facts:

No. of transactions300+

150+No. of investees


31%

27%4%4%

20%

14%

1%

31%

22%14%

5%

3%

Delhi NCR

Mumbai Region

Bangalore

Hyderabad

Chennai

Pune

Kolkata

Indore

Mundra

Panchkula

Surat

Goa

Jalandhar

Others

Office

Residential

Hotel

Retail

Mix Use

Others

Source: JLL Capital Markets Research Note: Others include 18 cities with less than USD 15 million of investments

PE Investment Across Asset Classes

Wide Spread PE Investment in

Real Estate

12%

9%

66%Contribution of Top 3 cities

Domestic investor participation (% of total) 37%( 1 = most lenient;

5 = strictest)Intensity of

due diligence 3Average return

expectations 23%

~44Average ticket size (USD million)5-7Average tenure of

equity investment years

60+No. of investors

Investment in residential and office (% of total) 58%PLAIn VAnILLA EQuItyFlavour of

the phase


57%13%

30%

Sequence of events:

While the first phase witnessed all the signs of a bull run wherein investors wanted to take an equity stake in every available opportunity, the scenario turned upside down following the GFC. Compared with the previous phase’s downpour of funds available for investment in India, this one remained mostly dry. Except for 2013 when signs of recovery were visible, all other years witnessed fundraising of around USD 700 million annually. This was an offshoot of the GFC which affected the return and exit options of various funds invested in the previous phase. In terms of numbers, only 29 India-dedicated funds, totalling USD 3.9 billion in over five years, were raised during this phase. Policy inertia further dampened the spirit of (specifically foreign) investors.



32%

19%

38%

1%

10%

Indian Rupee Singapore Dollar US DollarDiversified Industrial Office Residential Others

78

654321

1,000

1,200

800

600

400

200

2009 20122010 2013201100 0

USD

mn



Fund characteristics:

While funds raised during this phase were limited, they showed more focus. Almost 68 percent of the funds were asset-focused, compared with just 34 percent in the previous phase. In addition, the participation of Indian investors was visible, as they contributed 30 percent of the funds compared to only 12 percent before. This can be attributed to the familiarity in the development of various micro markets rather than macro markets in the country.

Structured Equity

Investors

Phase2(2009-13)



Source: JLL Capital Markets Research Note: Others include 5 cities with less than USD 15 million of investments

Quick facts:

No. of transactions270+

160+No. of investees

StRuCtuREd EQuIty & CoRE ASSEtSFlavour of the phase


The combination of a weak economic scenario across the world and lack of end-use demand due to high property prices in India left opportunistic investors with limited exit options, hence reducing the quantum of overall investment by 30 percent to USD 8 billion. The focus also shifted from returns on investment to safety of principal; thus, structured equity or mezzanine (mezz) investment became the preferred route from 2009 onwards, especially in the earlier part of the phase. In 2009-10, while 47 percent of PE investments in India went through a structured equity route, a large portion of the plain vanilla equity investments were in the core rent-yielding assets, reflecting an increased importance towards safety of principal. As the phase progressed, market confidence started to rise and the focus on plain vanilla equity started to increase; however, it was still largely restricted to non-residential assets. Investment in residential reached more than 55 percent in the earlier part of the phase (2009-10) and reduced to 40 percent in the latter part, reflecting an increasing number of investors who were willing to look at other asset classes in addition to residential. A geographical focus was also highly visible, as only 12 cities enjoyed investment compared with 30 earlier.

Wrap-up:This phase witnessed the bottom of investment activity in India, and its recovery to some extent. While the deal flow in this phase was limited, the attractive entry point for investors (led by a combination of lower capital values and bargaining power of developers) helped achieve good investment returns. The structured equity route, a better focus on asset classes and geographical locations, and a more intensive due diligence were a few other key factors behind the good returns.

5Average tenure of equity investment yearsless

then

Geographical Spread of PE Investment in

Real Estate

28%

24%19%

13%

8%

6%1%

1%

Delhi NCR

Mumbai Region

Bangalore

Pune

Chennai

Hyderabad

Kolkata

Others

11%

8%

46%

4%

3%

22%

1%

3%

2%Entity

Hotel

IT & Commercial

Land

Mix Use

Residential & Township

Retail

Slum Rehabilitation

Warehousing & Logistics





due diligence 4Average return

expectations 23%

~30Average ticket size (USD million)

65+No. of investors

Investment in residential and office (% of total) 68%


Fund characteristics:While the majority of funds raised so far in this phase are residential-focused, the appetite for industrial and warehouses is increasing; the anticipated success of the passing of the Goods and Service Tax (GST) Bill in the parliament also helped seed up investment. Despite good quality office assets valued closely to their replacement cost, commercial asset-focused funds are surprisingly missing so far in this phase. Interestingly, dollar-denominated funds have increased their participation, but it cannot be said that fundraising outside India is on the rise, as there have been no Singapore-dollar denominated funds so far.

70%

30%

Sequence of events:

This phase started with positivity surrounding the elections and in anticipation of a government led by Narendra Modi. The optimism was witnessed among domestic and foreign investors. Fundraising activity started to pick at a good pace even before the election results and continued to get better following its outcome. While this phase is expected to continue for another few years, India-dedicated funds have already managed to raise USD 2.2 billion in just the initial 18 months, considerably higher than the average annual fundraising in the previous phase. The key difference was the focus on long-term partnerships, largely platform-level deals, with developers that have an established track record. The focus created a pool of funds that can be invested over a specific number of existing or future opportunities subject to the fulfilment of required conditions. The



15%

85%


Indian Rupee US Dollar

Diversified Industrial Residential

7

98

654321

1,6001,4001,200

1,800

1,000800600400200

2014 1H 201500 0

USD

mn



key benefit of this route is that it allows developers to scout for big-ticket development projects without having to worry about funding them. Recently, largely since 2014, India witnessed various platform-level deals, creating an aggregate pool of more than USD 2 billion.

Long-Term Partnership

Phase3(2014-ongoing)


Investment activity in this phase has complemented fundraising, achieving more than 95 deals with an aggregate investment of USD 3.7 billion in just 18 months. In this calculation, it is interesting to note that we have not considered investment pools and platforms that are yet to be deployed (approximately USD 2 billion). This clearly shows the rise in optimism in the Indian economy compared with the earlier phase hence in the real estate industry. The investment activity in this phase has remained focused on residential, office and entity/platform levels. By the end of this phase, one may see an increased focus on a few other asset classes as well; however, the overall target is expected to remain unchanged. Geographically, only seven cities have witnessed investment. While the list will see new entries, we expect the top three to remain unchanged.

Quick facts:




due diligence 4No. of transactions 95+Average return

expectations 21%

~39Average ticket size (USD million)4-6Average tenure of

equity investment years

30+No. of investors 70+No. of investees

Investment in residential and office (% of total) 68%PLAtFoRM LEVEL dEALSFlavour of

the phase


19%

1%

33%

12%

1%

9%

41%

13%

10%

30%

3%

30%

8%6%

Ahmedabad

Bangalore

Chennai

Delhi NCR

Hyderabad

Mumbai Region

Pune

Mix


Focused Investment

Wrap-up:

While it seems like a good start to the phase, there is a hint that the phase might end far sooner than expected if the government does not deliver its promises and the real estate sector does not pick up. We think otherwise and believe that, from a medium to long-term perspective, and given the time frame for the current phase of investments to mature, the Indian economy will react and respond positively to the slew of reforms and measures being brought about by the current government.

Entity

Hotel

IT & Commercial

Land

Mix Use

Residential & Township


5%


community

Voice of

PESince the election results, India has enjoyed global attention. If its government manages to fulfil the majority of its promises, there is no denying that this phase will last longer. To make our study more comprehensive, we reached out to various fund managers through an online survey which garnered excellent participation. The focus of this survey was to understand the fund-raising scenario, its deployment preferences and the long-term strategies. Below are few interesting findings from the study.

Survey results:

Fund-raising1. The majority believes the fund-raising scenario for Indian real estate has improved, locally and abroad.

2. More than two-thirds of participants expect an increase in foreign investor participation in Indian real estate. Majority of these investors are expected to be from the United States, the United Arab Emirates, Singapore and Europe. Surprisingly, despite India’s improving relations with Japan, not many participants believed there would be enough investment demand from the latter.

Fund-raising scenario compared to pre-election period (Indian rupee denominated funds)

Fund-raising scenario compared to pre-election period (uS dollar denominated funds)

14%17%

69%

Deteriorated Improved No material change

Deteriorated Improved No material change

Decrease Increase Stable

Source of new funds (LPs) Participation of foreign LPs in coming years

JapanIndia

Hong Kong

SingaporeUAE

EuropeChina

CanadaUSA

0% 20% 40% 60% 80% 100%

24%30%

46%

27%34%

39%


Participation in developer’s operations (compared to 2010)

24%

38%12%

26%

Increased Unchanged

Investment type

3. Close to two-thirds of participants believed that equity investments would be less than 50% of their portfolio by end-2016, reflecting a greater focus on structured equity compared with other investment types.

4. While confidence in equity investments has not yet reached its full strength, it has surely recovered, as a quarter of participants believed that equity would contribute more than 70 percent by end-2016.

Asset class

5. Residential, excluding luxury, remains the most popular choice among investors.

6. Commercial office space has considerably high number of investors than for information technology (IT), IT-enabled services and special economic zones.

7. Demand for industrial and warehousing is clearly gaining momentum on the back of the anticipated passing of the GST Bill.

8. Investors prefer the wait-and-see approach for retail and hospitality sectors; they are not keen on investing at this point.

Preferred asset class for next three years

Contribution of Equity investments in portfolio (by end-2016)

Preferred investment strategy for next two years

Role of PE at end-2020

Going forward9. Investors prefer to take part in a developer’s operations,

unlike in the past when their focus was largely restricted to investments only.

10. Most feel that being part of a developer’s journey is the right approach for investors. This helps them build trust among themselves and provides access to good investment opportunities.

Selective Asset Focussed Investment

Land Funding

Distressed Asset Buyout

Plain Equity

Redevelopment

Structured Investments

Core & Core PlusCity / Region

Specific InvestmentApartment Funding

0% 20%10% 40%30% 60%50% 70% 80%

Office - SEZ

Residential - Mid End

Office - IT & ITESOffice - Commercial

Residential - Affordable

Retail

Residential - Luxury

Warehousing

IndustrialHospitality - 4 & 5 Star

Hospitality - 3 Star & belowEducation

0% 20% 40% 60% 80% 100%

Opportunistic investor

Patient lender

Developer’s long-term

partner

0% 20%10% 40%30% 60%50% 70%

17%

83%

Less than 20%

Between 20% and 50%

Between 50% and 70%

Above 70%


None of the mentioned risks

Leasing Risk - Unleased

Leasing Risk - Less than 50% leased out

Construction Risk

Approval Risk

0% 20% 40%30%10% 50% 60%

11. More than two-thirds of participants believe that the deal flow has improved in the past two years, while the time required to close a deal has increased. This can be attributed to the increased intensity of due diligence.

12. For equity investments, investors prefer a well-located project by a credible developer over certainty of future cash flows and approval.

Momentum of deal flow (Compared to 2013)

Willing to invest in residential project - at pre approval stage

Change in time to close PE deal

Willingness to take risks for commercial projects

Relative importance of criteria for structured investments

26%19%

10%2%43%

60%

19%

21%

Considerably Improved Considerably WeakenedUnchanged Slightly Improved Slightly Weakened

Increased Reduced Unchanged

13. For structured investments, investors prefer safety over saleability.

14. Subject to developer credibility, 73 percent of participants have shown willingness to take approval and construction risk in a residential project.

15. Investors are not keen to take approval risk for commercial projects. However, construction and leasing risks are not considered acceptable reasons to reject an investment opportunity.

Yes May be No

Relative importance of criteria for equity investments

41%27%

32%


Conclusion

PE investment in Indian real estate started moderately in 2005 before peaking in 2007-08, when opportunistic investors largely dominated the market. However, the GFC in the latter half of 2008 took away most of them, and structured equity gained popularity, largely for non-core asset classes. Following the low in 2009-10, investment activity started to gain momentum at end-2013 in anticipation of the positive election outcome. The optimism increased considerably following the elections and India again started garnering attention from foreign institutional investors, which was missing in the earlier phase. However, compared with the opportunistic investors in the first phase, the current phase has seen the creation of a fewer, but definitely more long-term partnerships, which is required for a developing country like India.

While the 2007-08 period saw an excess of 230 deals across 30 cities, the 2014-15 period witnessed 95 deals in just seven cities. The number of investors and investees in the latter phase is half the figure of the earlier period. Investor expectations (especially for structured equity) was reduced, and the due diligence process has become more intensive to ensure better quality investments. Moreover, the average ticket size has increased to USD 39 million, considerably higher (30 percent) than the earlier period, which means investors are willing to invest more, once they have done their due diligence. In summary, passing through all these phases, PE investment in Indian real estate has matured to a large extent.

Is this the starting of a new phase for Private Equity Investments in Indian real estate? We believe so; the PE investment community has learned from the past and has improved, and the possibility of them focusing on higher returns at the cost of risk again is unlikely. If the Indian government, which has generated a lot of hope, works on the right path and delivers what it promised, the industry will have patience and will move positively.


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

Akshit Shah has joined Jones Lang LaSalle Research team in 2013. Based out of Mumbai; he is the data custodian for Capital Markets and contributes towards incorporating Capital Markets related research into REIS.

Akshit also contributes to whitepapers. Akshit is a Chartered Accountant and has 9 years of Equity Research experience; including 6 years of Real Estate sector research. He has tracked more than 90% market capital of Indian listed real estate space and has authored several reports on the companies he tracked.

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

Authors Profile

For research enquiries, please contact:

Please click below thumbnails to download reports:

Decoding Private Equity Real Estate Exits in

India

Horses for Courses

Changing Investment Patterns Across Property Periods in India

October 2014

Horses for Courses

Rebooting Indian Real Estate

A Twelve Month Realty Report Card of the NDA GovernmentJune 2015

Rebooting Indian Real Estate

Is Indian real estate heading towards a

tectonic shift?

July 2015

Is Indian real estate heading towards a tectonic shift?

http://www.asiapacific.joneslanglasalle.com/india/Gurgaon/2015/JLL_Research_Is_Indian_real_estate_heading_towards_a_tectonic_shift.pdf

http://www.asiapacific.joneslanglasalle.com/india/Rebooting%20Indian%20Real%20Estate.pdf

http://www.asiapacific.joneslanglasalle.com/india/Gurgaon/Nov2014/JLL-Nov-2014_Horses-for-Courses-e_version.pdf

http://www.asiapacific.joneslanglasalle.com/india/Decoding_Private_Equity_Real_Estate_Exits_in_India.pdf

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. With annual fee revenue of $4.7 billion and gross revenue of $5.4 billion, JLL has more than 230 corporate offices, operates in 80 countries and has a global workforce of approximately 58,000. On behalf of its clients, the firm provides management and real estate outsourcing services for a property portfolio of 3.4 billion square feet, or 316 million square meters, and completed $118 billion in sales, acquisitions and finance transactions in 2014. Its investment management business, LaSalle Investment Management, has $57.2 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.comJLL has over 50 years of experience in Asia Pacific, with over 31,100 employees operating in 83 offices in 16 countries across the region. The firm was named number one real estate advisor in Asia at the 2015 Euromoney Real Estate Awards and won ‘Best Property Consultancy’ in seven Asia Pacific countries at the International Property Awards Asia Pacific 2014. For further information, visit www.jll.com/asiapacific

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 7500, 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 named the Best Property Consultancy in India at the International Property Awards Asia Pacific 2014-15.For further information, please visit www.joneslanglasalle.co.in

Jones Lang LaSalle Property Consultants (India) Pvt Ltd © 2015. 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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