Real-estate funds have helped fuel the expansion of Indian realty in recent years, and are poised to grow stronger as developers build an appetite for their tailored offerings. Since the current wave of regulatory reform got underway in 2014-15, boosting demand for housing through the Pradhan Mantri Aawas Yojna and according affordable housing infrastructure status with incentives for home buyers and developers, coupled with higher FSI norms, the real-estate sector’s need for capital has significantly increased, from about Rs 4,000 billion to about Rs 6,000 billion, of which about Rs 2,000 billion was to be met by banks and non-banking financial companies (NBFCs), notes Amit Goenka, Managing Director & CEO, Nisus Finance Services Co. “Given that banks have sought to limit their exposure to real estate and have come under increasing regulatory norms, and NBFCs are gradually being subjected to more stringent regulations with the credit meltdown over the past few months, real-estate funds have emerged as a viable financing option and are stepping in to fulfil about half of this capitalisation need.” The (current) scale of development in the industry would not have been possible if the industry had only banks to rely on for funds, agrees Shobhit Agarwal, Managing Director & CEO, Anarock Capital. “Banks, private equity, overseas sovereign and pension funds and NBFCs have jointly increased the scale.” While NBFCs in particular have significantly increased their exposure to real estate since 2011, from over 30 per cent of the Rs 1.5 trillion advanced to developers to more than 50 per cent of the Rs 4 trillion advanced, Agarwal notes that real-estate funds have helped developers get funding for buying land at a time when banks were reluctant to provide such funds. “Historically, most developers have depended on debt for land acquisition,” explains Suresh Castellino, Executive National Director, Capital Markets & Investment Services, Colliers International India. “However, restrictions on banks and muted appreciation in land in recent years – a factor that used to take care of the cost of servicing debt – have significantly increased developers’ need for equity.” Now that developers have geared their accounting systems around the Real Estate (Regulation and Development) Act and GST, thus bringing greater transparency into the industry, the need for capital is only expected to move upward.  “We see real-estate funds playing a key role in the real-estate growth cycle in future,” says Castellino. “Indian realty is maturing into an organised, consolidated business from being relatively unorganised, becoming more transparent after a slew of reforms and setting conditions for real-estate funds to feel more comfortable to transact,” observes Harshavardhan Neotia, Chairman, Ambuja Neotia.  “In these new conditions, we expect real-estate funds to emerge as a viable financing option.” More viable funds “A typical real-estate development in India needs about 30-60 per cent equity money, with the rest coming from debt-like sources,” says Parry Singh, Chairman & CEO, Red Fort Capital. “For larger developments, as the quantum of capital increases, institutional investors like private equity tend to be a better fit.”  Goenka expects the inclination to work with real-estate funds to increase because their offerings, irrespective of whether those are equity, equity-linked, debt or quasi-debt funding, are likely to be better aligned to the ground realities of the real-estate business, making them friendlier financing options.  A good thing about real-estate funds is that “they offer flexible structured repayment options and are willing to fund a project at different stages, factors which are the need of the hour for most industry players,” says Castellino. “We are willing to step in at any stage of the development,” agrees Khushru Jijina, Managing Director, Piramal Capital & Housing Finance. The flexibility of real-estate funds extends to the nature of their offerings. “Our offerings span wholesale and retail housing finance and include structured debt, construction finance, flexi lease rental discounting and customised solutions for different stakeholders operating in different micro-markets,” elaborates Jijina.  For instance, the Mumbai Redevelopment Fund was the first fund exclusively focused on private equity investments towards slum redevelopment in Mumbai and the Apartment Fund focused on bulk buying individual units at a discount with appropriate risk sharing with the developer counterpart to arrive at a target return profile. “Under SEBI regulations, funds are able to better tailor their investments than financiers governed by banking or non-banking norms,” observes Goenka. “They don’t require ongoing projects to be classified as non-performing assets owing to reasons such as the Commercial Operations Date (COD) (changing), which may be beyond the control of developers. This makes real-estate funding a more confidential arrangement allowing development companies that aren’t able to necessarily provide monthly or quarterly returns to go in for rearrangement and establish terms that are synchronised with their project cash flows without detriment to their credit rating or credibility.” “Unlike commercial banks that tend to be more rigid about their end-use requirements and covenants, real-estate funds and NBFCs can better accommodate the practical challenges that developers face such as delays owing to reasons beyond their control,” observes Prateek Jhawar, Director and Head, Infrastructure & Real Assets, Avendus Capital. Opportunism drives flexibility The target investment category of a real-estate fund is aligned to its analysis of the market needs. Consider Red Fort Capital, which has been investing in Indian realty for over 15 years. In 2004, the fund started out by lending support to the commercial segment, given the strong demand for commercial office space. “For every 300 sq ft of office space leased, we forecast 900 sq ft of residential demand; so we invested in residential development projects in the area, if there were not enough,” explains Singh. A decade later, Red Fort has added logistics and warehousing to its portfolio to cater to that emerging industrial sector while, last year, it started to invest in schools to fulfil its goal of being a socially responsible investor.  “Opportunistic investment is flexible by nature and demand-based,” affirms Singh. Nisus Finance Services Co’s exposures are also well explained by market realities. “We are mostly exposed to mid-segment housing projects in key metros, a location that accounts for 65 per cent of the national residential realty demand,” says Goenka. “We are also exposed to affordable housing, a segment boasting the biggest consumer base.” Helpful funds Opportunism does not rule out the fact that real-estate funds are sensitive to industry challenges. In 2004, Red Fort Capital invested in Prestige Tech Park II (Exora), in Bengaluru – a 2.2-million-sq-ft commercial development – thus, helping the Prestige Group promoter take on a project of bigger complexity with confidence, shares Singh. “When the 2008 crisis happened, Red Fort’s ability to fund additional capital in times of market desperation helped bring the project to completion.  So by the time the market turned in 2009-10, we had a fantastic development that companies like eBay, Linked-In, Juniper Networks and others were proud to occupy.” At Nisus Finance Services Co, one of the focus areas is “brownfield projects stuck owing to capital mismatches,” to quote Goenka. “We believe we add greater value to the industry by bailing out stuck projects with good economic value and a ready consumer base rather than financing new projects in a scenario where the unsold inventory is considerable. It is more relevant to ensure that our capital provides the last-mile push to projects with waiting home buyers.” Future direction What classes of realty are real-estate funds likely to look out for in 2019? “Commercial office space was the most vibrant and active asset class in 2018, followed by the retail sector, particularly good quality malls,” observes Agarwal. He expects this trend to continue in 2019.  “The high-end office space segment is at an interesting point in its cycle with very little space under construction,” observes Karan Bolaria, CEO, Godrej Fund Management.  “Real-estate funds are expressing greater interest in industrial, commercial and retail real assets, given that the residential sector is struggling with slow sales and unsold inventory,” agrees Castellino. “With the introduction of GST, the industrial sector has gained immense potential and large pools of capital from real-estate funds are chasing this sector. This class is closely followed by income-yielding commercial assets, which is where most foreign institutional investors have exposure.” “Logistics and warehousing transformed rapidly in 2018 after being accorded infrastructure status in November 2017,” continues Castellino. “Owing to implementation of GST, increased interest from national and international investors, strong economic fundamentals, proactive reforms and increasing use of technology, warehousing stock supply is expected to see substantial increase over the next two years.” Real estate may be down but it is certainly not out. “While the residential segment is currently at a low, it has strong fundamentals behind it and will revive soon, although it is hard to say exactly when that will happen, in six to eight months or 12 to 18 months,” says Bolaria. “That makes now the right time to invest in residential projects.” “In the near future, we believe housing for the middle income group will see the highest demand, essentially because India has a large middle class and Indians favour putting down money on their own homes,” says Jijina. “Demand for affordable housing is expected to touch Rs 6.25 trillion by 2022, supported by a growing population, a young demographic profile, the shift towards nuclear families, rapid urbanisation and high real-estate prices vis-à-vis the average household income of would-be buyers. Over 50 per cent of the launches over the past year have been in the affordable category.”  What are some new products that might attract real-estate funds? “In future, we may invest in data centres and/or co-working spaces; these seem to be emerging spaces with potential,” says Bolaria. “Emerging asset classes in 2018 that saw growing interest of institutional funds included living spaces for seniors, housing for students and co-living spaces,” says Agarwal. “Although these segments are at a nascent stage, the stage is set for them to grow.” What increases the chances of success for a fund? It is important to have a clear strategy for the fund,” says Karan Bolaria, CEO, Godrej Fund Management. “Strategising well increases the chances of success of the fund; it involves deciding exactly what sort of real estate you will invest in by pre-identifying micro-markets with high potential and then using a strong asset selection framework to zero in on deals to fund.” “Discipline in portfolio construction is also very important; it appropriately distributes risk,” adds Bolaria. “Imposing caps on a fund’s exposure to a single market or deal ensures that any one segment is not over-leveraged.” Currently, Godrej Fund Management invests equally in the residential and commercial segments and, within these, in clearly defined niches. “Our investments in residential realty are primarily in projects for the middle classes; this is an area we understand well, in which we have proven management capabilities,” says Bolaria. “In the commercial space, we invest in high-end offices for industries other than information technology; essentially, premium spaces that may be challenging to execute with a special focus on sustainability.” Monitoring the use of funds also contributes to their success. “We monitor the execution of projects by analysing propriety as well as third-party data to make sure we are staying with the original plan,” says Bolaria. “We enter into regular dialogue with the project teams. And while we stay out of residential operations, we do get involved whenever the project encounters a hurdle.”