Wednesday, November 24, 2010

A snapshot of the Real Estate sector

The real estate industry in India is currently estimated to be worth approximately US$ 16 billion with a CAGR of 30%. Growth in this sector is driven primarily by IT/ITeS, growing presence of foreign businesses in India, the globalization of Indian corporates and the rapidly growing middle class. The high growth curve in the real estate sector also owes some credit to the liberalized Foreign Direct Investments (FDI) regime in the real estate sector.
Role of FDIs in real estate
The Government of India in March 2005 amended existing norms to allow 100 per cent FDI in the construction business. This liberalization cleared the path for foreign investment to meet the demand for development of the commercial and residential real estate sectors. It has also encouraged several large financial firms and private equity funds to launch exclusive funds targeting the Indian real estate sector.

In 2003-04, India received total FDI inflow of US$ 2.70 billion, of which only 4.5% was committed to real estate sector. However, in 2005-06, post the liberalization, this figure went up dramatically. While total FDIs in India were estimated at US$ 5.46 billion, the real estate share in them was around 16%. The sector emerged as the recipient of the highest levels of FDI equity inflows in 2007-08, with a near five-fold increase over FY07.
India attracted FDI equity inflows of US$ 2,214 million in April 2010. The cumulative amount of FDI equity inflows from August 1991 to April 2010 stood at US$ 134,642 million, according to the data released by the Department of Industrial Policy and Promotion (DIPP). Better to put numbers in billions itself as done above
India will continue to remain among the top five attractive destinations for international investors during 2010-11, according to United Nations Conference on Trade and Development (UNCTAD).
Recent Developments
A recent joint report by Ernst and Young has urged the government to improve the regulatory environment to facilitate real estate development in order to stay ahead in the economic race. Some of the salient proposals of the report are:
  • Creation of a regulatory body for real estate: The ministry of housing had issued a draft Model Real Estate Act in September 2009; the purpose of which was to establish a regulatory authority for the sector. The report has suggested that the role of the body should be purely advisory, and should not serve as a hurdle to growth.
  • Infrastructure status to housing: Foreign direct investment norms of minimum area and minimum capitalization should be relaxed in case of affordable housing. At present, foreign investors are restricted by a minimum capitalisation requirement of $10 million (around Rs 45 crore) for wholly-owned subsidiaries and $5 million (around Rs 22.5 crore) for joint ventures with Indian partners; and a minimum area of 50,000 sq metres.
  • Greater flexibility to foreign investors: According to the report, the three-year lock-in period for Foreign Direct Investment (FDI) in the real estate sector has been dubbed as too tough a restriction to allow the smooth flow of foreign funds. Currently while the original money invested cannot be repatriated before a period of three years from the completion of minimum capitalisation, investors can exit earlier with prior approval of the government through the Foreign Investment Promotion Board (FIPB). This approval is very difficult to obtain, and cases of investors exiting before three years have been very rare. It has also been proposed that greater leeway be given to foreign investors in cases of dispute between residents and non-residents, and the non-resident wishes to exit the project; or where the project could not be initiated due to lack of statutory clearances.
Government Decisions
In September, this year, the government announced that foreign investors in the country’s real estate sector will have to remain invested for a minimum of three years and rejected industry claims about the policy restricting FDI inflows.
According to Commerce and Industry Minister Anand Sharma, foreign investors should be willing to stay invested for longer than three years. The purported purpose of the move is to limit exposure of the domestic economy to external risks and fluctuations. In fact, Sharma pointed out, India was able to come out of the real estate generated global financial downturn quickly only because of its prudent policies in FDI. India’s central bank, RBI too is highly cautious of allowing unrestricted FDI into the real estate sector.
Furthermore, the department of Industrial Policy and Promotion (DIPP) has clarified that the lock-in period of three years will be applied from the date of receipt of each instalment/tranche of FDI or from the date of completion of minimum capitalisation, whichever is later. Previously, it was understood that original investment meant initial investment. DIPP has clarified it implies total investment.
The change could be a boon to at least 30 Indian real estate groups, large as well as small, which had sold put options to foreign investors to bring in FDI through various deals. These put options required the Indian promoter to buy out the foreign investor. But grappling with a cash crunch, low demand and soft property prices, these developers are today not in a position to honour these options. And, even if they can cough up the amount, they want to avert a large payout.
Under these circumstances, if the government spells out that the entire investment of the foreign investor belocked-in for three years, the foreign investor will not be able to exercise the option immediately. This will give several cash-strapped developers time to organise money. However, it will further dampen the sentiments of foreign investors in real estate.
Future prospects
The Indian market has emerged as an attractive destination for foreign investors interested in investing in the retail sector. India was ranked as the fifth most attractive destination for future real estate investments in a list topped by China, according to a latest report of FCCI and Ernst and Young. In such a scenario, given the forthcoming opportunities, policy restrictions would not be the best way to protect traditional retailers.
The government should instead impose regulations such as sourcing requirements, zoning regulations and back-end investment requirements to protect traditional retailers. Furthermore, it should strive to make regulations more investment-friendly, like boosting the availability of liquid vehicles for investment such as REMFs and REITs.
The sector assumes an even greater importance given that real estate is second only to agriculture in terms of employment generation and contributes heavily towards the country’s GDP. In countries such as China, the retail sector has been a major propellant of growth and with a more liberal FDI policy; the story can be repeated in India.

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