Published on December 2nd, 2013
The chance to buy into a recovery early is attracting some big foreign funds to India, but its economic problems and difficult business environment still make it a no-go area for many investors.
India was not rated highly by respondents to the ULI’s Emerging Trends in Real Estate Asia Pacific 2014 report, with four Indian cities at the very bottom of the ‘best cities for investment’ table.
This negative sentiment is “a result of ongoing economic problems, an uncertain currency outlook following a steep plunge in the value of the rupee in the middle of the year and an investment environment widely perceived to be unfriendly to international investors,” the report said.
India saw a surge of foreign investment in real estate before 2008, but a substantial proportion of those investors lost money, anecdotal evidence suggests. Since 2008, the office and retail sectors have been plagued by oversupply, although the residential sector has bounced back and prices are ahead of pre-global financial crisis levels.
However, India’s economy may be starting to show signs of a recovery and larger overseas investors have shown some interest in the nation’s real estate.
Data for Q3 2013 showed manufacturing activity swung back into expansion mode, while the GDP growth rate picked up from a more than four-year low in the summer. Economists at Capital Economics in Singapore said the economy appears to “be bottoming out”, although they cautioned of a “bumpy recovery ahead”.
India’s economy grew 4.8% in Q3 from a year earlier, picking up from 4.4% growth in the prior quarter. Meanwhile, the soft Indian rupee has made Indian goods more competitive on international markets.
Nonetheless, a real recovery will depend on more domestic investment and consumption, while stimulus efforts have run afoul of what some describe as India’s poor investment climate.
“A whole host of investment projects are stalled because of bureaucratic issues,” Capital Economics’ economist Miguel Chanco said in a note. Obstacles such as difficulty of land acquisition are among the reasons why foreign investors are losing interest, he added.
Meanwhile, consumer price index inflation is forecast at 9.3% throughout 2014, marking the sixth consecutive year above 9%, according to Nomura. Elevated food prices as well as agricultural sector wages indexed to the CPI are seen as reasons for the price spiral. Nomura believes economic growth “is near its trough”, but it cautioned that the economy will mend slowly.
If India’s economy is bottoming out, then recent buyers such as Singapore’s sovereign wealth fund GIC Private, as well as real estate specialists Blackstone Group, Ascendas and Mapletree, could make significant gains.
However, India remains notable as the region’s only large economy which pan- Asian investors are happy to disregard or to admit they have no strategy for. One veteran of the region recently said: “I just can’t see how to make money there.”
Big players bet on game-changing Indian reforms
India’s economy remains sluggish, but many big property investors see a political push to better regulate the real estate market, coupled with depressed prices, as cues to buy again in top-tier cities
India has been out of favour with foreign investors since the global financial crisis, but a number of large investors have been increasingly active, in the expectation of better days ahead.
Depressed valuations, improvements in the regulatory environment, the pending introduction of real estate investment trusts (REITs) and the untapped consumer potential of the world’s most populous democracy are being seen as good reasons for a second look.
Singapore’s sovereign wealth fund GIC Private, as well as real estate specialists Ascendas and Mapletree, among others, are reportedly active buyers of office buildings and commercial complexes in Mumbai, Delhi and other top-tier Indian cities.
Still, their moves are a bold step during a period of weak sentiment after some investors were burned or otherwise saw their joint ventures with local Indian partners end badly after the global financial crisis.
The push is also happening as global investors have fallen out of love with emerging markets. Once lauded for rapid growth and potentially huge consumer markets, the Bric countries – Brazil, Russia, India and China – have been derided of late as a missed opportunity.
Swedish economist Anders Aslund argues that these nations are paying the price for failing to initiate important reforms when times were good.
A squandered economic opportunity
Aslund even singles out India for squandering the opportunity to improve the underlying state of its economy. He notes that India suffers from a number of ailments, including chronic inflation, as well as a federal budget deficit, public debt and current account deficit that are all too high.
“Governance is mediocre at best, [there is] substantial corruption and a poor business environment,” Aslund says.
The World Bank ranks India 132nd out of 185 countries in terms of ease of doing business, trailing Brazil, at 130, to rank as the least business-friendly of the Bric countries. So why are real estate funds piling into
India as interest from equities investors weakens? One reason is that the hoped-for policy changes and other reforms alluded to by Aslund, which did not materialise when times were good, now appear to be making their way onto the political agenda.
Slowing economic momentum, as India’s GDP growth rate eases to 5%, or nearly half of what it was a few years back, has ignited a push for economic reform and spurred more business-friendly talk among candidates in upcoming regional and national elections.
There are signs that Indian lawmakers are becoming more proactive, especially in addressing some of foreign investors’ long- held concerns. Colliers International praises revisions to land ownership laws and says new bills being drafted should help to improve the operating environment.
In September, India’s parliament passed the Land Acquisition, Rehabilitation and Resettlement Act, which sets out minimum levels of compensation for rural and urban land holders. “These changes aim to bring much needed transparency in the sector, which will boost investors’ confidence,” says Surabhi Arora, Colliers International’s associate director of research.
However, Indian developers’ association CREDAI argues that the new law will raise land and property prices. “The entire process will put the country 20 years behind, instead of pushing it on the road to progress,” says chairman Lalit Kumar Jain.
REITs to open new investment channel
In coming months, progress is also expected on new rules that will enable REITs to be
set up (see p24-25). The listed investment vehicles should make it easier for both local and foreign investors to tap yield-generating assets and act as a channel that will direct more fund flows into the sector.
REITs are also seen as being important for large investment funds that eventually want to sell or exit their property holdings. Big investors would breathe easier knowing they can flip properties in an environment where REITs are active, analysts say.
“It’s a very smart move; they are going to make a ton of money,” says Anuj Puri, Jones Lang LaSalle India chairman, referring to Blackstone’s efforts to build up its portfolio of income-yielding properties.
Blackstone, the second largest holder of office property across India, recently completed three deals with local developers DLF, Panchsheel and Embassy Group.
Other groups planning to invest include Canada Pension Plan Investment Board, which will pay around $200m for an 80% stake in a joint venture with Shapoorji Pallonji Group to target leased offices.
Singapore’s Ascendas recently launched its third India-focused investment fund. The group aims to raise S$600m ($478.5m) to buy office property in Bangalore, Chennai, Hyderabad and other top-tier Indian cities. Singapore’s sovereign wealth fund GIC, which opened an office in Mumbai in 2011, is a principal investor in the fund. Other active investors include Tishman Speyer and Morgan Stanley.
Analysts of India’s property market tend to point to 2008 as a benchmark year, when the office, retail and residential sectors peaked, before a sharp fall in values. Since then, residential property has more than recovered, exceeding its previous peak by 23%. But the office and retail sectors both remain below their previous peaks, although they have recovered from lows in 2009.
India’s high rate of inflation means that prices need to be adjusted to account for the effects of monetary debasement. To create a comparison to 2008, prices should be adjusted upwards by 35%, according to calculations by Jones Lang LaSalle.
The outlook for the office sector is mixed, depending on where you look. India’s top- tier cities are experiencing a healthy rebound, a trend that analysts refer to as ‘micro markets’, while elsewhere conditions are largely bleak, with excess supply and poor project planning. Nationwide excess office supply will top 50m sq ft by the end of the year, Jones Lang LaSalle estimates.
Meanwhile, things are looking up in India’s seven main cities: Mumbai, Delhi, Gurgaon, Bengaluru, Chennai, Kolkata and Pune.
About 28m sq ft of office space was leased in the first three quarters of 2013, roughly in line with rates of take-up last year.
Take-up cooled slightly in Q3, with about 6.2m sq ft leased, a drop of about 20% from last year’s levels. Rents in these cities were stable, although pockets of the Kolkata and Gurgaon markets were down between 1% to 7% from the prior quarter.
Occupiers return to city centres
Companies that had headed out to peripheral areas as prices rose are moving back to inner-city areas, taking advantage of cheaper rents on offer. Jones Lang LaSalle’s Puri says core areas inside top-tier cities are less affected by the excesses supply problem in outlying areas. “My opinion is that there is very little downside left,” Puri says.
With few office developments breaking ground, supply should be tighter in the next few years, helping to shore up rents.
“We are not building any new offices, so in the next three to four years, vacant offices will be occupied as demand goes up,” Puri says.
Another bright spot is the take-up at information technology parks in special economic zones. Vacancy rates in these complexes recently fell to 24% from around 29% in January 2012. Pricing trends in these IT parks should continue to improve as around 6m sq ft of new supply is due to come on to the market by the end of 2015. Meanwhile, 13m sq ft of business park space is set to be completed at the same date.
While organised retail is a small part of India’s overall retail market, the Associated Chamber of Commerce and Industry estimates it will grow by 24% pa in the next four years. JLL research says only Delhi and Mumbai have significant quantities of grade A retail property suitable for investment, with smaller quantities in Bangalore, Pune, Kolkata, Hyderabad and Chennai.
Since the global financial crisis, the supply of modern retail space exceeded demand in all years except 2012. JLL expects oversupply to continue until 2015, with the nationwide grade A retail vacancy rate increasing from 18% this June to around 20%.
JLL’s India’s Retail Luxury Quotient report notes that vacant space is not evenly spread. “Malls in good locations and backed up by a sustainable consumer community are performing well,” Puri says. “Meanwhile, overambitious projects launched with poor designs, especially when coupled with poor locations, contribute to higher vacancy rates.”
Home prices have risen sharply in recent years, sparking concern that values now look inflated as incomes have failed to keep pace with the price gains.
However, the mid-level housing market looks set to go higher, says Anshuman Magazine, chairman of CBRE India. “The mass residential sector is India’s most resilient real estate market owing to limited supply and the home buying aspirations of India’s growing middle classes,” he says.
It is hard to see a convincing case for price falls, says Magazine, who believes the pace of gains will moderate somewhat. In Delhi, mass residential prices have dipped by around 9-12%, but the drop looks more like a temporary correction and conditions should soon begin to improve.
“Overall we have seen a market that is rising, but at a slower pace, and which has been under pressure,” Magazine says. “India’s high interest rates will help keep prices in check,” he adds.
Regulator aims to jump-start stalled tax-efficient vehicles
REITs are back on the agenda in India with the publication of draft rules for tax-efficient property vehicles, in a move that could provide an exit route for investors and boost values by up to 30%
India’s real estate markets could be given a significant boost if real estate investment trust legislation is introduced.
The Securities and Exchange Board of India (SEBI) has restarted moves to develop REITs and moved to accelerate the process in September by issuing draft guidelines to set up REITs. The move revives efforts it had put on hold in 2008 during the global financial crisis.
REITs will provide an exit route from investments for real estate developers with developed property and also provide overleveraged companies with an opportunity to deleverage. A successful REIT structure would increase the depth of the Indian real estate market and provide additional liquidity. It would also offer a regulated structure for investment in real estate and improve the market’s transparency.
Since REITs were first introduced in Asia, the market capitalisation of the sector has grown dramatically, particularly in Singapore and Japan, the region’s most dynamic REIT jurisdictions.
Public comments on the draft legislation had to be submitted by October 31 and SEBI is examining submissions.
Peter Mitchell, chief executive of the Asia Pacific Real Estate Association (APREA), which has been closely involved with the revamped REIT plans, says the two major points to be dealt with before REITs are introduced are ensuring their tax transparency and that foreign institutions would be able to invest in them.
SEBI is in talks with India’s tax authorities aimed at ensuring tax transparency. REITs in other jurisdictions tend to be exempt from tax at the company level (if certain qualifications are met), to create a level playing field between REIT investors and direct investors in real estate.
Tax efficiency is key to success
“For REITs to be successful, they have to be tax efficient – there’s no question about it,” said SEBI chairman UK Sinha last month.
India’s draft regulation for REITs comes 24 | AsiaProperty December 2013 at a time when property developers are struggling to raise debt and equity, while the Indian economy is growing at its slowest pace in a decade.
Earlier moves toward introducing REIT legislation were abandoned in favour of developing real estate mutual funds, but these did not emerge either.
“The [REIT] definition of ‘real estate’ seems constricted. it should be broadened to include all commercial and residential property and completed infrastructure assets, such as roads and highways that have a regular income flow”
Rajiv Luthra, Luthra & Luthra Law Offices
The draft rules propose that only companies with assets worth at least INR10bn ($163m) could list as a REIT, provided they sell at least INR2.5bn worth of stock in the initial public offering. A REIT must have 90% of its portfolio in income-generating properties and REITs will not be able to invest in vacant or agricultural land. The vehicles will be externally managed.
The draft guidelines allow for single-asset REITs, as long as the asset is valued at a minimum of INR10bn. A maximum loan-to-value ratio of 50% will apply to their borrowing and REITs that trade with more than 25% debt will need a credit rating and shareholder approval. Also, any transaction that exceeds 15% of the asset value will require investor approval.
Unlike REITs in other jurisdictions, SEBI proposes limiting investment in the trusts initially to institutional investors and wealthy private investors, to protect smaller investors who may not understand the product or risks involved – even though retail investors are allowed to invest in developer stocks, which tend to be far more volatile than REITs.
Regulator errs on side of caution
Mitchell says the restrictions on retail investment in REITs are likely to be ‘transitional’ and reflected understandable initial caution. “They want to see how the REIT market unfolds,” he adds.
APREA is also pushing for REITs to adopt IVSC international valuation standards and to follow rules set out in its Best Practice Handbook. Mitchell says India is likely to follow both standards.
Some in India would like to see the remit of REITs widened further than is planned.
Rajiv Luthra, founder and managing partner of Luthra & Luthra Law Offices, says: “The definition of ‘real estate’ seems rather constricted. It should be broadened to include all commercial and residential property and completed infrastructure assets, such as roads and highways that have a regular income flow.”
Luthra also believes that “the sponsor eligibility condition of five years’ experience in the real estate industry on an individual basis should be widened to enable non-core real estate players such as hotels, hospitals and other corporate entities with real estate to participate”.
Anshuman Magazine, chairman and managing director, CBRE South Asia, says: “This is a welcome move. Once in place it will provide an additional exit route for investors and enable retail money to be channelled into India’s real estate sector through a regulated network. The introduction of REITs in the long term would propel the sector, spurring capital inflows and bringing institutional credibility.
“Rumours are that it could be [introduced] as early as next month and if it does not happen then, I think we are talking some time later next year,” he adds.
If the legislation is not enacted in the next two months then it is likely to be pushed back until the fourth quarter of 2014, because “elections are coming [in March to April] and everything kind of stops in terms of policy making”, according to Magazine.
Anuj Puri, country head of Jones Lang LaSalle India, says: “The good news is that the regulator has expressed its willingness to kick-start REITs in India. SEBI’s cautious approach during this initial period is acceptable and appreciable. One concern regards the strengthening of our legal framework surrounding real estate in India, which is a prerequisite for REITs to thrive.”
If legislation does come through, it could trigger a rerating of income-yielding properties, with values jumping about 30%, assuming REITs become active in about 18 months, according to Jones Lang LaSalle.
Much of the focus in India has been on the effect REITs will have on domestic developers; however, foreign investors are also set to benefit from using REITs as an exit strategy for large investments.
Blackstone likely to exit via REITs
Blackstone, which has bought billions of dollars of assets in India, is expected to use Indian REITs to exit investments if the legislation is passed in a usable form. Initial public offerings have been the cornerstone of Blackstone’s recent exit strategies.
Hotels group Hilton, which Blackstone bought in 2007, is set to raise $2.4bn in a forthcoming IPO, valuing Blackstone’s stake at $14.6bn, although the investor plans to be a long-term shareholder.
The group’s Brixmoor US strip mall arm raised $825m in an IPO in October. Singaporean investor Ascendas, which
plans to invest S$600m ($478.8m) in India alongside GIC Real Estate, already manages a Singapore REIT – Ascendas India Trust – which owns five business parks in India.
The new venture with GIC will target investments including “business space developments that may have other complementary uses, and stabilised completed business space assets,” Ascendas said in a press release. Target cities include Bangalore, Chennai, Delhi National Capital Region, Hyderabad, Mumbai and Pune.
Such assets would fit well in a REIT portfolio and GIC has previously participated in IPOs of its real estate investments, such as the flotation of Global Logistic Properties in 2010.