Alternative Investment Funds (AIF) - Category-II Potential of Indian Real Estate

AIFs Neither Face The ALM Mismatch Nor Are Impacted By The Credit Squeeze. Hence, In The Current Scenario, Where Fresh Disbursements Have Been Tough For NBFCs, AIFs Have Not Been Impacted. The Current Crisis Presents A Great Opportunity For AIFs Who Could Partner With Large Developers At Really Attractive Valuations/Prices. Gain more knowledge from the exclusive article by Mr. Sharad Mittal, CEO, Motilal Oswal Real Estate

The Real Estate sector has been reeling under a prolonged down cycle led by high inventory and muted demand. While government’s implementation of Goods and Services Tax (GST) and demonetization led to an initial disruption in the real estate sector, the structural changes over the last two years with the implementation of Real Estate Development and Regulation Act (RERA) and Government’s schemes to push affordable housing, seemed to push the sector towards a new phase of accountability and transparency.

The Rise Of NBFCS

The organized real estate lending universe typically comprises Banks, NBFCs and AIFs. Growing NPAs lead to many PSUs being placed under prompt corrective action (PCA) by the RBI. PSUs were therefore reluctant to lend any further to the realty sector. This void was largely filled by NBFCs and HFCs. For the past five years, NBFC loans to the real estate sector witnessed a phenomenal rise. In FY18 alone, NBFCs accounted for a little more than 50% of developer financing. This rampant growth in NBFC/HFC funding came to a sudden standstill when the industry was hit by a major blow sparked by IL&FS defaults that led to a huge and unprecedented liquidity crisis in September 2018.

The Crisis

The IL&FS defaults in September combined with the selling of some DHFL CPs at a higher yield sparked a crisis in the credit market. Consequently, the asset liability management (ALM) mismatch that already existed in most NBFC/HFCs created a liquidity crisis which impaired their ability to invest in new assets. This liquidity crisis which still exists has been a problem for developers already burdened with piling up inventory.

How AIFs are better placed than NBFCs

An Alternative Investment Fund (AIF) is a privately pooled investment vehicle which collects funds from sophisticated investors, whether Indian or foreign, for investing it in accordance with a defined investment policy for the benefit of its investors. This money is more long term in nature, typically between 7 to 9 years as compared to an average investments’ tenure, which is typically between 3 to 5 years. As a result, AIFs neither face the ALM mismatch nor are impacted by the credit squeeze. Hence, in the current scenario, where fresh disbursements have been tough for NBFCs, AIFs have not been impacted.

The working and operations of NBFCs are regulated by the Reserve Bank of India (RBI). They have to adhere to a lot of regulations including interest payments at monthly rests. Due to these restrictions, it is difficult for NBFCs to structure transactions. In today’s scenario, it is important that developers get maximum money into the project so as to avoid any future cash-flow mismatches due to unavailability of capital. AIFs unlike NBFCs can structure transactions in a way that the cash-flows from the project can initially be utilized towards project completion and regular interest servicing does not put a burden on the project.

Opportunities Lie Ahead For AIFs

Majority of the NBFC lending is concentrated in the Mumbai and Delhi NCR market. The unwinding of this debt across these two markets will pose challenges over the next couple of years for all the stakeholders involved. Along with these challenges, a lot of opportunities shall emerge. Large and well capitalized developers shall have huge opportunities to acquire some of the assets at stressed valuations which would come up over a period of next 2-3 years. These assets could be either through small sized developers who aren’t able to manage projects/ raise capital or through NBFCs stuck in projects due to liquidity issues. The current crisis presents a great opportunity for AIFs who could partner with these large developers at really attractive valuations/prices.

The opportunity can be at various stages arising due to market consolidation and continued halt in NBFC funding:
Buying Land at distressed valuations from NBFCs/ smaller developers.
Discounting of receivables and completed inventory.
Last mile funding - Investments due to undisbursed NBFC sanctions.

Even NRIs can participate through AIFs

According to a report, NRI investments in the real estate sector have doubled to $10.2 billion in 2018 from $5 billion in 2014. In 2022, when independent India turns 75, the Indian real estate sector is expected to receive as much as 30-35% of NRI remittances accounting for nearly $26 billion, the double of what it received in 2018.

However, most of these investments have been made in physical real estate where the growth has been minimal due to prices majorly remaining stagnant across cities for the past few years.

Financial real estate assets (like Real estate Funds, REITs) help investors to make superior risk adjusted returns. Besides, financial assets have way more advantages over physical assets like asset diversification, geographic diversification, active asset management and control, low overhead costs, higher due diligence etc.

Unlike physical assets, returns from financial real estate assets are not dependent on price rise in the property. In fact, the returns are linked to the project profitability.

Given the benefit of AIFs over physical real estate, NRIs have a great opportunity to channelize their money in Indian real estate through financial assets in these times. They can also take benefit of the Double Taxation Avoidance Agreement (DTAA) Treaty that India has with many countries and can enjoy lower taxation by adhering to just a few compliances.

The Views and opinions expressed in this article are those of the authors.The Views and Opinions expressed here do not reflect the view of pmsbazaar.com