PM’s reforms have helped create debt boom, but market is ‘frothy’, reports Doug Morrison
With a politician’s impeccable timing, Narendra Modi, India’s pro-business, pro-foreign investment Prime Minister, celebrates his first year in office this month, during what appears to be something of a boom in the country’s market for real estate debt finance, much of it from overseas.
New Cushman & Wakefield figures reveal a surge in the number and value of Indian real estate private equity deals, but with a post-financial crisis focus on structured finance rather than riskier equity investment.
Following “massive fund raising” of $5.2bn between 2012 and 2014, the firm says the number of structured debt deals rose more than 6.3 times in the same period, with a near four-fold leap in investment value. Most of the money is directed at the housing sector, as part of India’s urbanisation process.
“Structured debt finance is likely to dominate real estate funding in the future, as investors will continue to exercise caution while entering pure equity deals,” says Sanjay Dutt, Cushman & Wakefield’s executive managing director, South Asia. “Such deals are also filling the gap left by major Indian banks.”
The firm says structured debt accounted for nearly 75% of all private equity property deals in 2014, with some big global investors among the key players, including Qatar Investment Authority, Standard Chartered and Morgan Stanley (see table).
It would be a stretch to attribute the figures wholly to Modi’s reforms so soon after the election, but overseas investor sentiment towards India has improved in the past 12 months and property has been part of that narrative. As C&W’s research shows, overseas funds and investors accounted for a third of all structured debt deals by value between 2010 and 2014.
This is quite a turnaround. A Legal & General Investment Management briefing paper by emerging market strategist Brian Coulton points out that just two years ago, India was seen as one of the “fragile five” group of emerging market economies struggling with slow growth, high inflation and poor trade balances.
Reforms help spur growth
Coulton says India has been one of the biggest beneficiaries from low oil prices, but Modi’s “better economic policies” have played their part too. The reforms will help India achieve up to 8% economic growth in the medium term, Coulton says. He adds: “Political realities will make progress slow, but early signs have been encouraging, with changes to allow more foreign investment and infrastructure spending.”
Yet more grist to the Indian debt mill was Canada Pension Plan Investment Board’s announcement earlier this year of plans to provide rupee debt financing to residential projects across major cities such as Mumbai, Delhi, Bangalore, Pune and Chennai.
It is one thing for seasoned sovereign wealth funds and investment banks to play in this market, but quite another level of acceptance when blue-chip Western pension funds move in, albeit in this case in a joint venture with one of India’s largest conglomerates, Piramal Enterprises, which has built up a $300m residential loan book in the past two years.
A host of Indian groups have launched debt funds recently, including BlackSoil Realty, Essel Finance, IDFC, Indiabulls, Kotak, Piramal Enterprises and Reliance Capital Asset Management.
CPPIB and Piramal will each chip in an initial $250m to their venture, which some believe shows the way forward for other overseas investors. Dutt says: “Local players bring in expertise and a ready platform for overseas funds/investors, so such partnerships are likely to continue in the future.”
In some respects, domestic and overseas lenders owe a debt of gratitude to Indian conglomerate Kotak Mahindra Group, which claims to have started the present structured finance trend in 2009, when the economy was very fragile, there was little appetite for equity investment in property and even less property lending from India’s main banks.
The group runs three property funds and has $1.2bn under management, of which nearly $800m is structured credit. Though Kotak has not disclosed details, the group is known to be deploying $400m as structured finance on a managed account basis for two sovereign wealth funds, understood to be Qatar Investment Authority and Abu Dhabi Investment Authority.
All of which makes Kotak’s residential stance worth monitoring – and against the prevailing sentiment, it is surprisingly sober.
“It’s a pretty crowded market and there’s probably an oversupply of capital,” says S Sriniwasan, chief executive of the main Kotak Realty Fund. “The market was very attractive between 2009 and mid 2014, but with the level of traffic we are seeing now from limited partnerships and potentially new managers getting commitments from other investors, we are looking at a pretty frothy residential market. There is an excess of capital for structured credit for residential and I’m certainly not raising more capital on that strategy.”
But Sriniwasan admits the long-term case for residential investment is compelling, based on urbanisation, a growing middle class and rising home ownership, all of which first attracted Kotak and its investors. Residential is India’s largest property sector and he says the annual sales volume for the country’s top six cities totals up to $50bn.
Residential sales slowdown
Yet residential sales are slowing, particularly in Delhi and Mumbai. This, plus excess capital from so many investors “coming late to the party”, makes the sector a short-term risk, at least as far as Kotak is concerned.
Sriniwasan says that up to early 2014, three- or four-year residential finance was typically based on 20-22% rupee internal rates of return. But since the middle of last year, competition has forced IRRs down to 18%, while loan-to-value levels have shifted from 30-50% to as high as 90%.
He adds: “We are very cautious right now. It has been over four months since we put out a single dollar of capital [in residential] and we still have at least $200m of dry powder to invest in our managed accounts.”
C&W’s Dutt says that in this increasingly competitive market, structured debt deals are being “commoditised”, so for structured debt to be sustainable, slightly different product structures are needed. He suggests, for instance, that investors should consider providing mezzanine finance and diversify away from residential into steadily recovering sectors such as offices.
“In our opinion, the office market will be quite interesting in the next couple of years,” agrees Sriniwasan. It is worth noting that Qatar Investment Authority and Standard Chartered are exclusively invested in offices.
“Modi effect” is positive
Despite his “long-term positive, short-term negative” residential stance, Sriniwasan acknowledge that the effect of Modi’s reforms on prospective investors “is a factor. People believe that whatever Prime Minister Modi is doing will lead to an economic recovery that should be positive for the real estate market. Modi makes very good press copy, for the right or wrong reasons. So, India as a destination has come back into the reckoning among the LP world.”
But Sriniwasan says as important as Modi for sentiment is the fact that investors have enjoyed solid returns on Indian real estate. He adds: “A lot of the structured investment made in 2009-11 was on a two- to three-year horizon. People have started to see money coming back and I think that has given confidence to other investors.” n