With funding from banks and NBFCs to India’s real-estate sector continuing to be a struggle, the sector recorded an investment of $5.397 billion in 2019.The year 2019 saw India’s real-estate sector record an investment of a total of $5.397 billion. The majority of investment happened in commercial real estate and REIT. Notably, foreign funds accounted for about 78 per cent of total investments in 2019 – the highest share ever. (see box on Foreign Share.)Besides private equity (PE) inflows, total real-estate loans by banks and NBFCs or HFCs together equal nearly $93 billion, according to Anarock research. Of this, more than 62 per cent or about $58 billion is completely stress-free while another 22 per cent (about $21 billion) is under some pressure, but can potentially be resolved.As Shobhit Agarwal, Managing Director & CEO, Anarock Capital, says,“The stress on this segment is largely on recovery of interest and not on the principal amount. However, $14 billion or 16 per cent of overall lending to Indian real estate is under ‘severe’ stress, meaning there has been high leveraging by concerned developers who have either limited or extremely poor visibility of debt-servicing owing to a combination of factors.”Current funding scenarioThe sector is facing a severe shortage of capital because of demand issues in the residential sector and liquidity issues at local and shadow banks (NBFCs and HFCs). “Capital providers are cautious and have become selective. Even high-quality credit deals are facing challenges and delays in securing financing,” says Sharad Agarwal, Executive Director, Capital Markets, Knight Frank. “The 250-billion stressed fund is expected to provide much needed liquidity to net-worth-positive projects from quality developers.” “Currently, NBFC funding from banks and the mutual-fund market has dried up completely. Hence, NBFCs are not funding any new projects. In several cases, NBFCs have recalled their loan; and several have down-sold their portfolio to financial investors to reduce their book size,”adds Vijay Agrawal, Executive Director, Equirus Capital. “However, with both banks and NBFCs and HFCs now doing due diligence before giving loans to developers, the situation is gradually getting ironed out.” Funding from banks and NBFCs to Indian real estate continues to be a struggle with only a few players getting the requisite funds, that too after severe scrutiny, adds Shobhit Agarwal. As for PE funds, they once again remained laser-focused on the commercial segment in 2019.Attracting asset classesReal estate by itself is a large sector. Funds need to assess their risk tolerance, investment horizon and return expectations before deciding which subsector to invest it. Commercial office assets have remained the key attraction for PE investors for the past few years, with the sector backed by strong demand dynamics and rental appreciation. Also, the return on investment (RoI) in commercial is fairly steady. The commercial segment comprised over $3.3 billion, accounting for a 66 per cent share of total real-estate funding in 2019, although it reduced by 13 per cent on a yearly basis.Retail is also rising as an attractive asset class; it received total PE inflows of $970 million in 2019as against $355 million in 2018 – an annual rise of over 170 per cent. “PE investors started considering investment options outside Tier-I cities, as a result of which, the retail sector attracted more than $1 billion (Rs.71 billion) investment during 2019, with Tier-II cities accounting for more than 61 per cent of the total,” says Vijay Agrawal. “This amount was two-and-a-half times that of 2018.”The residential segment received PE inflows of $395 million last year; the warehousing and logistics segment attracted about $200 million; and mixed-use developments saw inflows of approximately $155 million, as per data from Anarock Capital.On the residential side, affordable housing is driving investment, says Dr Niranjan Hiranandani, Co-Founder and Managing Director, Hiranandani Group, “Hotels as investments have also begun seeing renewed interest from fund managers.”Fund-flowing citiesThe MMR and NCR were the top favourites for PE investors in 2019; together, the two regions received close to $2.7 billion PE funds, comprising a 53 per cent overall share, according to data from Anarock Capital.Mumbai continued to be at the forefront of investments, seeing 25 per cent of total investment inflows in 2019. “Bengaluru was second with inflows of $655 million (Rs.46.50 billion),” shares Vijay Agrawal. Pune and Hyderabad are also witnessing increased interest led by office investments.Funding preferenceNotably, of the total PE inflows of over $5 billion in 2019, nearly 96 per cent were via equity deals. Also previously, PE investments largely remained focused at the project level compared to the entity level, considering the higher complexity involved in the latter. However, says Shobhit Agarwal, “since 2017, entity-level interest began to grow. Investors used a combination of plain vanilla equity and structured equity for investments into projects but preferred to stay with vanilla equity while investing at the entity level considering the longer-term focus at entity coupled with availability of limited structural options while investing at the entity level.” Initially, developers typically preferred debt they could raise from banks or NBFCs as it was cheaper compared to PE, believes Vijay Agrawal. “However, as funding from NBFCs has dried up in the aftermath of the NBFC liquidity crisis, developers are exploring debt and equity financing from PE.”Buyouts accounted for a major share of PE or ventured capital (VC) investments in 2018 and early 2019. “The primary investors in this case were global pension and sovereign funds who were investing in yield-generating commercial assets,” says Vijay Agrawal. “Nine out of the top 10 deals in 2018 and early 2019 were buyouts. With the entry of large limited partners as direct investors in India, this trend is expected to get stronger in coming years.”Platform-level trades and equity deals can be fairly uncertain in terms of both returns and timing of exit,” says Amit Goenka, Managing Director & CEO, Nisus Finance Investment Managers. “We have typically seen large sovereign, hedge and global funds undertake platform deals with top developers and likewise large international capital sources take equity positions in commercial real-estate and limited residential developments with segment leaders with a typical investment outlook of five to ten years. It requires a significantly large patient capital pool to undertake platform deals as well as equity trades.”From the developer perspective, the Hiranandani Group has worked with different types of equity and structured debt funds, along with platform deals and JVs. Says Dr Hiranandani, “The optimal structure is worked out based on what best suits the underlying asset and its tenor while meeting the return requirements of the stakeholders involved.” The group recently signed a deal with Blackstone to develop 12 million sq ft of industrial and warehousing assets across the country in three to four years. In the recent past, the group’s commercial and retail assets in Powai, Mumbai, were acquired by Brookfield Asset Management for $1 billion, making it India’s largest office space transaction at the time.Tata Realty and Infrastructure (TRIL) has several ongoing projects in the residential and commercial segment. “On the commercial side, we will put in our own equity for upcoming projects and borrow construction finance like any other developer, then manage that equity and complete the project. Once we complete construction, we move to leasing,” says Sanjay Dutt, Managing Director & CEO, TRIL. In a recent move, TRIL sold two of its malls to Xander-backed Virtuous Group. This move is in line with their business strategy to focus on expanding their commercial portfolio across key markets in the country and exit Tier-II and Tier-III cities.Pure platform Since 2015, Indian real estate has seen over 30 platforms getting created, aggregating to more than US$ 11 billion by global investors like , among others. “Majorly, these deals are sector-focused and created with the aim to build a long-term partnership with other partners, mostly developers,” says Shobhit Agarwal.“The preference for platforms is there for long-term assets where investors want to have operating development partners with the capability to develop high-quality assets and also manage them,” adds Prateek Jhawar, Director and Head, Infrastructure & Real Assets, Avendus Capital. “For short-term financing, the debt route is preferred.”Foreign investors too preferred to invest through platforms with domestic developers or investors (joint) in 2019 compared to the previous year. “Funds are preferring the platform approach where they are engaging with Tier-I developers for investment in multiple projects,” says Vijay Agrawal. “In many cases, they are entering into forward buyout deals for rental yielding assets. This helps developers generate liquidity from the project after completion. Many developers such as Salarpuria Sattva, Embassy and Phoenix have entered into such arrangements.”What do fund managers consider before lending?Unlike earlier, fund management companies today are far more vigilant and assiduous, diligently following due process of scrutiny before giving away funds. “As the refinancing market has dried up, any fund or lender is looking at project cashflows and liabilities closely to assess whether the project or developer is capable of repayment based on the current market situation,” says Sharad Agarwal. For his part, Jhawar points to sales velocity and at a certain price as the most important aspect considered by fund managers before lending. “And, of course, the coverage they have on the asset,” he adds.In Goenka’s view,“Each investment decision involves a complex assessment of multitude variables to enable risk, rewards and returns assessment.” Key factors his firm considersbefore lending: a) Track record and performance of the developer. b) Type of development, which should essentially be mid-income or affordable, within key micro markets of major metros, of standard quality with amenities and price points that suit the buyer demographics, with no legal encumbrances for completion. c) The impact and assessment of the projects on acceptable environment, social and governance standards of funds. d) The capital and human resource involvement of the developer, authenticity of data, security covers available for business variances and predictability of the outcomes within an acceptable tolerance limit.The firm has backed projects of Shriram Properties, Mera Ghar and Karamvir Group, among others, in recent times.  Challenges in securing fundsThe biggest challenge faced by the Indian real-estate sector today is the availability of funds and the receipt of timely approvals from governing authorities. Further, the ongoing economic slowdown and weak consumption, subdued residential demand, lack of funding available to residential projects, inconsistent implementation of RERA, slow pace of infrastructure development, bureaucratic delays leading to high compliance cost for firms, and delays in land acquisition and approvals are among the primary challenges in securing funds. “The recent announcement by the government on the ban on subvention schemes has made the situation worse for many developers,” explains Vijay Agrawal.Funds on the lookoutDifferent funds have different strategies regarding the type of funding. Most funds are looking for rental yielding assets for investment with a long-term horizon. For the short term, they are looking for last-mile funding or projects that are about to start with a three-to-five year horizon.“In the current market scenario, distressed funds are actively looking for opportunities across the capital stack,” says Sharad Agarwal.PE firms are increasingly looking at distressed assets, especially at the last-mile funding stage, as some developers struggle with cashflow, says Vijay Agrawal.Future outlookReduced liquidity in the market is leading to greater opportunities for investors as well as developers in the form of distressed assets, believes Vijay Agrawal.The twin effects of the financial meltdown of shadow banking, ie, reduced availability of capital and higher costs with stringent terms, are likely to be pronounced in this year in funding real-estate projects. “Interestingly, 2020 will come to be known as the year of stress assets investing,” says Goenka. “Large fund corpuses, both domestic, ARCs and global, estimated at over  Rs.400 billion, including the government-sponsored fund, will be focused on extracting value in distressed but solvent last-mile and incomplete projects. This will include buying assets from the NBFC space to investing through the IBC process or even directly through stressed developers. Stressed assets space investing, hence, may be a dominant theme this year as exiting lenders, investors and developers try to pare down their exposure to service their own obligations, allowing new capital to earn higher risk-adjusted return.”The liquidity situation of leading NBFCs and HFCs is getting eased compared to the past year, believes Jhawar. “We expect viable projects to achieve financial closure going forward. Some secondary trades will also take place, where new lenders will provide incremental funding to complete projects.” He believes we have gone back to an era where PSU banks have liquidity and are selectively looking at purchases they can finance. “Banks such as ICICI and SBI have started lending back to real estate in smaller and more conservative ways, and large-format financials sponsors like foreign funds have started coming back in the residential space in a more structured manner.” According to him, stuck projects – where underlying developers are under stress and have taken money from NBFCs that they now want to take out – will now be bought by distressed and special-situation funds like Varde Partners, Oaktree, Cerberus, AION Capital Partners and Apollo Global, among others, whom he expects to sign some deals this year.Conclusively, real-estate funding will gravitate towards stronger players and more mature projects in the residential space and creating a strong delivery pipeline in the commercial space for Grade-A assets in key metro locations.Foreign ShareForeign funds accounted for about 78 per cent of total investments in 2019 – the highest share ever. Traditional US-based PE investors like Blackstone and KKR have dominated the PE real-estate investment landscape with Blackstone following the buy-and-operate strategy and KKR adopting the structured credit investment route. Blackstone alone pumped in over $1.8 billion in India’s real estate in 2019.That said, Singapore-based funds like GIC, Ascendas-Singbridge and Xander have made increasing investments recently. In 2018 and early 2019, these funds invested around $2 billion, accounting for 27 per cent of investments. Further, Canadian funds such as Brookfield and Canada Pension Plan Investment Board (CPPIB), along with sovereign wealth funds such as Abu Dhabi Investment Authority (ADIA), have also committed significant amounts of capital to the sector.Green shoots for residential, finally?Stressed funds have started considering residential assets and 2020 is expected to see many last-mile funding deals in the segment.This year may be focal upon stressed assets, more residential and some commercial, says Amit Goenka, Managing Director & CEO, Nisus Finance Investment Managers. “The total capital required in stressed and last-mile projects is estimated to be over $20 billion to unlock assets worth nearly $38 billion. With the liquidity crisis of shadow banks and smaller HFCs, and the acceleration of the IBC process that is available to home buyers, the need of last-mile and stressed financing will be unprecedented. Our fund is selective on taking such investments that will help complete mid-income projects in the short term and release significant capital and value to all stakeholders.”The residential segment is seeing some green shoots of revival in 2019,“and this will continue in 2020 as the government’s distress funds are deployed,” says Shobhit Agarwal, Managing Director & CEO, Anarock Capital. “In contrast to previous years, investors are now showing a keen interest in last-mile funding for stuck and delayed residential projects. This, along with government support of Rs.250 billion for stressed projects, is expected to go a long way in relieving residential real estate from its woes.”Rate of Return While the rate of return a fund usually attracts depends on multiple factors, including location, type of say, developer, competition and entry point, “if it is in profit, it can be anywhere between 30 per cent and 100 per cent in three years,” says Shobhit Agarwal, Managing Director & CEO, Anarock Capital.“Typically, special-situation funds and any real-estate deals happening today are at a 20 per cent+ funding rate,” shares Prateek Jhawar, Director and Head, Infrastructure & Real Assets, Avendus Capital. “Owing to the value proposition of our fund, we are able to generate between 20-22 per cent annualised returns,” says Amit Goenka, Managing Director & CEO, Nisus Finance Investment Managers.According to Vijay Agrawal, Executive Director, Equirus Capital, “The majority of investors expect a return rate of higher than 16 per cent from commercial office assets that are under construction. Rental yields on housing are currently around the 2-3 per cent range; office space rental yields are generally from 8 per cent to 10 per cent. Under REIT, investors expect a return of about 8 per cent to start with. Over the life of the asset, REITs can offer annual returns of 12-14 per cent over the long term.” Generally, REIT investors are long-term yield investors. The first Indian REIT was issued by BRE Mauritius Investments, part of the Blackstone Group, and Embassy Property Development in March 2019. The issue was oversubscribed and has returned over 21 per cent in the past six months. “After the success of the first India REIT, other players are in talks to launch the next REITs,” says Vijay Agrawal. “So, we expect more REITs in the future, increasing investor participation.”SERAPHINA D’SOUZATo share more on the funding scenario in real estate, write in at feedback@ConstructionWorld.in