The real estate sector has been going through a turbulent phase for several years. The implementation of the RERA, the applicability of the GST to projects under construction and the liquidity crunch due to the recent NBFC crisis, etc., have caused multiple disruptions. The Covid-19 outbreak and the nationwide lockdown have not helped matters. Developers now want to ensure that external funding to fill cash gaps remains available in the absence of cash flow from sales due to further disruptions.
Project finance options for developers should be such that they provide the flexibility to meet the specific requirements of each project. The country’s capital markets are only part of the solution. Some of the gaps that could be filled are as follows:
- Wider capital structures: The real estate industry is currently too dependent on debt financing for projects. However, no two projects are similar in terms of risk profiles, capital requirement, gestation period, etc. It is therefore imperative to offer a greater variety of capital structures, whether they are debt, equity or hybrid mezzanine structures.
- Listed bond markets: The depth of the listed bond markets will go a long way to meeting the financing needs of the real estate sector. Public markets can differentiate the quality of papers offered due to the variety and sophistication of the investors who buy them, which will ensure that a deserving project obtains liquidity for construction according to the risk profile. In addition, if investors have the option of exiting the stock exchanges before the bonds mature, the appetite to buy such securities will be even higher.
- Financing for the acquisition of land: Land is the raw material of the real estate sector and is generally also the most expensive component of the cost of the project. Mutual funds are needed to finance the acquisition of the land. The authority allocates land on a deferred payment plan in cities like Noida, Greater Noida and Ghaziabad. While in Gurgaon or Faridabad, where land is bought from farmers or third parties, developers need financing solutions to acquire land. NBFCs and HFCs filled this gap much earlier. After the IL&FS crisis, most NBFCs focused on asset management and portfolio consolidation. The void left by these institutions must be filled.
- Construction financing: Developers who team up for the financing of the construction of the project publish the approvals and the RERA registration of the project. These funds can only be used to cover expenses related to the construction of the project, with loan disbursements linked to the construction, sales and collection milestones of the project. Only a handful of private sector banks are active in financing construction to developers. The cost of financing construction varies from 10% to 14% per year. Their counterparts at PSU Bank are grappling with bad debt and / or capital adequacy standards and therefore remain cautious about lending to the real estate sector. The opening of loan portfolios for the real estate sector by PSU banks will deepen the capital pool at competitive rates for developers.
- Real estate funds: Infrastructure and real estate are both capital intensive sectors. Both need large sums of money at affordable rates. Interest capitalization may be required in either case, and principal repayment may be linked to the generation of project cash flow. Like funds dedicated to the infrastructure sector, funds for the real estate sector could be set up. We could consider a quasi-sovereign entity like SBI or LIC Housing Finance to anchor such funds in terms of equity contribution. The money in the balance could be raised from foreign investors. With leverage, this could constitute a substantial pool of capital available for the real estate industry.
Large-scale real estate projects are complex to execute and require patient capital reserves. Construction work may be affected due to events such as Covid, NGT construction ban, etc. which are beyond anyone’s control. Therefore, it is imperative to have a greater variety of capital pools. Costs should be reasonable, access to capital should be available at different stages (land acquisition, construction, last mile finishing) and repayment should be tied to the cash flow generation of the project. After the implementation of RERA, the compliance and monitoring of projects has improved a lot. This has increased the confidence of home buyers and lending institutions in real estate projects. The conditions are ripe to introduce larger, deeper and more flexible capital pools for the real estate sector to address the issues outlined above.
About the Author
– By Sandeep Batra, Director – Capital Markets and Investment Services, Colliers India
A corporate finance professional with experience in domestic and cross-border M&A transactions, private debt placement, private equity and IPOs. I have worked with companies like Infosys, JP Morgan India, Religare Capital Markets and M3M before.
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