Have Real Estate funds moved to the other extreme?

1. Real Estate funds seeking safer debt structures

$ 211.61 Bn Cumulative Amount of FDI flows into India (from April 2000 to June 2011) $ 12.44 Bn Amount of FDI Equity Flow during FY 2011-12 (April to June) $ 50 Bn PE investments over the past six years which is a significant proportion of the total investment into India Inc. In comparison to IPO in this period is $ 31 Bn 7700 companies listed in BSE and 1470 companies listed in NSE. BSE states that about 2000 are actively traded between both the exchanges. In past six years there are about 1500 companies which have received PE investment. Even if third of these companies were to get listed over the next few years they will form a significant share of the total no of companies going for IPO. FDI in the real estate sector last year (In FY 2010-11 $ 1,227 mn) was the lowest in the four years (In FY 2007-08 $ 2,179 mn), but private equity activity gained momentum during the recent months. $ 444 mn PE investment in real estate between Jan to Jun 2011, 47% higher than the investments made in 2010 in same period The Real Estate sector accounts for around 10% of the Indian GDP and has grown broadly in-line with GDP over the past six years. Real Estate sector has underperformed the Sensex by 41% over the past year partly due to corruption scandals, but largely due to sagging fundamentals like fall in demand, increase in price of raw material, high interest rate environment, Price softening, etc For some listed developers (such as Puravankara, Sobha, Prestige), 35-50% of total balance sheet debt is coming up for repayment over the next 12 months. with banks now reluctant to lend against projects or land banks in this sector, developers are adopting one or more of the following approaches to meet their short term funding requirements o Delays in ongoing projects and new launches o Increasing focus on residential rather than capital intensive projects o Non-core asset sales o Balance sheet de-leveraging by utilizing surplus cash, if any, on the balance sheet. o Promoter share pledging o Alternate funding options (private equity or HNIs) Structuring by Funds: o Prior to 2007, the FDI money was routed through structures like Optionally Convertible Bonds/Debentures (OCB/OCD), Redeemable or Optionally Cumulative Convertible Preference Shares (ROCCPS) and the conversion/redemption was linked to the target Investor IRR. o Post 2007, the FIPB banned the use of optionally convertible instruments by classifying them as Debt and thereby making it fall in the trap of External Commercial Borrowings (ECB). However the PE players have come up with innovative Waterfall Distribution structures and Compulsorily Convertible structures (with predefined formulas for conversion). Latest is the entry of listed Non Convertible Debentures structures, wherein the Developer issues a listed NCD with a coupon yielding the return target by the investor, the transaction is warehoused by the Banker for few days and then fully bought out by the Investor. Since it belongs to only one/few investors there is no trading activity in the NCD and protects the downfall. o Brand Capital (Times Treaties) has a unique private equity model. It sells the advertisement space in the print and electronic media to the companies and in turn it gets a convertible instrument. This instrument is converted over a period of next 3 to 5 years into equity of the company based on the performance driven formula in the SHA. These companies are generally the one wanting a lot of media presence or planning an IPO in next 3 to 5 years.

2. Will these structures be honoured by developers

The question of honoring or not honoring is very subjective and a matter of debate. The developers like DLF, Unitech, etc have honored the commitments made to their investors by selling their stake in the listed companies. However there are also good number of Investors who have resorted to Company Law Board (citing Misappropriation of funds, cheating, mismanaging the SPV affairs etc.) thereby showing a clear lack of developers initiative to undertake execution of the project or unnecessary delaying the constructions. Such situations would be defined in the documentations as Deadlock Situations. Also many developers had given Side Letters guaranteeing the returns to be delivered. This side letters do not hold any validity in the court of law and were merely signed to give comfort to the investors so that the funding can go smoothly.

3. Global fund raising environment

Cross-border capital flows to developed countries are 20 percent more volatile than flows to emerging markets. The lower volatility of capital flows to emerging markets partly reflects the fact that more than 60 percent of such flows over the past decadeand in particular FDI have been in equity investments. Financial markets in developing countries still have significant room for growth.One reason is that the development of financial markets is associated with higher incomes and a greater degree of economic development. Most emerging markets financial depth is between 50 and 250 percent of GDP compared with 300 to 600 percent of GDP in developed countries. Emerging markets account for 18 percent of the global financial stock, but their share has tripled since 2000 as their financial systems improve and as the largest corporations and governments tap foreign investors Capital outflows from emerging markets remained significant even after the crisis, totaling $922 billion in 2010 The stock of global foreign investment assets hit a historical high of $96 trillion in 2010 87% of global foreign investment assets hold by investors from developed countries. In 2010, the United States

was the worlds largest foreign debtor and Japan the globes largest foreign creditor.
Largest net foreign creditors* (Net position in 2010) Japan 3,010 $ billion, China - $ 2,193 billion and Germany-$ 1,207 billion (*Calculated as foreign investment assets less foreign investment liabilities) Therefore the Current Foreign Fund raising has to be led by Countries Like Japan, China and Germany. More than half of global IPO volume occurred on emerging market exchanges in 2009 and 2010. IPOs on emerging market exchanges totaled just $11 billion in 2000. By 2007 that number had increased to $100 billion; by 2010 the total had reached $165 billion, exceeding IPOs on developed countries stock exchanges.