With a growth of 30% per annum, which is expected to continue well into the next decade, India’s real estate sector is understandably hungry for funds. The equity capital markets are their prime source for fund-raising. Private placements, public offerings, overseas listings, convertible bonds – all avenues are being explored to fund ever-escalating land prices and massive construction projects.
The involvement of the capital markets is a new phase for Indian real estate. Most players were, and continue to be, family-owned companies. Their area of coverage has historically been regional; accordingly, their size was in the small to mid-cap range. But thanks to urbanization, demographics and a galloping GDP, the sector has seen expansion in geographies and project sizes. Plus, asset prices have hit the roof and inflated the valuation of these firms. The growth story is undeniable and it appears a most attractive time to invest in property and construction. As a result, despite the well-known transparency problems on-the-ground in the sector, global investors are participating heartily.
Overseas listings began last year as several developers – such as by K Raheja, Hiranandani and Unitech – tapped London Stock Exchange’s (LSE) Alternative Investment Market (AIM) to raise funds. Following them this year were DEV Property Development (related to Indiabulls Real Estate), which raised US$270 million and Naya Bharat Property (US$60 million).
Going forward, Singapore looks set to be an exchange of choice. The first Indian property trust was listed here in July by Ascendas, a Singapore based regional property developer. The company has developed several IT-parks in India and bundled four of its projects across Hyderabad, Bangalore and Chennai into the trust. It has since indicated that dividends to shareholders in its fiscal first half will be 17% higher than its forecast, which should encourage investors to consider future REITs from the country. At least two major trust listings are expected to follow the route in early 2008. One sponsored by Unitech (about US$700 million) and the other by DLF Assets, a DLF group company (US$1 billion-plus).
Singapore’s established REIT market is an attractive contrast to India’s stock exchanges where the regulator has failed to put up guidelines for REITs despite the market’s anticipation of an approval for over a year. Nevertheless, domestic equity has seen a lot of activity. DLF’s US$2.27 billion IPO was the largest in India to date. Omaxe, another prime property developer, raised US$140 million (excluding greenshoe) in a heavily oversubscribed IPO. Purvankara Projects raised another US$215 million. Action is expected to continue full swing into next year. Among the most anticipated deals is Emaar MGF US$1 billion-plus IPO.
The debt markets, however, are a different story as regulators have largely fettered the sector’s access to borrowing. Bank loans have regulatory limits on how much they can lend to real estate, and in any case, capital thus raised cannot be used for purchasing land parcels.
The international debt markets are out-of-bounds for end-use in real estate under the External Commercial Borrowing (ECB) guidelines. And domestic debt markets aren’t a viable option as they are dominated by sovereign paper where corporate activity is minimal. Using legal loopholes, several players have issued structured paper that in spirit is borrowing (covered under ECB guidelines, hence not permitted for real estate end-use) but in law is equity (covered under FDI guidelines).
Take for instance, redeemable preference shares. The company pays a fixed coupon and redeems the share upon maturity, which makes the instrument similar to debt. Moreover, the promoter suffers no dilution – and in a landscape marked by family-owned and promoted companies, loss of control is a keen issue. Till mid-2007, this class of paper was classified under equity and was used by several players, such as Emaar-MGF, DLF and others, to raise fund from foreign investors
By June, RBI had wised up to the trend and noted, “...some Indian companies are raising funds under the FDI route through issue of hybrid instruments...which are intrinsically debt-like instruments. Routing of debt flows through the FDI route circumvents the framework in place for regulating debt flows into the country.” It proceeded to put all classes of convertible bonds and preference shares under ECB, unless they were fully and mandatorily convertible into equity shares.
But the subterfuge continues. Now fully convertible debentures that convert into common equity shares are being issued – but along with a put option to the issuer so that he can buyback that equity.
