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The India report 2013 A special supplement to PERE magazine

Editor’s Letter

Time for an open mind First, a confession: I like India. The diversity, the contrasts and, yes, the potential. Second a reflection: as you’ll be reminded elsewhere in this report, the real estate markets in India have seen both highs and lows and, at present, many who lived the lows can’t see the highs returning. Third, a prediction: there’s good reason to see investors realizing compelling returns from private Indian real estate through the next part of the cycle. This report is intended to help you make your own mind up about this - so I will only ask that you approach the idea with an open mind. The cornerstone of this country report is the roundtable session PERE hosted in Mumbai where we were fortunate to gather a select group of what is now a much rarer breed. The chance to debate the market with some of the most seasoned and successful domestic private real estate managers still active today was too good to miss. The result was more than we expected: candid, animated [no surprises there] and a very good way to start developing your own views of the opportunities and obstacles that exist. Enjoy the read from page 20. We also had two international real estate groups who have long-term experience of Indian real estate join the conversation in the form of keynote interviews: one is focusing on the mid-market residential segment, the other on high-end retail. Both are convinced that this sort of strategic discipline, with careful execution either with or without the right local partners is key. You can learn more about Portman Holdings and The Xander Group’s views and plans on page 6 and page 27 respectively. Then there is the small matter of how international capital is viewing the real estate proposition in India today. PERE’s Jonathan Brasse hooked up with a number of major limited partners to hear how they are reading the market – and what they have taken away from the experience to date. No surprise: some are wanting considerable convincing that India is worth the trouble. See whether you agree from page 8. Elsewhere you’ll be able to read about how one of India’s heavyweight developers is configuring his relationship with his capital partners today, how and why global juggernaut Blackstone has acquired tens of millions of square foot of commercial real estate across India and we’ve also assembled a range of telling data points for the market from our own and others’ sources. Put all this together and you have a country report that will give you a much clearer understanding of the who, what, where and why in Indian real estate today. Think focus, realism, long-term. And, yes, think: diversity, contrasts and potential. Tell me what you think once you’ve finished reading.

David Hawkins Co-founder [email protected]

THE INDIA REPORT 2013 | PERE

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Table of Contents 4 News

The PERE news team brings you highlights from the 10 most read news stories on India during the past 12 months.

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The long game

Atlanta-headquartered real estate investment group Portman Holdings reveals how it is reading an Indian private real estate market that has left other firms chastened and not a little wary. By David Hawkins.

After the wave

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There are nascent signs that some investors are returning to India’s private real estate market. By Jonathan Brasse

ISSN 1558-7177 www.perenews.com Senior Editor, Real Estate

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Sum of the parts

Getting private equity real estate investing right in India is all in the managing of multiple stakeholders says Vaibhav Rekhi, partner at Indiareit Fund Advisors.

Blackstone’s Indian blueprint

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PERE joins New York private equity real estate powerhouse Blackstone on an exclusive site tour of its Manyata Business Park in Bangalore. By Michelle Phillips

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Two-way traffic

International institutions are expected by Indian developers to be fully engaged on the investment committees they have so keenly sought to be part of says Karan Bolaria, fund manager of Godrej Properties. PERE’s Research and Analytics team looks back at capital raising for private real estate funds in India and forward at the funds currently in capital raising mode.

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Of lions and tigers

India’s private real estate market has been capital starved since a first wave of institutional investors in the market found little success. PERE hears from four surviving firms. By Michelle Phillips

Hunting for alpha

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30

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Xander Group has quickly grown to be one of the more prominent international investors in India’s real estate markets. Founders Siddharth Yog and Arthur Segel talk through the firm’s engagement with the country. By David Hawkins

Regulation and tax snapshot

Ernst & Young associate director Maadhav Poddar runs the rule over India’s current regulation and tax climate for private real estate investors.

Data room

Market data from CBRE, CREDAI and India’s Department of Industrial Policy and Promotion.

PERE | THE INDIA REPORT 2013

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News

India ink As global institutions rediscovered their appetite for private real estate in India PERENews.com was on hand to capture the news. Here are its 10 most read stories emanating from the country over the past 12 months July 2013

QIA to make $300m Indian property push The Qatar Investment Authority (QIA) was set to make one of large international institutional investors taking sizeable the largest investments in India’s private real estate investment capital positions in India’s still-nascent private real estate investment market, with a view to capitalizing on the country’s market since the start of the global financial crisis. According to a report by The Economic Times of India, QIA, growth prospects. According to Venture Intelligence, the private company and which has some $115 billion of assets according to the Sovereign Wealth Fund Institute, was said to invest Rs 1,800 crore analysis firm, investment activity dipped in India following an early wave of capital entering the country (€227 million; $300 million) into Bangaloreafter foreign direct investments were permitbased real estate developer RMZ Corp, with ted in 2005. However 2013 has already seen the Indian newspaper citing three unnamed some of the bigger foreign institutions have resources familiar with the situation. QIA was entered the market. Most of their investments understood to have committed the capital, have come via long-term joint ventures and in both equity and debt, to a special purpose vehidirect transactions with operating partners, cle that also counts private equity firm Baring with fewer coming via traditional private eqPrivate Equity Asia as an investor. According to one of the sources, the SPV Bangalore: QIA will gain exposure uity funds. to the city. In July, Reuters reported how the Abu Dhabi was expected to plough Rs3,000 crore into Investment Authority had appointed Kotak commercial properties in Bangalore, Hyderabad, Chennai and Pune. The investments made by the to invest approximately $200 million into the market. One vehicle were anticipated to occur before March 2014. RMZ month earlier, the same newswire revealed how the Governalready was thought to have identified listing its office invest- ment of Singapore Investment Corporation and Temasek, sovments via REITs in either Singapore or Thailand in as early as ereign wealth funds from Singapore, alongside Oman’s State General Reserve Fund, committed $200 million to lender one year’s time. QIA’s commitment was the latest of an increasing list of Housing Development Finance for a mortgage program. July 2013

June 2013

MSREI poised for $175m Mumbai deal

IDFC plots first real estate fund

Morgan Stanley Real Estate Investing (MSREI) was close to inking its first India deal in more than a year with a $175 million investment in an office development near the heart of Mumbai, using some of the last capital from its Morgan Stanley Real Estate Fund (MSREF) VII Global. The 1.6 million-square-foot project, named One BKC, currently is under construction and is expected to be completed by 2014. It is being designed and constructed by Mumbai developer Wadhwa Group. The outlay would give MSREI a 51 percent stake in the building. The firm’s previous investment in India was an approximately $100 million outlay made last year in a residential development in Mumbai called Vasant Oasis. Although the firm has retained a presence in India since it entered the country in 2005, it halted investments after the onset of the global financial crisis and only began investing again last year. To date, the real estate firm has invested about $850 million in India in total. One BKC is likely to be one of 10 transactions in a late flurry of made by MSREI on behalf of MSREF VII Global.

IDFC Alternatives launched in the summer its first real estate investment fund after almost six months of ‘soft marketing and research’, according to MK Sinha, its chief executive. The Mumbai-firm had been solely focused on India’s infrastructure market since its 2001 founding through various infrastructure and private equity vehicles. The real estate fund still will be expected to garner $500 million of equity. The capital is slated for investments in India’s Special Economic Zones (SEZs), areas in which foreign capital may be invested and benefit from certain tax advantages. The firm is targeting an 18% IRR for the fund, which it hopes to generate for “global LPs looking for low risk/steady return real estate investments in India, like pension fund and insurance funds,” Sinha said. IDFC only will invest in fully developed projects – an attractive investment strategy with capital rates at an “all-time high” and with struggling developers often willing to trade 100 percent of the equity in their projects for cash. IDFC has already secured a joint venture partnership with one domestic real estate developer for the fund, Sinha said.

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PERE | THE INDIA REPORT 2013

October 2012

June 2013

Blackstone inks biggest India investment

Ex-Red Fort exec’s new firm

The Blackstone Group purchased half-stakes in three office parks in Bangalore and Pune in its largest investment in Indian real estate to date. The New York-based firm invested approximately $200 million in Pune Dynasty Projects, a special purpose vehicle holding Embassy Golf Link and Manyata Business Parks in Bangalore as well as the Embassy Tech Zone in Pune. The investment was made on behalf of its Blackstone Real Estate Partners VII fund, which attracted a world record $13.3 billion of equity from investors last year. The vendor of the stakes in the vehicle was Bangalore-based developer Embassy Property Developments which will retain the other 50 percent in the vehicle. Details of the deal are yet to be announced however PERE understands that Blackstone acquired the properties at a mark-to-market capital rate of 15 percent and reflecting a price per square foot of $90. The deal sees Blackstone inherit exposure to properties benefiting Manyata Embassy Business Park: Blackfrom a number of international tenstone’s largest India real estate investment. ants including IBM, Capgemini, Mercedes Benz, Atos Origin and Accenture. It also means the firm has joint ownership of more than 30 million square feet of development land of which 19 million square feet has already been developed. When exiting from the investment it is thought the partners might seek to list it via a stock exchange. Blackstone has held an ambition to invest meaningfully in Indian real estate since setting up an office in Mumbai in 2007 when it hired managing director Tuhin Parikh from TCG Urban Infrastructure Holdings, a property company specialising in office development that was partly owned by New York REIT Vornado Realty Trust. Nonetheless, the firm stayed on the market sidelines for about four years and even today has only invested approximately $600 million of equity from its Blackstone Real Estate Partners series of global opportunity funds in total. [See page 14 for PERE’s site visit to Manyata]

The man formerly charged with creating new business initiatives at New Delhi-based private equity real estate firm Red Fort Capital will soon hit the capital-raising trail for the first investment funds of a new business he just launched. Raj Inamdar has formed TriVeda Capital with offices in Bangalore and New York, through which he is planning to invest in middle-tier residential developments in India.

August 2013

Red Fort plans India’s first core real estate vehicle New Delhi-based private equity real estate firm Red Fort Capital was believed to be exploring the launch of either an evergreen private real estate fund or a public REIT with a view to selling into it three large office buildings in New Delhi and Bangalore valued at approximately $1.5 billion. The properties are held in its first two opportunistic funds and generate net operating income of approximately $100 million and are occupied on leases averaging 12 years. Those stable core-like characteristics have led at least five large institutional investors in the opportunity funds to seek ways to both retain their exposure to the properties after the funds’ expiration, and retain Red Fort as the manager. To that end, investors have engaged in talks with Red Fort to design an investment vehicle that can maintain their exposure to these assets although should the assets be transferred, the investors, including sovereign wealth would need to accept lower than the opportunistic returns which they currently are receiving.

August 2013

Kotak turns fund to club The real estate fund management arm of the $20 billion Indian financial group Kotak Mahindra has changed its second fund into more of a club offering with an increased target size, and has held a first close on $240 million thanks largely to a sizeable commitment by the Abu Dhabi Investment Authority. June 2013

Everstone raises $200m The India-focused private equity manager has hauled $200 million for its second industrial property fund, attracting global institutional investors such as North American pension funds and endowments. The firm’s IndoSpace Logistics Parks II fund has garnered the equity from around half a dozen US LPs. June 2013

India pushes residential regulator The India Union Cabinet approved a bill to set up a uniform real estate regulator to keep developers in check and protect the interests of Indian home buyers, according to a government statement. The bill also is expected to improve the confidence of private investors in the sector, according to private equity real estate firms PERE has spoken to. August 2013

Milestone’s opportunistic returns The Mumbai-based fund manager said it was delivering IRRs of up to 25 percent from across eight real estate funds and has $153 million of exits slated for the next two quarters. All of Milestone’s funds have either partially divested or have divestments scheduled over the next two quarters, according to the firm.

THE INDIA REPORT 2013 | PERE

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Keynote interview | Portman Holdings

The long game Portman Holdings is the Atlanta-headquartered real estate investment group that has developed over 50 million square feet of real estate globally during its 60-year history. David Hawkins sat down with CEO Ambrish Baisiwala and managing director for India Rahul Anand to hear how they are reading a market that has left others chastened and more than a little wary. Margosa Heights: aimed at housing India’s growing middle class

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alk to any non-domestic group that deployed capital of taking money out, India is much easier. And if all the stated into the Indian real estate market in 2005 or 2006, taxes are applied in China then we find the IRRs are lower when FDI was first allowed into all property types than India.” That said, the China real estate proposition is also fundabeyond hospitality and the discussion will soon turn to how wild a time that was. The team at Portman Holdings is no mentally different – and arguably superior - for a number of exception. Chief executive officer Ambrish Baisiwala shakes key reasons. “China can absorb much more capital successhis head as he recollects a period where both the givers and fully – in terms of deal size as well as overall capacity – and the physical infrastructure is far more developed [than India]. takers of that capital expected much but realised much less. Likewise the development process itself is typi“Indian developers in 2005 and 2006 saw the cally more straightforward.” foreign capital inflows as nothing more than easy Capacity is a key theme for Portman when asmoney, and that influx ended up hurting everysessing the Indian market: over-optimistic asbody.” he comments, “Almost everyone who went sumptions around the ability to deliver successful into India in that period learnt a lot and some projects being a characteristic of many proposals the majority in my view - got turned off whilst in the past. “Until recently, there was a capacity others stood back and said let’s use these learnissue in terms of how much capital could be realings.” istically applied in India in terms of returns and For Portman, who are active in both the Chitime frame,” comments the firm’s Mumbai-based nese and Indian markets with teams sat in ShangManaging Director Rahul Anand. And in the hai and Mumbai, those learnings have helped reBaisiwala: using lessons context of a private real estate fund’s investment fine a strategy that started in 1998 when the group of the past life this sense of over-reach could achieve what in set up its architectural practice in Mumbai. hindsight was a comic degree of optimism. Says The fact that the firm has long term experience of both China and India makes comparisons inevitable and Baisiwala: “Proposing to develop 100 acres of greenfield in 7 Baisiwala is quick to reference some key differences: “The years clearly is impossible.” Portman’s appetite to develop a deep understanding of the government drives the market in China whereas the private sector does the job in India. And there’s a penalty for democ- Indian market as a precursor to deploying larger amounts of racy: things move much faster in China,” he smiles. “But we capital saw the firm apply their design and project execution find putting money into India much easier, whereas in China skills to two hallmark assets early on: the first was the Indian the money-in process is used to control capital flows. China School of Business in Hyderabad and the second was the Welalso requires more equity in the capital stack. Whilst in terms lington Mews serviced apartments project in Mumbai. This 6

PERE | THE INDIA REPORT 2013

latter development is owned and operated by heavyweight Indian conglomerate Tata’s hospitality business, Taj Group. As the firm advanced its understanding of the market, so the rush of capital that arrived from 2005 seemed all the more disquieting: land prices were rocketing, local developers were over-leveraging, too many people were talking about India as the next China. For Portman this spelt trouble, so the firm elected to shut their joint venture with HDFC down and completely change its strategy in 2007 as, in Baisiwala’s words: “Even with a strong partner like HDFC, we felt we couldn’t execute our business plan.” As the dust was beginning to settle on the global financial crisis, Portman adopted what Baisiwala calls its “defensive/ aggressive” approach to the Indian Market. It was on the premise that it uses just its own balance sheet to invest and that the focus was very specific. “We don’t see the office or hospitality segments as being ready for our kind of participation at present given our conservative approach to capital deployment and time horizon,” says Baisiwala, “and we are also staying away from the luxury residential end of the market as we think it is not as deep a market as the mid segment.” Tapping in to the macro trend of India’s burgeoning middle class [see chart], Portman instead wanted to partner with local developers to deliver residential projects for that growing demographic. “There’s a very real set of customers there,” declares Anand. As a result the firm has developed four residential projects in gateway cities in India so far, representing approximately 5 million square feet in total and each undertaken with local developer partners. For Portman, having access to that local knowledge by partnering with local developer groups is a key ingredient for successful delivery, just as it makes sense to join a project once the land and the approvals are in place. At present says Anand, “The biggest challenge for developers active in the big gateway cities is the slowness of the approval process.” More broadly the operating environment is challenging but not impossible. “I’d like to see the government make it easier to do business, to be more pro-business and also to sort the big infrastructure issues like roads and power,” says Baisiwala. “And if the government could be much more consistent in its policy making that would be welcome - although preelection positioning will blunt this.” Some see the upcoming national elections as being a watershed moment but for Baisiwala it’s more moot: “Whatever happens at the 2014 election - and many are predicting it will be a coalition - I don’t see the macro-political position changing in a negative way and in a five to 10 year perspective we only see things getting better. So we are not holding back of any of our plans… it’s business strategy as usual.” That strategy is also set to include a move by Portman to raise third party capital for India soon. Baisiwala confirms that they are now talking to a group of “like-minded investors” who could join the firm as it accelerates its India plans. “We believe there is a capacity issue in India, so we are looking to put together a fund or club of around $200 million to $300 million. We would not be comfortable trying to deploy a figure larger than that.” That strategic decision is confirmation, if any be needed,

that Portman sees much to win in India market now that the froth has been blown off the market. Says Baisiwala: “Everyone’s gone through a learning cycle that has been painful but sets us up better for the future. We are not negative on India, we are in fact very bullish but we see India as a long game you can’t rush it.”

Housing the middle class In December 2009 Portman partnered with local Indian developer Kolte Patil to deliver 876 residential units comprising approximately 1 million square feet in an eastern suburb of Pune in a project called Margosa Heights (pictured, left). The development epitomised Portman’s strategy of eschewing the start-up stage of such a project, with Kolte Patil already having assembled and purchased the land as well as having – crucially – gathered all the required permissions to proceed. Today, with the development three quarters complete and with 70 percent of the units already sold, Portman’s Anand says they have already seen the return of their original investment along with a profit [they are forecasting an ultimate gross IRR of over 22 percent], and Portman expects to exit the deal fully within five years from the date of investment. More fundamentally, Margosa Heights sat squarely in Portman’s target demographic: “Pune is a gateway city with many IT and manufacturing companies in the area so we could see significant demand from management level personnel wanting high quality homes for their families.” More recently, Portman has partnered with Tata Housing to develop a higher–end residential development that is still intended to service the target middle class demographic. The Promont is a 1.2 million square feet project in Bangalore that will see 410 units delivered, with Portman taking a stake in the project that was valued at R240 crore [€29 million; US$39 million] at the time of the investment in November 2012.

India’s changing income demographics Rich

Upper Middle Class

6

2

Middle Class 4

18

19 41

Poor

Poorest 9

32 43

93 80

36 54 35 22

1985

Source: KKR

1995

2005

2015e

2025e

THE INDIA REPORT 2013 | PERE

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Investor Focus

Mumbai: international institutions have largely shunned investments in India’s real estate since the late naughties

After the wave Private real estate investment in India has seen a lack of engagement by international institutional investors since the start of the financial crisis, but there are nascent signs that some investors are returning to the market. By Jonathan Brasse

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n July 9, India’s finance minister Shri Chidambaram landed in the US for a four-day tour. Bent on improving India’s economic prospects by encouraging greater foreign direct investment into the country by American institutions and businesses, he took in meetings with industry stalwarts including Microsoft, Lockheed Martin, Wal-Mart and Boeing. A communiqué posted before the tour by the Press Information Bureau, the government’s media-facing department, stated hat he wanted to talk on areas such as infrastructure, policy and tax. A dearth of foreign investment lately suggests that India’s private real estate market could do with some ambassadorial flag-waving as well. Venture Intelligence, the private company data and analysis firm, reports that last year there were just 38 investments valued at $1.2 billion defined as private equity real estate – a far cry from 2007 and 2008, when enthusiasm for private real estate was greater. In those years, a multitude of mainly international equity-infused opportunity funds were able to plough almost $14 billion into 185 transactions. On a year-on-year basis, Venture Intelligence reports that 2013 has yielded $887 million across 20 deals to date. However, considering that nearly half that amount represents The Blackstone Group’s investment in office parks developed by Bangalore’s Embassy Property Developments, activity by other stewards of international capital has been limited. Indeed, ac8

PERE | THE INDIA REPORT 2013

cording to Grant Thornton, the chartered accountancy firm, close to 86 percent of all private equity real estate investments in India happened between 2005 and 2010. Few tangible successes during that time have led to a dearth of non-domestic capital raisings since. “There are funds that have outperformed their vintage,” notes Nicholas Wong, principal at Cleveland-based investment advisory firm The Townsend Group. “However, for each of those, you can count 20 firms that have not done well.” On behalf of its clients, Townsend has committed equity to Red Fort Capital, Infrastructure Leasing & Financial Services (IL&FS) and Sun Apollo: three Indian private equity real estate platforms that have maintained strong reputations in the market in spite of a poor performing and often maligned first vintage of Indian opportunity funds. While Townsend is happy with its manager selection, the firm has little appetite to increase its exposure to India today. By way of explanation, Wong reiterates a commonly peddled view among international institutional investors and managers alike: India’s bricks and mortar has already sucked in meaningfully more equity than it has given back. He says institutions willing to commit resources to private real estate strategies today are fewer and further between than they once were. Venture Intelligence statistics merit this trepidation. The firm reports just 73 full or partial exits from the 563 private equity

Investor Focus

real estate transactions since foreign direct investment in the asset class were permitted by the Indian government in 2005. Those exits reflect just $3.8 billion out of $22.6 billion invested, meaning that 83.2 percent of the equity invested in Indian private real estate is yet to be returned, let alone increased.

Relative improvement

the country. In July, The Economic Times of India reported how the Qatar Investment Authority was in the final stages of investing $300 million into a commercial property development platform of Bangalore-based RMZ Corporation. In the same month, Reuters reported that the Abu Dhabi Investment Authority (ADIA) had appointed Kotak to invest approximately $200 million into the market. The pre-eminent sovereign wealth fund of the United Arab Emirates already is invested in funds of IL&FS and Red Fort, and the news service estimated ADIA’s exposure to Indian private real estate investments to be between $400 million and $500 million. The news service also reported that the Government of Singapore Investment Corporation and Temasek, two sovereign wealth funds from Singapore, had committed $200 million to lender Housing Development Finance.

Hari Krishna, director of Kotak Realty Fund, one private equity real estate firm to have contributed to the country’s successful exit tally, believes the trend is improving. “The perception that there are no exits is no longer true,” he says. According to Krishna, between Kotak and a limited number of rival firms, they actually can account for $2 billion of exits. Further, he claims these exits have produced a net IRR of 24 percent. That is in line with most institutions’ return requirements for opportunistic strategies. Lessons learned Nevertheless, proclamations by India’s private equity real Dutch pension administrator Algemene Pensioen Groep (APG) estate firms are not helped by India’s current political and eco- made its first investment in 2008. Sachin Doshi, its senior nomic situations. Of near-term portfolio manager responsible Early wave concern, institutional investors for Indian investments, stops Private Euqity investments and exits in RE in India evaluating India today must short of describing the outlay Investments contend with a state in the grips $9B as a learning curve. However, Exits of a power struggle between $8B he admits there were plenty of the Congress Party and the misguided cheques written by Bharatiya Janata Party ahead of $7B international investors in gennext year’s general election, as $6B eral after the doors to foreign well as the economic reforms a direct investment swung open. $5B victory either way would yield. “The first wave of capital that A significantly devaluing $4B went into India really backed a rupee further colors matters $3B lot of untested and unproven for international institutions. fund managers,” Doshi says. In 2008, one US dollar bought $2B For that, he argues investors 42 rupees. Today, it buys 60 $1B shoulder much of the responrupees. As such, some invessibility. “A lot of investors 0 tors that backed private real made huge bets in locations 2005 2006 2007 2008 2009 2010 2011 2012 2013 estate strategies in 2008 find India’s bricks and mortar already has sucked in significantly more equity that simply could not absorb themselves trapped today, even than it has given back the amount of capital chasing if the investment manager has Source: Venture Intelligence those locations. Eventually, performed well. that meant investors got hurt.” “All of a sudden, anything you’ve gained is wiped out,” exAPG has drawn positives from its early experience and last plains Ravi Hansoty, the former head of Asia at Citi Property year heralded two significant equity investments. In May 2012, Investors, the real estate investment management business of the steward of €338 billion of pension assets ignited a strategic Citigroup that was sold to Apollo Global Management in 2010. partnership with New Delhi-based Lemon Tree Hotels aimed at “On a rupee basis, you might have done well, but on a dollar developing a portfolio of mid-market hotels across the country. basis your sitting on a negative. That makes it hard to convince APG and Lemon Tree injected Rs 2000 crores (€255 million; investors to come back.” $337 million) into the platform, named Fleur Hotels Private, Still, certain institutions have come back, and those that be- with a view to developing 4,500 rooms by the end of 2016. lieve a weakened rupee is a temporary phenomenon say today Two months later, APG, Danish fund of funds manager Sparis the perfect time to jostle for position in an ever-more sophis- invest Property Investors and other global investors capitalized ticated marketplace. a development business in another partnership, this time with Paul Jayasingha, global head of real estate at institutional Mumbai-based Godrej Properties, focusing on middle-income advisor Towers Watson, notes that his firm had been deterred residential units. APG and its partners committed $95 million from recommending Indian private equity real estate firms due of initial equity, while Godrej put in $43 million. This platform’s to concerns about governance and valuations. However, the capital has since grown to $200 million, and both sides are exdownward currency direction has given it cause for a rethink. pected to deploy further capital to the platform over time. “We are starting to re-look at [India’s] strategic case again given These outlays by APG represented rare recent examples of the material moves in currency recently,” he says. international investors engaging with private real estate. “For Certain large institutions also have seen enough to return to us, 2012 wasn’t special, “Doshi says. “We accessed the market 10

PERE | THE INDIA REPORT 2013

at that time because we saw an opportunity to deploy capital wisely over the next few years. It’s true that we seem a little bit contrarian but, even though we entered into these relationships last year, they are for the long term.” Although India’s gross domestic product has fallen to its lowest levels in a decade and the International Monetary Fund just adjusted downwards its prediction of 5.6 percent GDP growth in the financial year to March 2014, APG still likes India. Says Doshi: “We continue to believe in the huge domestic consumption-driven story and that for the mid-income segment, across asset-classes, there’ll be a deep enough pool of demand that will continue to grow.” For APG, investing wisely does not likely mean investing in blind-pool commingled funds. Besides being limited life in nature, the pension manager wants greater control of its investments than these traditional private equity-style funds typically allow. However, in order to execute partnerships successfully, he believes having staff in close proximity to its partners is fundamental. To that end, having an Asia team based in the region is important. “Like a lot of Asian markets India is still relatively opaque,” Doshi says. “It is a market in which you must be willing to spend a lot of hands-on time to understand specific locations and to really cultivate a relationship with your partners.”

Risk on risk

Nonetheless, blind or lightly seeded commingled funds continue to be marketed. Townsend’s Wong says he probably received 20 presentations from Indian fund managers looking to raise a first-time fund in the last year alone. “Often, you are talking about someone who used to work for JPMorgan or another investment bank but their employer has decided India is not their focus anymore,” he says. “These individuals have left and are looking to start their own fund. For us, that’s risk on risk.” Hansoty is one such example. After leaving CPI in July 2010,

he sought $350 million for Cedar Figs Capital Partners, a firsttime fund for residential investments, entity-level investments and hotels. After eight months of soft commitments not hardening, he switched tact and has since advised investors on how they should think about private real estate in India. Hansoty is encouraged to see international institutions pay the market more attention, even if not at the same scale as before. “If you have the resources, the time and remain committed, I think you would be able to attract that pool of capital,” he advises to managers in fundraising mode today, based on his discussions with investors. Cognisant of India’s currency decline, Hansoty currently is advising investors to adopt a specific investment strategy that can take advantage. He advocates for a focus on identifying multi-national corporations that are concerned about crystalizing losses by repatriating their revenue and working with these corporations to instead invest their resources into Indian real estate. His advice points to a future of solid growth for both India’s property and its currency – one he believes will materialize. Hansoty’s advice presupposes healthier times to come for Indian private real estate, and he does acknowledge the difficulty in persuading capital sources to commit to a market where there have been few tangible instances of success. “You might find some deals that got close to a 2x equity multiple,” he says. “I tell investors: ‘You are an investor in the market not purely from a returns point of view, but for diversification and for the opportunity for your investment to lead to other things’. That’s why India should be part of the mix.” Widely agreed is that India is no short-term play. While that brings into focus the general viability of closed-ended funds, institutional investors able to take long-term, strategic positions in the market increasingly are doing so, proving there still are pockets of foreign capital that believes India’s spoils are still to be realized.

A township in Bangalore: India’s development story is still attractive to some foreign institutions

THE INDIA REPORT 2013 | PERE

11

Expert Commentary | Indiareit

Sum of the parts Getting private equity real estate investing right in India is all in the managing of multiple stakeholders, explains Vaibhav Rekhi, partner at Mumbai-based private equity real estate Indiareit Fund Advisors. Mumbai: is the sun rising on a second chapter for private real estate investing in India?

W

ith the benefit of hindsight, the private equity real estate story in India can distinctly be seen as a tale of ‘two halves’. The first was an outburst phase characterized by the heady days of 2006-7 leading into the global financial crisis and its immediate aftermath. This early vintage, perhaps unfairly, saw a large amount of money raised by fund managers who were focused more on growing assets under management and immediate deployment than on transaction and partner selection. The second was a reflective, more mature phase that best explains the period from 2011 and 2012 onwards leading up to the market environment that we find ourselves in today. Before we embark on a soliloquy on investing and an attempt to deliberate the current environment on behalf of all the stakeholders i.e. the end user, developer and the private equity fund manager (and ultimately the investors), we would have to reconcile the path that these very stakeholders have charted over the years. The Indian real estate market is fragmented, opaque and highly localized and its story is about more than just applied macroeconomics. Cultural affinity is important when dealing with a sometimes tedious regulatory framework and regional market nuances as is a firm appreciation of the forces that motivate each stakeholder in this market. Let us start by focusing on the developer as a part of this equation who had neither seen such a large quantum of capital available nor had the existing experience or execution ability to 12

PERE | THE INDIA REPORT 2013

show for their business plans, but still managed to successfully attract private equity. This money was then deployed via loosely defined strategies - across asset class and across Tier I and Tier II markets, perhaps without due regard being given to target hold period and astonishingly, even exit strategy. For residential focused fund investments (the majority), exits were predominantly forecasted by means of physical delivery of the properties. They were thus self-liquidating in nature and yet we see many examples of unsuccessful transactions from this vintage. If one was to analyze these, one common theme would be incentive misalignment – developers being cashed out upfront, unequal revenue sharing, no execution control or the absence of of effective ongoing asset management. These dangerous ingredients coupled with time delays in the approvals process, in some cases due to a lack of understanding the rules and in others due to factors like unsuccessful aggregation or incorrect zoning, greatly impacted realizations and returns. Further, developers resorting to leverage as a means of sustaining cash flows during a slowdown in sales velocity or funding opportunistic land acquisitions found their fate compounded. We will deal with the occupiers next, who, in a bid to continue to ride the ‘wave’ bought into real estate projects based largely on grandiose plans put forth by the developers - at times blindly and without any due diligence done on zoning, sanctions and approvals, building plans and even the financial health of the developer, viability of project. In some instances even pricing

to such developers even as financial health, execution track record, pipeline of delivered projects, and other items all begin to play an all important role in the buying decision. It is important to analyze the developers’ psyche here. Assuming you have already weeded out the initial market participants who are ‘in too deep’, a rational and well intentioned developer has no interest in delaying delivery of his project; units get sold at an established price and extended timelines merely increase the risk of escalated costs whilst at the same time postponing the developers’ milestone based cash flows and ultimate realization of profits. So the issue then is not one of ultimate delivery but the ability to complete. It is exactly this ‘last mile funding’ that presents perhaps the best buying opportunity for private equity to participate. Real estate tends to be a lumpy business with non-regular cash flows. This makes it unsuitable for the more traditional sources of finance that require a regular servicing of coupon payments. The ability to bridge this gap between the availability of capital and the demand for it offers up an ideal opportunity for private equity participation without compromising (when compared with vintage fund investments) on the quality of the developer, visibility of execution and ability to vet and validate the project and pricing assumptions. The litmus test of course is the attracting of occupiers to ultimately take the space. To that end, investments in this second chapter of private real estate investing in India are already bearing fruits. Within the residential asset class, Brighter climes for example, we are beginning to see delivery of All of this paints a more unfair picture than actual some marquee projects that are both changing the fact as there have been success stories even within skylines of micro markets and also tangibly and the trials and tribulations laid out above. But for substantially increasing the living standards of the purpose of reconciling the old with the new, it was important to make this distinction as starkly Rekhi: sees a more occupiers. That is precipitating an expectation for as possible. Let us now move to talking about the mature India better quality accommodation from an increasingly affluent population willing to pay for what market that exists today and how this particular vintage offers a more attractive basis for putting capital to work they can visibly see. World class architects and design consulto earn superior risk-adjusted returns, whilst also balancing the tants are playing their part. And fund managers are playing an equally important role in both project oversight and ongoing needs of all the stakeholders. The market has matured considerably since. With it, the de- asset management to ensure that a development stays on course velopers have also self selected into one of two camps – those from a cost, quality and time perspective. All this has led to a sophistication of the market. We are now that have successfully scaled up their institutional ability, execution capability and have realized that private equity is an en- seeing the emergence of standing commercial assets as a viable abler of growth for their business and others who quite frankly alternative for offshore capital looking for more ‘core’ opportuare in so deep that they are unable to extricate themselves from nities. There are some large REITs being slated as well as large the skeletons of their past. It is in dealing with the former that sovereign investors who are setting up or partnering with core vehicles to take advantage of this trend. ‘Capital stack’ investing the opportunity arises. Let us distill this thesis one step further. Many of these suc- or equity exposure to residential development by means of debt cessful developers who have demonstrated both the ability and like instruments and security is also gaining momentum. The the intent (both equally important) when dealing with end- market is now mature enough to sustain strategies other than users and private equity funds alike are faced with operating in opportunistic residential development over the coming years. Private equity has always walked a tight rope in India – one an environment where capital is scarce. Due to the excesses of the past, banks have closed their books for acquisition funding, that constantly balances the needs of all the stakeholders concapital markets are not supportive and external commercial cerned. But for those private equity real estate firms still standborrowings are heavily regulated. The developer is therefore ing after a turbulent first wave of capital hit these shores, the starved of flexible growth capital to both continue and scale up market situation that we find ourselves in today has just made his business. The end-users, meanwhile, continue to be loyal that rope a whole lot thicker! was disregarded in anticipation of limitless capital appreciation. Along with certified end-users there also existed in some markets a deep ‘investor’ community which tended to underwrite multiple apartments by paying minimal up front deposits. By locking in a low rate, they would then speculatively churn these units once prices rose thereby multiplying returns on equity. Developers would often look to such funding as a parallel source of finance, without realizing that these very units would come back to the secondary market at an inopportune time, consequently eating into a developer’s primary sales velocity and pricing. As markets turned and confidence dwindled, both end-users and investors alike withdrew their support as their capital became stuck in projects where ultimate delivery of the unit had been delayed or became questionable. In these situations developers were left nursing projects mid-construction all the while servicing expensive debt just to stay alive. Accordingly, as providers of equity capital, the private equity real estate firms and their underlying investors, had suffered. With this catalogue of toxic circumstances resulting in vintage investments not delivering underwritten returns and more often than not forcing assets to outlive the targeted hold periods or even entire fund lives, the sector in India took a battering and managers were not only unable to return to market and raise subsequent funds but also had to rely on third party assistance to extricate value from their deeply stressed portfolios.

THE INDIA REPORT 2013 | PERE

13

Special report | Blackstone site visit

Blackstone’s Indian blueprint PERE’s Michelle Phillips joins New York private equity real estate powerhouse Blackstone on an exclusive site tour of its Manyata Business Park in Bangalore, its largest investment in the country, and hears from its senior executives in India why it makes sense. Manyata Embassy Business Park: 7.7 million square feet and counting

A

s the Blackstone Group’s car winds through the narrow Bangalore streets, it is hard to imagine why the private equity real estate powerhouse picked this place among its first real estate investments in India. The city’s few highways are still under construction and the traffic is every bit as bad as its dire reputation. Cows saunter along against a backdrop of shanties, discarded furniture and children playing with bamboo sticks. Not exactly the sprawling commercial metropolises in which one might expect to find a Blackstone property investment. But things couldn’t be more different inside the Manyata Embassy Business Park, one of three office parks held in joint venture with Bangalore-based developer Embassy Property Developments accounting for approximately half the equity invested by the firm in the country so far. As might be expected of a partnership focused on development in an emerging market like India there is still plenty of construction happen-

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PERE | THE INDIA REPORT 2013

ing within this 110-acre gated commercial hub. But here the roads are wide, smooth and straight and the windows of its numerous office buildings give off a clean shimmer from the gray clouds. They set a stark contrast to the dirty environment outside. It is little wonder multinational giants including IBM, Microsoft, and IT outsourcing company Cognizant Technology Solutions have leased up 95 percent of the park’s 7.7 million square feet of completed office space. Such is the confidence of Blackstone and its development bedfellow that more bluechip occupiers are coming, Manyata is slated to deliver a further 5.2 million square feet in the next four years. Blackstone has been operational in India since opening an office in Mumbai in 2006. Yet until engaging with Embassy it had spent more than six years on the market sidelines. PERE took up the firm’s invitation to explore Manyata and, in so doing, the firm’s thesis for choosing it to anchor a rapidly

growing Indian real estate portfolio that is valued today at approximately $600 million.

The plunge

that same time. Such a shift in population has encouraged Parikh to the view Manyata will actually be absorbed by a rapidly expanding city. Jones Lang LaSalle, the global property services firm, reports there was 70.6 million square feet of office space in Bangalore at the end of the second quarter, yet just 6.8 percent of that space was vacant. Parikh believes the city’s current office supply is today grossly mismatched to the demand Blackstone projects.

Blackstone declined to divulge financial information regarding its investment in Manyata, which is held by Pune Dynasty Projects, a joint venture company held on a 50:50 basis with Embassy. However, PERE understands this asset and two others, Embassy Golflinks Park, also in Bangalore, and Embassy Office Park in Pune, were bought at an average of about $90 per square foot and at a capitalization rate of about 15 percent. An infrastructure asset The equity used in Blackstone’s investment came from its Parikh illustrates to PERE the quality construction techrecord-breaking seventh global opportunistic fund, Black- niques used at Manyata. But he is quick to point out Blackstone Real Estate Partners VII, which collected $13.4 billion stone and Embassy will need to offer more than quality at final closing last year. masonry to continue to attract blue-chip occupiers. Parikh India head and senior managing diinsists the environment and infrastrucrector Tuhin Parikh explains that Blackture of a business park are just as impor“We don’t want to play stone was spurred to take its first meantant as its buildings, particularly given the game of buying ingful plunge into India’s private real some of the most basic amenities are not land and building assets estate market via its collaboration with reliable in the city. For instance, Bangaground up. Instead, we Embassy primarily because of the scale lore is renowned for rolling blackouts of exposure to the country’s office space lasting hours at a time. For an IT compawant to stabilize the asset it offered. “In order for tenants to take for a core buyer or listing.” ny that can be devastating. Cognizant of large spaces in one location it is essential that, Manyata has its own diesel-fuelled that your parks have scale,” he says. power generator situated centrally with While Manyata and the other two parks had been on power lines to every building. Blackstone’s radar for some time, the firm was eager to avoid Parikh iterates the importance of Manyata being regarded significant development risk. As such, Parikh says it was im- as “an infrastructure asset” in itself. “India has infrastructure portant to trigger its investment when the park’s offices had challenges, so with large-scale office parks, you provide firstalready been 50 percent built and its infrastructure was suffi- world infrastructure to your multinational tenants.” The park ciently operational. That gave the firm comfort that its outlay also boasts its own water recycling system that reuses water would fit within BREP VII’s natural fund life. “We don’t want in its buildings for its toilets and for watering its landscaped to play the game of buying land and building assets ground gardens. For a country that has 16 percent of the world’s popup,” Parikh points out. “Instead, we want to stabilize the asset ulation but just four percent of its water, components such as for a core buyer or listing.” this carry extra weight for occupiers in India, Parikh says. Parikh’s deputy, and PERE’s tour guide, Asheesh Mohta, Mohta points also to the park’s shuttle service when he says: projects the firm’s investment will last between four and six “All the things you struggle with outside [the park] are taken years within which time the entire 12.9 million square feet for granted inside.” should reach practical completion. Crucially, the firm is also betting that core buyers will materialize within that time span too. Certain real estate investment managers in India question how Blackstone expects to generate opportunistic returns from its outlays in Embassy’s business parks given much of the development is already done. Nonetheless even in an approach more core-plus or value-added in nature, Parikh says Manyata has begun generating opportunistic returns from high yielding rental growth and development returns. Furthermore, he explains the firm has been able to introduce greater leverage, at attractive enough interest rates, as it convinces lenders of the parks’ institutional credentials to improve returns further. “The banks are getting more and more keen on lending to us,” he says. Parikh is also confident Bangalore’s growth story will aid the firm’s cause. Known as “the Silicon Valley of India”, Bangalore houses 900 IT companies and in ten years its population has nearly doubled, according to India’s national census. Manyata Embassy Business Park: a striking contrast with the environment Parikh has seen the size of the city itself quadruple in size in beyond its gates THE INDIA REPORT 2013 | PERE

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Special report | Blackstone site visit

India has a reputation for quickly erected properties that Indeed, he describes Blackstone’s experience and reputation are left unattended to decay. Parikh hopes that having Black- in this regard as a great asset. “Its global relationships add a stone and Embassy for landlords should offer a warranty of level of comfort for new tenants just entering India,” he says. sorts to prospective occupiers against taking residence in Further, Blackstone has also promoted international practices such a deteriorating environment. That should, in turn, con- including the “Energize” program, an initiative aimed at envince investors to feel confident in engaging with the develop- couraging occupiers to interact with one another, something ments. “Institutional ownership can take a longer-term view that it found has improved tenant retention in its western business parks. The Friday after PERE’s visit to Manyata, the here,” he says. This confidence he says is illustrated by the park’s occupi- business park held a relay race in one such activity. As a 50 percent stakeholder in its partnership with Emers, Mohta adds. Technology giants IBM and Microsoft have already implanted some of the most sophisticated security bassy, Blackstone has every incentive to be hands-on on its board. Even during PERE’s visit, Mohta systems and have furnished and decorated wastes no opportunity to dicuss with his Emtheir office space to a first-world standard. “All the things bassy colleagues potential tenant visits, rental This kind of capital expenditure demonstrates you struggle with levels and maintenance issues. Such face to their expectations of a long tenure at the park. outside are taken face dialogue is frequent given he visits the Away comforts for granted inside.” park every week. Parikh, for his part, is more focused on ensuring the park’s budget stays Having digested the development prowess on on track, something he is pleased to report is display at Manyata and heard Blackstone’s rationalization, PERE asks the potentially thorny question of the case currently. Manyata is expected to deliver 800,000 square feet of the what the private equity firm brings to the table. After all, it does not have the direct development expertise that many real remaining 5.2 million square feet of office space during the estate investment managers active in India insist is a prereq- next 18 months so there is still a lot of work to be done here. uisite for doing business in the country, nor does it have staff Mindful of that fact, Blackstone is keen to show PERE “the stationed in the city. Mohta admits that Blackstone prefers to finished article” and drives to Embassy Golflinks, another let Embassy run the day-to-day operations, and only “steps IT park in Bangalore’s central business district, also halfowned by the firm. In this fully-operational working space, in” if something is wrong. Pradeep Lala, Embassy’s chief executive officer, says never- away from the hustle and bustle of construction at Manyata, theless Blackstone’s expertise is well utilized in areas includ- it is easy to forget the cows, shanties, discarded furniture and ing leasing situations, particularly with international tenants. children playing on the streets outside.

Manyata Enterprise Business Park: tenants including IBM and Microsoft are benefiting from state of the art security

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PERE | THE INDIA REPORT 2013

guest Commentary: The developer’s perspective

Two-way traffic International institutions are expected by Indian developers to be fully engaged on the investment committees they have so keenly sought to be part of. By Karan Bolaria, fund manager of Godrej Properties

I

nvestors have changed their approach to investing in real estate in India. Today, enhanced controls and more rights over the investments they make is

the zeitgeist. As a consequence, investment managers and operating partners alike are asked for co-investment rights for fund investments but often also for entirely separately managed accounts. And even within these side-cars and separate accounts, their appetite for more autonomy is increasingly evident. Our experience with APG and Sparinvest is a case in point. We see our joint venture development business, Godrej Residential Platform, as a melding of our deep domain expertise with quality institutional capital to invest in India’s strong urbanization trends in mid-income housing. Our working relationship is the product of healthy debate and transparently discussing our positions on investments which has helped us forge a productive alliance. But it is also the result of mutual respect for what each of us brings to the table. As more investors go about taking on more such active roles, driving forward their agendas on alignment, transparency and governance, permit me to underscore the importance of investors taking on roles on the investment committee (IC) for it is the most critical aspect of running a successful venture, not least because it has the greatest impact on investments. For our part, clearly explaining, and to the extent possible, simplifying the complex risks associated with deals is key to ensuring we are aligned. We bring the essential ingredient of experience in the complexities of ground-level investing. Investors are looking for clear and focused investment strategies that are bound by well understood parameters. They will get that by participating in the

IC. There they will get upfront visibility into deals and a clear understanding of the risks involved. Investors, for their part, should fully engage in the committees so these insights are properly absorbed. Fully engaged investors can better guarantee that their investments stay within the agreed parameters and risk framework of the vehicles in which they are committed. And IC roles are the best way for investors to diligence a deal and understand the risks involved independently. Only then can an investor fairly exercise its opt-out rights when an investment looks uncomfortable. I don’t see the IC dynamic as one-way information traffic. I see investors bringing value to the committee by adding to our granular perspective their more macro perspective, sharing with us experiences from different geographies. A

lines and ensure that issues are brought to their notice promptly. In such scenarios, investors can weigh in with views on potential remedies immediately. However it never works when investors try to determine strategy or influence the operating plan. Outside of default scenarios, investors should position themselves to be well-informed first and foremost. The operating phase should be left in most part to the expertise of the partner. However, when mapping out a clear exit blueprint, this is the time for investors to become more active. Plan for all scenarios and diligence jurisdiction compliance and valid overseas reparation mechanisms. One should consider upfront worst-case scenarios and subsequently, contingency plans. Look for clarity on domestic enforcement, arbitration and litigation proceedings. In-

I see investors bringing value to the committee by adding to our granular perspective their more macro perspective lesson learned from, say, a development experience in France might actually be useful here in India. Investors should conduct legal diligence, check market performance whatever is needed to scrutinise an investment thesis. But, for example, they shouldn’t second-guess a developer’s procedural approvals timeline. Also, if an investor opts out of a proposed investment, it should explain why it wasn’t approved. There is nothing more frustrating for an investment manager than having a deal rejected with no clear explanation on why it was a no-go. Investors should engage in the asset management phase too, not just in approving investments. Often times it is in this part of an investment’s life that problems occur. Investors taking on board positions on the operating companies help to maintain functional reporting

vestors, who rightly are concerned about India’s regulatory environment, should also stay abreast of changes in the country’s regulation, particularly when concerning overseas funds. India has investment opportunities across asset classes. With a clear investment strategy and a prudent, involved approach investors can greatly maximize the probability of achieving superior risk adjusted returns. But let me leave you with some important context. While in other emerging markets like Brazil and China where the presence of investors on the investment committee is commonplace, in India it is actually extremely rare. It is therefore for both partners to manage this engagement carefully, which will greatly improve the chances of achieving a good working partnership and overall success. THE INDIA REPORT 2013 | PERE

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Capital Watch

Things not as they seem When assessing PERE Research & Analytics’ capital-raising records for private real estate investment funds in India during the past five years the story seems clear: the country’s growth potential pulled in equity in masses up until the start of the global financial crisis and then next to nothing afterwards. Indeed, more equity was hauled by Indian firms for funds in 2008 alone, the year Lehman Brothers collapsed, than in the following four and half years combined. But while 2013 has seen little raised for funds to date, some of the world’s largest institutions have indeed been reallocating their resources to India - only they are committing via joint ventures, separate accounts and partnerships.

$8

35

$7

30

$6

25

$5 20 $4 15

# of Funds Closed

Aggregate Capital raised ($bn)

India versus Asia private equity fundraisings 2008-2013

$3 10

$2

5

$1 $0

2008 Australia

2009 China

India

2010 Japan

2011

New Zealand

Singapore

2012 South Korea

0

2013ytd Vietnam

# Funds closed

The $500m club Investors keen to know the scale of opportunity in Indian private real estate could do worse than gauge the capital raising targets of its biggest players: six of the top 10 offshore funds in the market currently are looking for $500 million maximum. Fund Name HDFC Fund IV (Offshore)

Fund Manager HDFC Property Fund

Head Office India

Target Currency USD

Target amount (m) 500

Target amount ($m) $500.00

Fund Currency USD

Fund Amount (m) 200

Fund Size ($m) $200.0

Status 1st Close

Fund Strategy Opportunity

IDFC Real Estate Fund IL&FS India Realty Fund III

IDFC Alternatives Limited Infrastructure Leasing & Financial Services Ltd (IL&FS)

India

USD

500

$500.00

USD

0

$0.0

Launched

Value Added

India

USD

500

$500.00

USD

0

$0.0

Launched

Opportunity

Red Fort India Real Estate Fund III Shapoorji Pallonji Fund

Red Fort Capital

India

USD

500

$500.00

USD

0

$0.0

Launched

Opportunity

Shapoorji Pallonji Investment Advisors Tata Realty and Infrastructure SI Viridian Investment Managers

India

USD

500

$500.00

USD

50

$50.0

Launched

Opportunity

Sector Focus Commercial, Diversified, Residential, Retail Diversified, Other Commercial, Hospitality, Residential, Retail Office, Residential Diversified

India

USD

500

$500.00

USD

0

$0.0

Launched

Opportunity

Retail

India

Singapore USD

400

$400.00

USD

0

$0.0

Launched

Opportunity

India

Everstone Capital

India

USD

350

$350.00

USD

250

$250.0

1st Close

Opportunity

Kotak Mahindra Group INDIAREIT Fund Advisors

India

USD

350

$350.00

USD

0

$0.0

Launched

Opportunity

Commercial, Other, Residential, Retail Industrial, Logistics Diversified

India

USD

300

$300.00

USD

0

$0.0

Launched

Opportunity

Residential

India

Tata Mall Chain Overseas Fund The SphereInvest Viridian India Property Fund II (Millennium Spire II) IndoSpace Logistics Parks II Kotak India Realty Fund II Indiareit Offshore Fund II

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PERE | THE INDIA REPORT 2013

Country Focus India

India India

India India

India India

Amanora Town Centre, Pune

33 million square feet of real estate across 16 Indian cities Retail | Industrial | Mixed-Use www.everstonecapital.com

IndoSpace Chakan, Pune

Roundtable | India

Photography by Gautam Singh

(L to R) Subhash Bedi, Subramanian Sriniwasan, Khushru Jijina and Rajesh Jaggi

Of lions and tigers India’s private real estate market has been capital starved since a first wave of institutional investors in the market found little success. PERE hears from four surviving firms keen to ensure returning investors don’t suffer a similar fate. By Michelle Phillips

Roundtable | India

T

he monsoon rain and high tide are a deadly combination in Mumbai. All around the distinctive One Indiabulls Center office building where PERE is holding its inaugural India roundtable discussion, rain pounds the windows and major roads flood. Somehow, all four participants have managed to find their way here. Each is glad to be in a dry place. Despite the depressing weather, the roundtable is in good voice. We have Kotak Realty Fund chief executive Subramanian Sriniwasan, Everstone Capital real estate managing partner Rajesh Jaggi, Red Fort Capital managing director Subhash Bedi, and Indiareit Fund Advisors managing director Khushru Jijina. Perhaps because they are old acquaintances, they quickly find comfort in one another’s company. Over the course of the two-hour discussion it becomes evident they also share similar thoughts on how to operate in India’s private real estate market today. Between 2005 and 2008, almost $14 billion was invested in the country’s bricks and mortar, according to data provider Venture Intelligence. Enchanted by India’s growth story, institution after institution committed capital and often to loosely defined strategies. But when they yielded scant success, the Indian property market’s place in the institutional investment portfolio largely became marginalized, particularly by nondomestic sources of capital. In response, these roundtablers are quick to agree the future resides in demonstrating a clearer focus. Out go broad, allencompassing strategies. Instead a distinctive, strictly-defined game plan is the tonic they believe will induce at least certain investors to return to these shores. They cannot guarantee

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PERE | THE INDIA REPORT 2013

mistakes will not be repeated. But these men claim the firms which have survived are now hands-on in approach and hyperfocused in strategy.

Stampede in, stampede out

Each roundtabler has operated through 2005 to 2008, when 30 percent IRR expectations were common; and to a greater or lesser extent, each has the scars from what happened next. “I think in many ways, 2005 to 2008 was really about venture capital investment in real estate,” Sriniwasan says. Most institutions came to India with little or no experience of the country’s real estate, and committed large sums of money to managers and developers, who were equally in the dark about institutional expectations, he says. According to PERE’s Research and Analytics Division, almost $24 billion was raised in India for private equity real estate funds between 2005 and 2008, more than quadruple what has been raised since. As Jijina sees things, Indian managers were unaccustomed then to handling such large amounts of capital. “They had to set up with developers who were actually doing smaller projects, and suddenly these developers were bombarded with liquidity,” Jijina explains. Participants agreed that fund managers and developers alike had taken on more capital than they could handle. When $12 billion of foreign direct investment chased about $3 billion worth of equity deals in India’s top five cities, mistakes were bound to happen, Sriniwasan declares. Replete with resources, there was less emphasis then on tight investment parameters and mandates would include everything from residential to office to logistics, Sriniwasan says. Ji-

jina chimes in by describing “non-understanding” institutional investors marrying with developers who were unacquainted with working with private equity. “In those days, most developers didn’t know the difference between an SPV and an SUV,” Sriniwasan responds, half-joking. The years immediately following the start of the global financial crisis in 2008 were dark days indeed (see inflation and GDP growth chart). Investors who had “lost their shirt” from their forays stampeded out of Indian real estate as quickly as they had stampeded in. In the course of just a year, roundtablers recall watching foreign capital dry up. The market’s reputation took a battering in the process. This is where Bedi chimes in: “The perception of India was built by the LPs that invested in 2005 to 2008, [and] their voices overshadow the one in 10 that stayed with it,” he says. “The people who put out money then were still on the fence licking their wounds as recently as a couple of years ago. They’re now getting to a stage where they can acknowledge that mistakes were made in terms of the managers or strategies or whatever. They are ready to move on.”

A beautiful thing

Since the crisis started, managers still ambitious to succeed in India claim to have learned too. The lesson for them, they confide, was in finding a focused strategy that is as robust as it is attractive. It must be easily explained to investors too. For Everstone that meant tightening the remit to funds focused purely on logistics real estate. Red Fort meanwhile has kept its focus predominantly on the residential market. “Strategies today are far more sharply focused than five years ago, when pretty much everybody wanted to do everything,” Sriniwasan says. “It’s only now that you get ‘real’ real estate investments, because people have gone through the cycles, people have learned from their mistakes. There are survivors and then there are people who decided to leave the industry. That leaves you with a consolidated industry and very few managers.” Those that have survived have done so because they have adopted clearly defined and often limited strategies, PERE hears. And that is playing into the hands of institutional investors as they seek to cement long-term positions. “The market is a beautiful thing: it’s weeded out people who know what they’re doing and those that do not,” Bedi points out. “And so once a person decides to re-look at India, it’s actually much easier to underwrite the manager, strategy, track record, and then to put capital to work.” While distinct strategies are top of the agenda, also important these days is for real estate investment managers to be able to demonstrate operational expertise. The ability to source a development is today as attractive, if not more, as sourcing a developer with which to partner. The same applies to developers too when it comes to attracting private equity partners. “The number of developers who will receive capital has shrunk significantly, so it’s easy for Subhash or myself or any of these guys to look at the paper and say, ‘might be a great project, but this developer? Not doing it,’” Sriniwasan says. Investing then gets even harder as the good developers become cognizant of their increasingly attractive position, Jaggi adds.

The participants Subramanian Sriniwasan Chief executive officer, Kotak Realty Fund Director, Kotak Investment Advisors Sriniwasan joined the Kotak Mahindra group in 1993, working in its investment banking joint venture with Goldman Sachs until 2005. Now serving as the chief executive of Kotak Realty Fund and the founder of Kotak Mahindra’s real estate fund management business, he raised the firm’s first $100 million fund in 2005. Under his leadership Kotak Realty has scaled up to over $1 billion assets under management.

Rajesh Jaggi Managing partner, real estate Everstone Capital With over 14 years of real estate experience in India, Jaggi is responsible for all facets of Everstone’s real estate investments and operations. Prior to Everstone, he was the managing director of Peninsula Land, a $250 million listed Indian real estate company. Everstone has about $2 billion under management and has developed 33 million square feet of retail, residential, commercial and industrial real estate projects across 16 Indian cities.

Subhash Bedi Managing director Red Fort Capital One of the founders of the $1 billion Indian real estate fund manager, Bedi has led or closed about $1 billion of Indian real estate transactions. Before starting Red Fort in 2007, he held the position of partner at advisory firms Krista International and American Capital Realty.

Khushru Jijina Managing director Indiareit Fund Advisors With over 2 decades of experience in real estate, corporate finance and treasury management, Jijina was one of the key founders of Indiareit in 2005. He played a key role in raising the firm’s two domestic funds (totaling INR1,014 crores) and the $200 million Offshore Fund, as well as in deploying that capital. The firm currently has INR43 billion under management.

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Roundtable | India

Of course, this emphasis on operational expertise can provoke certain investors to miss out the investment manager altogether in favor of working directly with the lions within the developer fraternity. “Developers also know that they are being chased by private equity money,” Jaggi adds. That is why, the table agrees, it is important nowadays for the manager to demonstrate its development credentials, whether to work better alongside developers or, in some instances, replace them altogether.

Hands on, cash out

Bedi points out that by focusing their strategies on logistics and residential respectively, Everstone and Red Fort have made themselves into fund managers cum developers. Further, an

allocator-only approach of throwing capital at developers from a corporate tower and expecting quarterly interest payments is “doomed to fail,” he claims. “That’s what happened in 2006: you don’t just show up at a quarterly board meeting and expect your money back.” Each of today’s participants can share anecdotes of peers doing that with negative outcomes. “So all of us have strong operational teams involved in these projects,” says Bedi, motioning to everyone around the table. “Because at the end of the day, the developer’s going to give your money back if he’s making money.” The Red Fort executive says to that end his firm employs staff with development expertise to ensure a strong outcome. However adept a firm’s development expertise becomes working with bona fide developers will remain a reality. Jaggi

The big picture Inflation (CPI)

GDP growth rate

14%

12%

12%

10%

10%

8%

8%

6%

6%

4%

4%

2%

2% 0%

2013

(to date)

2012

2011

2010

2009

2008

2007

2006

0%

2013

(projected)

2012

2011

2010

2009

2008

2007

Indian inflation has been hard to curtail since the global financial crisis started while the country’s growth has also taken a battering in recent years Source: Inflation.eu; World Bank

24

PERE | THE INDIA REPORT 2013

2006

International assumptions

The roundtable underlines the feeling that operating as a fund manager and a developer concurrently can be challenging, particularly when you consider India’s real estate investment proposition predominantly centers on development. One major challenge is staying abreast of local movements in the market and government regulation. Since most regions of India are subject as much to localized forces as countrywide forces, adding value in one area of the country might have little in common with adding value in another. Jijina says: “People ask me what the prices are in Mumbai now. Are they going down? You can’t generalize. It can be central Mumbai versus the eastern or western suburbs. These markets do not perform uniformly.” He admits this can be frustrating for new entrants to the market as they apply experiences gleaned from other corners of the globe to India’s property markets. International investment assumptions are of little help in India, Sriniwasan continues. While an investor might balk at the proposition of say, a township that is completely sold out even though the road to it still is not built – he has offered tractor rides for site visits on occasion – the development mentality in the country is such that these schemes often still work. “These guys are saying: ‘what’s going on in this country? There’s no road here, but everything is sold,” he explains. The roundtablers admit the idea of needing “local expertise” in real estate has been rehashed beyond cliché. However, such

Exchange fate When it comes to arresting the decline in value of India’s rupee compared to international currencies, PERE’s India roundtable believes India’s central government has their backs. Real estate investment managers active in India perennially worry about rapidly changing local policies. That is unsurprising given India is a country comprising 29 states, each with largely independent economies. Nonetheless, at PERE’s India roundtable a central government issue is more pressing: the falling price of the rupee when compared to international currencies. The value of the rupee is understandably enough to keep many fund managers up at night, as it has fallen by about 50 percent since 2008. In 2013 alone, the currency’s valuation has fallen from INR54.8 per 1 US dollar to INR61. The table remarks that it has not seen fall in valuation like this since 1991. Kotak’s Sriniwasan says it has been eating into fund performance with some investors having lost 6 percent to 7 percent in value on the exchange rate alone. Sriniwasan, however, is not panicking because of commitments the government has made to prevent it from dropping too far below 60 rupees to the dollar. In 1991, to honor a similar commitment, the government actually guaranteed a buffer with its gold reserves, and Sriniwasan believes it is just as committed this time. “I’m not worried, because India always works when its back is against the wall, and it currently has its back to the wall,” he says.

Currency trap

USD/Rupee conversion last 5 years 65 Rupee per dollar

reiterates the need for a hands-on approach in such situations. “We actually sit with the developer and go through the plans, we go through the costing, we go through everything. So it’s almost like we’re managing the show together.” Such micromanagement was rare between 2005 and 2008. Then, he recalls: “everyone just made investments on a spreadsheet.” The roundtable agrees unanimously the market is healthier for its better engagement with development partners. Further, investing in development via a fund manager like those present today offers a selection of possibilities in terms of what form the investment takes. Versus 2006, when investors had few options beyond taking equity positions in developments, Bedi says: “Today, you can do development as equity, you can do development as debt, you can actually invest in an NBFC [non-banking financial company] if you choose to do so, and you can buy yield-producing assets.” Playing the role of developer comes with a price for managers, however. For one, most managers cannot charge development fees in addition to management fees. While not a legal condition, Bedi says it would not be acceptable to institutional investors, given the high risk associated with deploying capital in what is still widely regarded as an immature property market.“Investors are happy to give development fees in much more mature markets to private equity fund managers,” he says. “I guarantee you, the Indian fund manager is doing triple what those funds do, but we can’t charge for it.” Despite begrudging the lack of fees, Bedi’s peers here today extol a certain prowess when describing their development capabilities. “We always say that we are real estate professionals first and fund managers second,” says Jijina.

60 55 50 45 40

2009

2010

2011

2012

2013

Rupees have fallen in value by 50 percent compared to the US dollar and that has trapped some of the first foreign investors in Indian real estate. Source: XE.com

are the intricate nuances between one suburb and another, let alone one city and another, it unquestionably still carries weight. Jijina illustrates by touching on the processes of gaining planning permissions. Delhi’s system is different from Mumbai where the process can take up to two years. That implies potentially sticky situations for limited-life investment THE INDIA REPORT 2013 | PERE

25

Roundtable | India

mandates that need to see returns quicker. To mitigate possible investment paralysis Jijina says his experience and the right connections have enabled him to push certain projects through the system in as little as six months. Jaggi believes the key to ensuring local expertise is by recruiting in markets in which the firm wants to transact. This roundtable won’t identify platforms which had “plopped” an international executive into a role that demanded local nous but said these platforms were burned because the executive could not grasp local practices effectively. This gives the table a reason to warn investors keen to shun third-party investment managers and tie-up with developers directly to reconsider. One recent tie-up came last summer when Dutch pension manager Algemene Pensioen Group (APG) partnered with Mumbai-listed developer Godrej Properties (see guest commentary, page 11) to form a residential development company, with an initial capital injection of INR770 crore (€109.5 million; $138 million). The JV firm has earmarked the next seven years for generating returns, and in the meantime APG has told PERE it is unlikely to commit to a fund structure in India. Though not referring directly to APG and Godrej, the managers of this roundtable say that while direct partnerships can work, especially for income-producing assets, development is an “entirely different animal” and investors doing it directly will need to commit plenty of resources to the effort, and not only capital. Sriniwasan’s Kotak is one firm that has managed to attract the capital of large institutional investors that would rather trust a third-party manager than wade into the market directly. While he could not divulge the firm’s capital raising activities, it was reported in the summer that Kotak has raised $200 million in seed capital for its latest offshore fund from sovereign wealth fund Abu Dhabi Investment Authority. Likewise, Everstone also held a $200 million first close in May for its $350 million JV logistics fund with capital commitments from around half a dozen US investors. And PERE has learned that Red Fort is poised to hold a first closing for its third opportunistic fund for which it wants $500 million. The members of this roundtable believe it is equipped to work with developers. “At the end of the day, I would say the toughest beast to tame in India is your [joint venture] partner,” Bedi says. “A lot of times people ask me, ‘Why are the Indian managers so cocky?’ Well, the ones that are left have to tame these lions.” He draws a distinction with “some classic Harvard business school turned New York investment banker” who, in his opinion, “would be eaten alive,” to explain why Indian real estate fund managers might have “strong personalities.”

Long haulers

“It’s been our experience that it takes time for a person to peel the onion on India,” Bedi explains. Consequently, it is of little surprise to this roundtable that it is the largest institutional investors that have returned to the market first as these typically have longer-term investment horizons. Accordingly, it is the prerogative of the managers present today to appeal to this source of capital with strategies that fit a lengthier tenure than before. 26

PERE | THE INDIA REPORT 2013

“When we’re talking to the LP world, we are actually wanting them to commit money for the longer time frame,” Jaggi says. The Indian real estate market also goes through very fast cycles, Jijina adds. A six-year project might pass through two complete cycles, he points out. As such, a poorly-timed entry or exit could derail its prospects. Bedi wades in: “Am I brilliant enough to pick the peaks in values? No. But I do know that the fundamentals of the middle class are there, so over a five or six-year project, it’s all going to even out.” It is little wonder then why certain investors have committed capital to evergreen investment structures that peg their fortunes to a longer time frame. But what does that mean for managers of limited life funds? Perhaps predictably, this group of managers still sees a place for closed-ended offerings. By Bedi’s reckoning a five-year fund is dangerously short but a fund life of between eight years and ten years is about the right gauge. Widely agreed is that the impatience for quick returns commonly associated with domestic capital makes it less appealing compared to the longer-term positions sought by international equity providers. There’s a feeling that the property investments of India’s non-banking financial companies (NBFCs), for example, are an accident “bound to happen” and, as such, avoiding this nonetheless sizable pool of resources is advisable. The Reserve Bank of India has thousands of NBFCs registered to hand out short-term loans like banks. However, the roundtablers believe very few know how to properly underwrite real estate risk nor do they appreciate how long development can take to bear fruit. And the table points out that international investors that have taken longer horizon positions, perhaps ironically, have already begun reaping the rewards. Indeed, since 2010, private equity real estate firms have made 66 exits, returning more than $3 billion to investors, according to Venture Intelligence. While in no way comparable to the mountain of overseas capital invested before the crisis, that’s still quite a leap from the $736 million returned from 10 exits between 2006 and 2009 that the data provider has recorded. “The people that had longer-term conviction and stayed with the long-term story putting capital to work in 2012, 2011, even 2010, they’ve seen the results, they’ve made money, and they’re willing to invest more,” Bedi says. Long-term investors have taken the strategic call to stay invested in India’s property markets and as such, it is unlikely the market will see such attrition as it did before. “If you know the strategy you’re following, you’re convinced about it, I think then you are able to play the long-term real estate game,” Jaggi concludes. By the time the roundtable concludes, the storm has cleared over Mumbai. The sky is still gray, but the four participants are glad to step outside for PERE’s cameraman to take photographs set against the city’s varied skyline. The property visible from the terrace ranges from greenfield developments in their infancy to completed grade A office buildings, aptly demonstrating that, even here in India’s financial stronghold, the market is still a work in progress. For these tigers who feel their survival enables them to lead investors into the next chapter for private real estate investing in India, it is work they are gladly still engaged with.

Four lines of site At the end of PERE’s India roundtable participants were asked to peer into their crystal balls to provide a snapshot of what might happen in the country’s private real estate market tomorrow. Subramanian Sriniwasan, chief executive Kotak, Investment Advisors: Admitting he is going out on a limb, Sriniwasan predicts private real estate in India will benefit from much better liquidity during the next 12 to 18 months. In addition to healthier recent capital raisings the Indian government is edging closer to implementing a REIT regime which this roundtable regards as a viable exit route. Extending the point, he sees better engagement with international investors from policymakers. “So I would not be surprised if the carpet is rolled out to sovereign wealth funds and public pension funds, which means better exits and better norms for all investors,” he notes. Rajesh Jaggi, managing partner, Everstone Capital: Jaggi foretells of a private Indian real estate market where there’s more focus on commercial real estate, even perhaps as much as there currently is on the country’s residential market. Many firms are coming to see retail and commercial assets as “insurance,” Jaggi explains. Now that those sectors are becoming more mature and their prices are currently bottoming out, Jaggi predicts some exciting opportunities to materialize. “I think that’s where the running starts,” he adds. Subhash Bedi, managing director, Red Fort Capital: Bedi sees a future involving another wave of institutional capital seeking private real estate crashing on India’s shores. He cautiously welcomes it but fears there might not be enough appropriate investment opportunities to satisfy the demand. “We all tell the story, in some way, shape or form, that the lack of capital has created opportunity for people who have capital in real estate today,” he says. “Could that go away if all of a sudden a bunch of new capital came to India? Yes, it could.” Khushru Jijina, managing director, Indiareit Fund Advisors: Jijina predicts the demise of non-banking financial companies as private real estate investors. Labeling them short-term in nature and a poor underwriter of risk he says at least one will “blow up” in the next 12 to 18 months. Says Jijina “There are many opportunistic lenders in the market today who are perhaps not adequately underwriting the risks inherent in investing. There is some stress in the system and I foresee some defaults as inevitable. I fear that investors would tend to blame the sector again rather than treat these as anomalies stemming from a lack of understanding.”

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27

KEYNOTE INTERVIEW | THE XANDER GROUP

Hunting for alpha Established in 2005 by former CBRE Asia executive Siddharth Yog, alongside former co-founder of TA Associates Realty and current Poorvu family Professor of Real Estate at Harvard Business School, Arthur Segel, The Xander Group Inc. has raised a number of private equity real estate funds, created a retail platform of scale and has also moved into debt financing. David Hawkins sat down with Yog to hear more about the group’s engagement with India.

I

t is late on in the interview with Sid Yog, the co-founder and enough for him to have seen two full investment cycles. It is managing partner of The Xander Group, and the discussion with that in mind that he argues that Indian real estate is not has returned to investing, particularly the fundamentals fundamentally different to other markets - but that you need of returns expectation and delivery. It is suggested that inves- to understand what these cycles mean specific to different astors looking at gaining exposure to Indian real estate in their set classes across markets within India - and what they don’t. allocation mix are doing so in search of alpha: the potential to “When you are cycling downhill everyone is a champion. It’s achieve outsize returns on a risk-adjusted basis. Yog frowns at when the going gets tough that conviction and skill is importhe generalization: “The market never returns alpha, the man- tant,” he says, “and we can see opportunities to both buy and ager does. Markets should never be expected to deliver alpha. create value in India today.” “You must remember that foreign investors could only invest And for many investors it would be far better if they didn’t rely on the market alone to generate returns when they deploy capi- in greenfield projects of more than 25 acres or 550,000 square feet between 2005 and 2010,” says Yog, “although many tried tal in Indian real estate.” Clearly for Yog, whose firm has over US$2 billion of equity to find a way around this requirement by using debt-like strucunder management, the vast majority of which, circa. $1.5bn, tures and then burnt their fingers badly as regulators clamped is in real assets in India, there is a constant need to stress test down.” This regulatory limitation required investors not only to find development partners to work with but also assumptions about the investment proposition to have the development skills to manage both this market offers. “For short term investors we the project and the partner. It was no surprise think there are better opportunities in other parts that many found this challenging in a market that of the world. Only if you are a medium to long was at once extremely local and often opaque. Yog term investor does India look to be at an interesthas no illusions that many of these challenges ing stage,” he continues. remain: “The biggest risks to doing business in For in Yog’s view the Indian real estate markets India relates to ESG [Environmental, Social and are certainly interesting at the moment; the macGovernance].” And ” he continues, “that substanro-growth story has proved to be less predictable tially limits the universe of vanilla opportunities than some expected, liquidity is extremely tight, we look at in this market.” local and international real estate investors have For Xander today, these opportunities to debeen left nursing sometimes sizeable wounds Yog: the market never ploy capital in India take three forms. The firm is and as a result many are searching for answers to returns alpha currently investing its fourth opportunistic fund questions they never expected to ask. – it is 50 per cent committed - and also has a high “I would tend to agree with those investors who say: ‘Why India now…?’, when some of their domestic markets yield debt business in the form of Xander Finance, although it can offer better short term returns. I also think it vital investors is the firm’s investment in Virtuous Retail that has captured the recalibrate their return expectations - wherever they are look- most headlines [see box]. Yog describes his company as being a classic private equity ing in the world - because those 30 per cent plus returns are rare anywhere without substantial leverage and risk, and even operation where he and his team spread across three offices in then - arguably - not of meaningful scale.” It is worth noting India - and also in their Asian headquarters in Singapore and here that Xander has reported a USD IRR of 28.48 per cent for Yog’s office in London - are always looking at how to uncover its first 2005 vintage opportunistic fund [which is in the final value. That has meant that they have alighted not just on real stages of liquidation], net of fees, promote, expenses as well as estate opportunities but also on infrastructure-flavored assets after factoring in the rupee’s depreciation. Yog also points out in India too: in 2010 the firm acquired a portfolio of toll roads, that the firm achieved this with almost zero leverage across the that were a mix of already built and operating and advanced development projects. fund or the underlying assets. The company has also been acquiring class A buildings Xander has been investing in India since the real estate market opened to foreign investment in March 2005 and Yog him- [whether let or not] in India’s gateway cities, a strategy that has self has been involved with Indian real estate since 1993 - long become increasingly popular amongst a number of fund man28

PERE | THE INDIA REPORT 2013

agers. Indeed, Xander has been outbid on a number of occasions recently, something that gives Yog pause for thought: “I think those investors who are buying core assets and are counting on cap rate compression will suffer. If you can buy off market deals at attractive valuations and then value-add to improve the numerator or cash flow then that is still interesting. But don’t just rely on the denominator to deliver the value.”

This last point takes the conversation back to that issue of defining, and delivering, alpha. For Yog, any fund manager deploying capital into Indian real estate is going to have to be both bold and extremely cautious. “You never can afford to lose sight of the many risks, never assume that a local opportunity can be scaled more widely. But there is still lots to win here: India is still significantly under built.”

Delivering value in retail In 2007 Xander initiated what many engaged with Indian ceived the prior day [41,000, it was a Sunday] and remains real estate saw as the firm’s boldest – and some would add bemused at others’ attempts to deliver retail projects for riskiest – investment project yet. Virtuous Retail [VR] is a international tenants: “they were located in the middle of platform 100 percent owned by the group that is develop- agricultural fields or are sometimes eight storeys high!” Key for Xander is the opportunity to exploit VR’s first ing upwards of 10 premium retail developments across India either exclusively or on a joint venture basis. Each is at mover advantage by developing a portfolio of prime releast 550,000 square foot in size, each is designed to home tail developments that other foreign investors, owners or global brands anxious to engage with the Indian consum- developers would take years to replicate. “We have been er and each is being developed to a precise set of criteria at this since 2007 and our current developments and pipeline are much more advanced than anybody else’s,” says and standards. No one thinks it’s going to be easy. “Virtuous Retail is in an independent platform,” em- Yog. “These projects need scale - between 550,000 and 1m square feet - and if you are phasizes Yog [who is chairlooking to build out nine man of VR], “so we have the or 10 of these you will take same relationship with it as some time. No retail project we do with any other of our can be delivered in 2 years investments - we just hapwe can’t see how that could pen to own all of it. It has a ever happen - it will take at completely independent least 4-6 years per project.” management team and we And the VR team have cerare both the venture capital tainly been busy: the next and growth equity provider, development will open In with the hope of being the Whitefield in Bangalore in buy-out investor as well..” July 2014 [VR has two furXander financed Virtuther developments planned ous Retail with $600m of for the city], then Pune in equity, $500m coming from VR Surat: the first release from Virtuous Retail late 2014, Mumbai in late Xander’s investors expressly 2015, Chennai in early 2016 for this special strategy and $100m co-invested via their 2006 opportunistic fund - all with Kolkata arriving later that year. So how is Surat performing? “We’re 80 percent let and on the same terms and at the same time. “We raised equity for the platform but it is an evergreen venture for us. This is the last leases signed were between 160 and 180 rupees not a blind pool - all our investors understood the plan. It’s [US$2.62 to US$3] per square foot per month triple net a nine year strategy for our current investors, who will be on the ground floor,” declares Yog. The in-place income replaced with longer term public or private capital at the will deliver a yield of over 15 percent in the first full year, with future upsides from three yearly rental escalations, appropriate time.” Six years in and VR has gone live with the first devel- revenue shares (all leases have a revenue share compoopment in Surat [population 6 million] which opened in nent) and commercialization income. More broadly the VR April of this year. “People asked: ‘Why Surat? Why go there platform is already evidencing the returns potential that where the customers don’t exist?’” reports Yog, “and I said: Xander’s investors want: “Virtuous Retail enables us to ‘Guys, just because you haven’t developed the product deliver value at different times and in multiple ways that are interesting: in terms of dividends from annual income doesn’t mean the customer doesn’t exist’.” Yog clearly is aware of the nay-sayers and stays very refinancing at the appropriate time [VR has zero debt curclose to both VR’s operations let alone strategy: he ea- rently] and potentially future minority equity interest sales gerly shares how many visitors the Surat development re- at the asset and/or the platform level.”

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Regulation and tax

Regulation and tax snapshot Navigating the current tax and regulatory environment in India for private real estate investors is a challenge but it is getting easier. By Maadhav Poddar, Associate Director, Ernst & Young LLP

T

he Indian real estate construction development sector has seen very strong growth in the last decade. Among factors such as urbanization and increasing disposable incomes a significant reason is the permitting by the Indian government of foreign direct investment (FDI) in the real estate construction development sector in March 2005. Since then, this sector has garnered significant interest from both strategic and financial investors from around the globe. Within this sector, sub-sectors that have caught the fancy of foreign investors are housing, urban offices and investments made within special economic zones.

Foreign investment policy

A holistic reading of this policy suggests that, as regards assets listed above, FDI is only permitted in green field projects. FDI is not permitted in completed projects. As regards assets listed

in items B & C, FDI is permitted both in green field projects as well as completed assets. External commercial debt is generally not permitted in this sector except in certain kind of specified projects. The above policy was first introduced in March 2005 and there has not been any significant change to it since. There has been uncertainty regarding A. For one, there has been confusion as to the definition of green field and brown field projects. There has also been confusion about FDI requirements on mixed-use projects, for example a project comprising a hotel and a shopping mall. Further, there has been confusion as to the applicability of conditions in the case of a large township project: does the policy cover whole townships or does each sub-project require classification? Confusion has also set in over the application of minimum capitalization requirements in case of a restructuring. That has been particularly apparent in cases of mergers or de-mergers. Can

A brief snapshot of the prevalent FDI policy in the Indian real estate construction development sector:

Serial No A

Nature of asset Housing, townships, commercial premises, shopping malls

% of FDI allowed and whether approval route or automatic route Key conditions 100% automatic route

1.

2. 3.

4.

Minimum area to be developed - in case of serviced housing plots minimum land area of 10 hectares; in case of construction-development projects - minimum built-up area of 50,000 sq.mts; in case of combination project - any one of the above two conditions would suffice. Minimum capitalization of US$10 million for wholly owned subsidiaries and US$ 5 million for joint ventures with Indian partners. Original investment cannot be repatriated before a period of three years from completion of minimum capitalization. However, the investor may be permitted to exit earlier with prior approval of the Government through the FIPB. At least 50% of each such project must be developed within a period of five years from the date of obtaining all statutory clearances. The investor/ investee company would not be permitted to sell undeveloped plots.

B

Hotels & tourism projects, hospitals, Special Economic Zones (SEZs), education infrastructure, old age homes, warehousing,

100% automatic route

No conditions prescribed

C

Industrial Parks

100% automatic route

1. 2. 3.

D

30

FDI is not allowed in real estate business

PERE | THE INDIA REPORT 2013

Infrastructure, common facilities, industrial activity specifically defined in the policy It should comprise of a minimum of 10 units and no single unit should occupy more than 50% of the allocable area The minimum percentage of the area to be allocated for industrial activity shall not be less than 66% of the total allocable area

an initial non-resident investor exit to another incoming nonresident investor if the asset is completed and has complied with FDI requirements is another question without seemingly a clear answer. Given that the policy is almost a decade old, it has outlived its useful life, and significant changes are required to help this sector evolve to its next level.

AIFs & REITs

In the last few years, the concept of pooling domestic funds from high net worth investors and investing as part of an Alternate Investment Fund (AIF) structure has also gained attraction. AIFs are governed by the Securities and Exchange Board of India (SEBI) and at concept level, the AIF regulation had been introduced to monitor private pooled investment vehicles and replace domestic venture capital regulations. From a tax perspective, depending on the structure of the AIF, it may be possible to achieve tax transparency. But, while the AIF seems to be a good route for pooled investments, there is lack of clarity as regards foreign investment in AIFs which focus on real estate construction development investments. Given that AIFs are already regulated by SEBI, the government could consider allowing FDI in AIFs under the automatic route without any conditions which otherwise apply to the real estate construction development sector. Mature economies such as Japan, US, Singapore and HongKong offer investors the choice of investing in real estate in a systematic and diversified manner, through Real Estate Investment Trusts (REITs) or Business Trusts. In 2008, SEBI had issued a draft REIT regulation for public comments. The regulation however, could not be implemented due to reasons including: volatility in the Indian real estate market, vulnerability of small investors, lacunae in the regulations. Recent press reports suggest that SEBI is re-considering introducing a REIT-like regime in India, under the AIF platform. Reports also suggest that the trigger for the same is to replicate the success story in real estate listings in Japan, HongKong and Singapore. Given that many developers in India are currently cash-strapped and all traditional sources of finance are inactive, the introduction of a REIT -like regime could open a new source of capital for developers who have large funds locked in completed commercial assets.

Indian parliament: the Union Cabinet Committee has finally approved the Real Estate (Regulation and Development) Bill 2013

certain transactions; and an uncertainty on withholding tax with regard to cross-border transactions stemming from the Vodafone litigation and changes to the law thereafter. Bringing clarity on ambiguous issues such as these would likely encourage greater investments from both domestic and international players in this sector.

Real Estate (Regulation and Development) Bill, 2013

Earlier this year, the Union Cabinet Committee of the Government of India finally approved the Real Estate (Regulation and Development) Bill 2013. The Bill was also recently placed before the Rajya Sabha, the Upper House of the Indian Parliament, for its consent towards becoming effective law. The Bill proposes setting-up of a Real Estate Regulatory Authority, to monitor the conduct of real estate developers, utilisation of funds for the project, adherence to plans and designs, appropriate disclosures to customers etc. This Bill when it becomes law will contribute towards making the sector more transparent and efficient thereby spurring further investment.

Land Acquisition, Rehabilitation and Resettlement Bill 2011

There has been another bill that has attracted a fair amount of attention recently. Broadly speaking, the Land Acquisition, Rehabilitation and Resettlement Bill 2011 seeks to strengthen the rights of landowners during the acquisition of land for development and to ensure proper rehabilitation Poddar: regulation is and compensation is provided for those being moving in the right direction displaced. In the past there has been public outTax cry over land acquisitions by developers on the On the tax front, the Indian real estate sector also does still suffer from a lack of clarity on a range of issues such ground that the previous land owners were not compensated as stamp duty, service tax, withholding taxes and capital gains appropriately. This Bill seeks to address this issue and make tax. Some such key issues include: The withdrawal of exemp- land acquisition more transparent and smooth. Overall, from a regulatory standpoint, the Indian Governtion from corporate tax, minimum alternate tax and dividend distribution tax benefit (provided earlier) to developers of ment seems to be moving in the right direction, in supporting SEZs; a levy of service tax on rent or lease charges on commer- the real estate sector as a whole, with the proposals on REIT, cial properties; from tax withholding on all real estate trans- the real estate regulation and development bill, land acquiactions of value exceeding INR5 million (€64,000; $85,000); sition bill etc. More support in the form of mature tax and high levels of stamp duties in comparison to other countries stamp duty laws is on the wish-list of industry, which if proand lack of clarity in law with respect to levy of stamp duty on vided could help the industry move to the next level faster. THE INDIA REPORT 2013 | PERE

31

Data Room

Numbers that tell a story There are a host of reference points and metrics to consult when evaluating real estate activity in India but here is some context around how foreign capital is connecting with construction activity, how real estate supply and rentals are trending in the key Indian cities and how the forecast real estate supply for all of the country is set to grow through to 2025.

Foreign Direct Investment in Construction Development 50

9%

46.84

7%

37.74

300

34.83

35

32.90

6%

30 25

24.65

22.82

3%

15

200506

200

200607

200708

200809

Total FDI Inflow (USD billion)

200910

201011

20112012

201213*

150 100

2%

8.96

5 0

250

5%

4%

20

10

350

Million sft

40

400

8%

41.87

Share (%)

45

USD Billion

The Spread of Organized Real Estate Space in Leading Cities of India in 2012

1%

50

0%

0

NCR

Mumbai Bangalore Chennai Hyderabad

Share of FDI Equity Inflows in Construction Development

Residential

Source: Department of Industrial Policy and Promotion* till February 2013 Construction Development includes townships, housing, built-up infrastructure and construction-development projects

Kolkata

Office

Source: CBRE Research

Real Estate Supply in India from 2013 to 2025 (in billion sq ft)* 9

Retail

Pune

India Office Rental Indices 8.2

400

New Delhi-CBD Mumbai-CBD

8

7.8

350

Bangalore-CBD

7.2 6.7 6.3

5 4

3.6

3.8

4.1

4.4

4.7

5.1

5.5

5.8

3

150

50

1 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025

Source: CBRE Research, CREDAI *covers organised office, retail, residential, unorganised residential (urban) only

32

200

100

2

0

250

PERE | THE INDIA REPORT 2013

0

2001 Q1 2001 Q2 2001 Q4 2002 Q2 2002 Q4 2003 Q2 2003 Q4 2004 Q2 2004 Q4 2005 Q2 2005 Q4 2006 Q2 2006 Q4 2007 Q2 2007 Q4 2008 Q2 2008 Q4 2009 Q4 2009 Q2 2010 Q4 2010 Q2 2011 Q4 2011 Q2 2012 Q4

Million sft

6

300

2001 Q1 = 100

7

Source: CBRE Research

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