Steep ‘waterfall clauses’, mezzanine, cash-out deals feature in deals seen in the sector.
Recently, an international realty fund invested Rs 47 crore in a residential project in Delhi in which the developer had put in Rs 35 crore. The deal was structured in such a way that from the overall revenues, the fund would first get 25 per cent post-tax returns on its investment and the principal amount. Only after that will the developer get its returns. In that case also, the developer will get 25 per cent return on the Rs 15 crore investment, but will not get any return on the remaining Rs 20 crore.
Whatever left after that will be shared in a 60:40 ratio, wherein the developer will get 60 per cent and the fund the rest. After that, the ratio changes to 80:20, wherein the developer will get 80 per cent and the fund 20 per cent.
If the above mentioned “deep waterfall structure” (as it called) is not enough, look at this ‘mezzanine deal’ that took place between a financial institution and a Delhi-based developer for a project in Gurgaon.
In this deal, the developer’s 50 per cent share in the special purpose vehicle was fully pledged with the fund. The remaining 50 per cent is with the investor. Besides, the land and all the fixed assets are charged to the fund. In addition, the developer was required to give a collateral worth the investments made by the investor. In this deal, the cover comes to 2.5 times of the money put in by the investor and it was a fully secured deal. The developer needs to pay 18 to 20 per cent as fixed coupon rate to the investor besides sharing profits.
Call it their bad experience with the Indian developers on previous occasions, or their own redemption pressures or tight liquidity conditions with realty companies, real estate investors, especially property funds, are signing deals to secure their investments many times over and draw enough profits to qualify for a windfall.
Besides, according to property consultants, “cash-out” deals are also fast becoming favourite of developers, wherein the developer will take out the money invested by the fund for his use as soon as he gets the cheque from the investor.
Consultants say at least half a dozen cash-out deals have taken place in the Indian real estate sector in the last one year as developers were stuck with incomplete projects and huge debt on their books.
Though such deals are against the spirit of foreign direct investment (FDI) norms as it lead to profiteering, developers are insisting and getting such deals in exchange for hefty returns for funds.
In one such deal taken place recently between a property company and an international property fund in Delhi, the developer had taken out Rs 40 crore to complete another project. Though the project value is much smaller, it will be showed in the books at much larger to execute the transaction.
The private equity investment is shown as a zero per cent loan and that is settled by the profits generated from the project by assigning super normal profits to the developer.
“Funds are very cautious about risks involved with investing in realty projects, as many of them have not taken off in the past. So, they want timely exits and fully secured returns now,” says Amit Goenka, national director (capital transactions) at Knight Frank, an international property consultant. And funds are aware of the good times they are in.
Says Ramesh Jogani, chief executive and managing director of Indiareit Fund Advisors, promoted by the Ajay Piramal Group: “Developers are left with very few options as initial public offerings (IPOs) are delayed and banks are lending very selectively. Markets have turned in favour of PE players now. Hence they are extracting maximum now.”
A quick look at developers’ IPO plans reveals that about a dozen realty companies plan to raise nearly Rs 17,000 crore from capital markets. But even those who have got the nod of capital market regulator Securities and Exchange Board of India (Sebi) have not announced the dates for their issues.
According to market sources, barring a few funds including IL&FS and Indiareit, most of the funds are doing structured debt deals in the market. “Most of the developers opting for structured deals are facing cash crunch. These developers came up with very high projects, but the demand was not as robust as they thought and are taking long time to sell,” says Goenka of Knight Frank.
“In most of the structured deals, developers see money only after 4-5 years,” he adds.
According to industry estimates, home sales have slowed 10-20 per cent since December quarter of the previous fiscal as developers raised prices of apartments. Developers are also facing debt problems. Though, most of the big listed developers have restructured their loans, according to government estimates, they have to pay Rs 25,000 crore in interest and principal in the current fiscal
Subhash Bedi, managing director of Red Fort Capital, an India-focussed real estate PE fund, has a different take on the trend.
“As markets have improved, investors are looking at deals differently. Earlier, they were concerned about protecting their downside, but now they are focussing on sharing upside from the project. I think both developers and funds are making money side by side,” he adds.
Meanwhile, the chief financial officer of a Mumbai-based developer bats for enhanced PE interest in realty space. “This kind of deals are not restricted to real estate alone, these are common in most of the sectors. PEs also ensure good corporate governance norms, transparency, bringing in international practices, among others. I do not see anything wrong in them asking for more returns,” he adds.
