Residential realty struggles as private equity firms focus on commercial

Private equity firms turn cautious after Rera, GST implementation

Private equity (PE) firms seem to be shifting their focus from residential to commercial real estate after a slew of reforms, such as the Real Estate (Regulation and Development) Act, or Rera, and the goods and services tax (GST), were implemented last year.
 

The share of the residential real estate segment in PE investments dropped dramatically from 59 per cent in 2016 to 35 per cent in 2017 (until November), according to property consultancy Anarock Property Consultants.

Commercial real estate, especially the information technology (IT) and IT-enabled services segment, remained the focus area of institutional investors, and its share in PE investments rose from 30 per cent to 40 per cent during the same period, Anarock said.

The main deals by PEs in commercial real estate included Singapore sovereign fund GIC buying 40 per cent of promoter stake in DLF’s rental arm for $1.4 billion and Shapoorji Pallonji and Germany’s Allianz tying up for a $500-million fund to invest in office assets.

“PE funds are not prone to knee-jerk reactions. They have certainly noted the rebooted policy environment surrounding residential, but these measures will take time to start impacting the industry in market-significant terms,” said Anuj Puri, chairman of Anarock.

Downhill

• The share of residential real estate in PE fell from 59% in 2016 to 35% in 2017 (until November)
• The commercial segment saw PE investments rising from 30% to 40%
• In 2017, new residential launches in top seven cities declined 45-50%
• In 2016, the top seven cities added about 240,000 units, new launches fell to only 125,000 units in 2017
• In 2017, prices in top seven cities remained stagnant or corrected by 3-7% in some areas

Source: Anarock Property Consultants

Rera has restricted developers’ cash flows, as it disallows pre-launches and mandates that 70 per cent of the proceeds be kept in an escrow account. The new law has led to increased consolidation in the sector. The GST, on the other hand, has added to the compliance burden for developers and increased their cost structures. The new indirect tax regime has especially hit the sale of luxury apartments, as the input credit available is not enough to offset the rise in levy.

Puri said stringent Rera compliance norms, coupled with steadily declining housing demand, led to the exit of many small and financially weaker players, including builders, land owners, and brokers. Additionally, debt pressure, the inability to execute projects, and other financial challenges resulted in insolvency of many developers.

Amit Bhagat, chief executive of ASK Property Investment Advisors, a property fund manager, said that in the residential segment, most investors were structured debt players, and barring ASK and some others, not many pure PE funds had invested in the past couple of years.
 

“Structured debt players became very cautious due to transformational changes like Rera, the GST, and the insolvency code. These changes are leading to consolidation and, hence, PE players have been trying to gauge the impact of these transformational changes on various micro markets and players,” Bhagat said.

Besides the new laws, the residential segment in 2017 also struggled in terms of launches and pricing, which could have influenced the decision of PE funds, analysts said.

In 2017, new launches across top seven cities declined by 45-50 per cent compared to the previous year. While in 2016, these cities added around 240,000 units, the number fell to 125,000 units in 2017, according to Anarock.

Last year, due to a massive burden of unsold stock and low demand, the average property prices in top seven cities either remained stagnant or corrected by 3-5 per cent in some areas, it said.

Ramesh Nair, CEO & country head, JLL India, said, “India’s tier-1 office and retail sectors are projected to show the highest total returns in Indian real estate in 2018. We have seen the end of short-term disruption in India resulting from reforms such as demonetisation and the implementation of the GST. The year 2018 may be the one for investors to consider a strategic entry into India, given its positive long-term fundamentals and economic growth.”