WHY PE INVESTORS FIND COMMERCIAL REALTY LUCRATIVE?
As the sector is undergoing challenging times with the drying up of funds from NBFC and banks, private equity investors seem to be the light at the end of the tunnel.
TEXT: LEANDRA MONTEIRO
In the recent months the real estate industry has witnessed a surge in the inflow of private equity funding into the sector. According to a recent industry survey, 37% of Indian UHNWIs increased their allocation in Private Equity in 2018 which is further expected to increase in 2019. On an average, Private Equity, makes 4% allocation in the overall investment portfolio of Indian UHNWIs.
Private equity inflows touched Rs 46,268 crore in 2018 with Mumbai recording the largest share of 27 percent of investments among all cities, According to the industry report, Office sector led the investment inflows commanding 46.4 percent of the annual fund flows. Residential segment investments accounted for a 29 percent share of the total. Though the percentage share was on par with the previous year, investment volumes in absolute terms saw an 11 percent year-on-year dip, standing at Rs 13,320 crore.
There are many reasons for surge in PE investments in real estate sector beginning from introduction and stabilization of RERA to relaxation in FDI norms which has made the entry and exit easy for PE investors. The scarcity of funds from NBFC has been another reason for heightened interest. The inflow in this sector could be largely attributed to various reformatory measures such as SEBI’s REIT guidelines, Government’s Housing for All Mission, the Real Estate (Regulation and Development) Act, Benami Transactions (Prohibition) Amendment Act and progressive relaxation in FDI norms.
COMMERCIAL REALTY LEADING THE WAY
Commercial and office segment is witnessing the highest inflows of PE investments. Especially the Grade-A commercial and office spaces are much in demand. Over the recent years, commercial real estate has been the flavour for several investors. In line with this trend, commercial assets experienced the highest quantum of PE investments in 2018. Some of the reasons for this preference are the quality of assets and tenants, high occupancy levels and rental trends, all of which in turn help PE investors realize better value for their investments.
“One of the primary area of investment is into developers who let out commercial properties to MNC tenants and have very large portfolios of income and rent yielding properties. The REIT listing of Embassy including retaining the listing gain has given the much needed boost to the future listings and confidence to PE investors.” explains Sandeep Shah, Partner, NA Shah Associates LLP.
Due to the positive market indicator and tighter regulations, private equity investors are showing their faith in the Indian real estate sector – particularly the commercial realty. There has been a surge in the entity-level PE investments in retail as well as sunshine sectors of logistics & warehousing. The residential sector has witnessed a massive decline in entity-level PE inflows with investors favouring project level investments for reduced risk exposure. Data centers and student housing emerge as clear winners among new asset classes
PROJECT LEVEL OR ENTITY LEVEL INVESTMENTS?
Entity-level investment is an efficient strategy to get a firmer foothold in the real estate market. It allows a private equity investment firm to not only deploy its capital but also gain synergetic skills in the real estate marketplace. PE firms invariably look for high levels of corporate governance in a real estate development company before deciding to invest in it at an entity level.
“Entity level investments have benefits for the PE investors as well as the real estate developers. For e.g. the PE investor gets the ability to deploy its funds over multiple projects. Similarly, the developer has greater flexibility vis-à-vis use of the funds and can thereby plan his overall financing in a more efficient manner.” says Punit Shah, Partner, Dhruva Advisors.
Project-level investments take shorter-term view of capital deployment as they do not necessarily involve partnering with the developer over the long haul. Rather, a PE firm will invest in a developer’s project, which involves a lower commitment and is, for that reason, a less risky approach to investing in real estate.
Kishan Lal Agrawal, Director, Worldwide Insurance Brokers Ltd, further adds, “The institutional investors have showcased their renewed optimism towards entity-level investments since the real estate sector is currently facing a cash-crunch scenario and most of the projects require long-term investment commitment.”
Unlike earlier, PE firms are now paying greater attention to entity level investments. This is also backed by data which shows that entity level PE investments have increased in the last few years. While other sectors like residential, retail and logistics/warehousing have also obtained PE funding, the rollout of the GST regime coupled with grant of infrastructure status to the logistics sector makes it a space to watch out for in terms of future growth potential.
As per market reports, around 63% of the investors said they are likely to invest up to 20% of their investments in distressed assets which can be availed below cost. However, such assets are often fraught with legal challenges and therefore can be a risky proposition. While the real estate sector is poised for promising growth in 2019 on the back of sound economic fundamentals and demand/supply dynamics, events like the outcome of general elections will also play a critical role in shaping the sector’s fortunes.