The real estate industry has been going through a turbulent phase for the past couple of years. Implementation of RERA, the applicability of GST on under-construction projects, and liquidity crunch due to the recent NBFC crisis, etc., have caused multiple disruptions. The outbreak of Covid-19 and nationwide lockdown didn’t help the matter. Developers now want to ensure that external financing to plug the cash flow gaps remains available in the absence of cash flows from sales due to any further disruptions.
Project financing options for developers should be such that they offer flexibility to serve the specific requirements of each project. Capital markets in the country are offering only part of the solutions. Some of the gaps which could be bridged are as under:
- Broader structures of capital: Real estate sector is currently over-dependent on debt funding for projects. However, no two projects are similar in terms of risk profiles, capital requirement, gestation period, etc. Hence, it is imperative to have a wider variety of capital structures on offer, whether debt, equity, or hybrid mezzanine structures.
- Listed bond markets: The depth of listed bond markets will go a long way in addressing the financing requirements of the real estate sector. Public markets can differentiate between the quality of papers on offer due to the variety and sophistication of investors buying into them, which will ensure that a deserving project gets liquidity for construction as per risk profile. Additionally, if the investors are given an option to exit through stock exchanges before bond maturity, the appetite to buy such securities will be even higher.
- Financing for land acquisition: Land is the raw material for the real estate sector and is usually also the most expensive component in the project’s cost. Pools of money are required for financing the land acquisition. Authority allots land on a deferred payment plan in cities like Noida, Greater Noida, and Ghaziabad. While in Gurgaon or Faridabad, where the land is bought from farmers or third parties, developers require financing solutions to acquire land. NBFCs and HFCs were well serving earlier this gap. Post IL&FS crisis, most of the NBFCs are focused on asset management and portfolio consolidation. The void left by these institutions needs to be filled up.
- Construction finance: Developers tie-up for construction finance of the project post the approvals and RERA registration of the project. These funds are allowed to be used only for meeting construction-related expenses of the project wherein loan disbursals are linked to construction, sales, and collection milestones of the project. Only a handful of Private Sector Banks is active in lending construction finance to developers. The cost of construction finance ranges from 10% to 14% p.a. Their PSU Bank counterparts are struggling with bad loans and/or capital adequacy norms and hence remain cautious on lending to the real estate sector. Opening up of lending books for the real estate sector by PSU Banks will deepen the capital pool at competitive rates for developers.
- Dedicated funds for real estate: Infrastructure and real estate are both capital-intensive sectors. Both need large sums of funds at affordable rates. Interest capitalization may be required in both cases, and principal repayment may be linked to cash flow generation from the project. Similar to dedicated funds for the infrastructure sector, funds for the real estate sector could be formed. We could look at a quasi-sovereign entity such as SBI or LIC Housing Finance to anchor such funds in terms of equity contribution. Balance money could be raised from overseas investors. Together with leverage, this could form a substantial pool of capital available for the real estate sector.
Large-scale real estate projects are complex to execute and need patient pools of capital. Construction work can get impacted due to events such as Covid, NGT ban on construction, etc., which are beyond anyone’s control. Therefore, it is imperative to have a wider 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 linked to cash flow generation from the project. After the implementation of RERA, compliance, and monitoring of projects has become much better. This has increased the confidence of home buyers and also the lending institutions towards real estate projects. The conditions are ripe to introduce broader, deeper, and more flexible pools of capital for the real estate industry to address the issues highlighted above.
About the author
– By Sandeep Batra, Director – Capital Market and Investment Services, Colliers India
A corporate finance professional with transaction experience in domestic and cross border M&A, private placememt of debt, private equity and IPOs. I have previously worked with firms like Infosys, JP Morgan India, Religare Capital Markets and M3M.
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