FDI status for FIIs in real estate pre-IPOs

The government proposes to treat the investments by foreign institutional investors in pre initial public offers (IPOs) of real estate companies at par with foreign direct investment (FDI).

The FII investments in the pre-IPO allotment of real estate companies will have a lock-in period of three years, in line with the FDI norms. This means the investments cannot be withdrawn before three years. The lock-in period of three years is currently applicable to FDI in real estate.

The changes will be notified by the Securities Exchange Board of India through changes in its regulations for the foreign institutional investors.

According to the official sources, the decision on granting FDI status was taken to clamp down on foreign investments in real estate.

The overseas funds were seen to be contributing to an asset bubble in the real estate space, by pushing the prices up. The government recently clamped down on the use of external commercial borrowings for the real estate sector for integrated townships.

The review of the pre-IPO allotments in real estate follows the concerns expressed by the Reserve Bank of India a year back on foreign inflows into the sector. The concerns were further heightened by fears of inflation being impacted by foreign inflows.

Apart from recommending a lock-in period for pre-IPO allotments, the central bank had also stated that there is no way it could be ascertained whether the foreign investments were used for the development of "integrated township", which is one of the criteria for FDI.

Under the current norms, funds could be fungible and used for purposes other than the proposed project. There should therefore be stringent norms to monitor the use of funds, stated the RBI.

According to a government of India policy update, the Indian real estate sector is likely to see the entry of 20 real estate funds in the first half of 2007, bringing in foreign investments worth another $10 billion.

More than 35 foreign funds including Carlyle, Blackstone, Morgan Stanley, Trikona and Warbus Pincus are already operational in India. A Merrill Lynch report forecasts that the Indian realty sector will grow from $12 billion in 2005 to $90 billion by 2015.

The government had said that it intended to slow down the flow of foreign debt into the real estate sector through its recent curbs on external commercial borrowings (ECBs).

The finance ministry on Friday barred those setting up integrated townships from raising ECBs and made it difficult for small players to raise such borrowings by lowering the ceiling on the interest rates to be paid on such debts.