real estate financing- options & issues euro corporate services 1

REAL ESTATE FINANCING- OPTIONS & ISSUES

EURO CORPORATE SERVICES 1

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INTRODUCTION : REAL ESTATE IN INDIA

The asset classes in real estate sector can be divided into : Residential Commercial/IT offices Retail Hospitality segments Industrial Parks/SEZsWarehousing

EURO CORPORATE SERVICES

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SECTOR DYNAMICSDriving Force Residential – changing demographics, urbanization, ease of finance Office Space – IT, Telecom and BPO; Retail – new retail formats and entry of global brands; Hotels – domestic business travel and domestic tourism; and Warehouses – organized retailing and requirement of logistic services. Current annual Indian real estate market size is estimated @ US$ 40 bn

• Residential 70%• Commercial segment 25%• Organized retail, industrial warehouse and hospitality combined at 5%

To promote institutional funding in the sector FDI norms were relaxed in 2005 ( Red Tape to Red Carpet)

During 2005-10, industry recorded growth of 30% CAGR and is concentrated in the top 7 metros.

7 cities account for approximately 70-75% of Grade A office space in the country, with a leased space of around 279 MM sq.ft. ( as against 373 mm sq.ft in Manhattan , London is 210 mm sq.ft.)

Indian real estate market is expected to grow at a CAGR of 20%, with an estimated market size of US$ 180 bn by 2020


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FINANCING OPTIONS

• BANK CREDITS: -CC/OD/ PROJECT LOAN - FACTORING - LC/BG(Non fund Based) - LRD - LAP • EXTERNAL COMMERCIAL BORROWING (ECB)• PRIVATE EQUITY- DOMESTIC FUNDS• FOREIGN DIRECT INVESTMENTS-

CCD/CCP/EQUITY• FCCB/ADR/GDR/QIP(For Listed Co.’s)• Listing in International markets such as AIM


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BANK CREDIT - GENERALLending by Banks continues to be the biggest sources of financing for real estate companies in India. They also finance the real estate sector by providing housing loans to individuals. Banks provide indirect finance to real estate sector by giving loans to housing finance institutions.

Some of the prominent Indian Banks lending to real estate are :

EURO CORPORATE SERVICESSource: ET dated 29th nov, 2012

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BANK CREDIT – CC/OD/ PROJECT LOAN

• Purpose: To meet working capital requirements. • Amount of facility: Based upon the Bank's

assessment of the working capital requirement (WIP & book debts)

• Security: Charge on current assets Collateral(s) on case to case basis.

• Interest Rates: 12% -16%


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BANK CREDIT – FACTORING Factoring is a service that covers the financing & collection of

account receivables of series of trade transactions between a seller & a buyer in the domestic market as well as international market.

Advantages: • It is among the quickest way to get advance cash. • Cost effective with the cut in invoice processing and collection

activities. • Getting cash with factoring helps in eliminating the risks of bad

debts. • It helps the company in concentrating over more projects. • It gives an opportunity to offer credit to customers. • It helps in building credit history and no long-term obligation.


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BANK CREDIT – LC/BG

Letter of credit(LC) is a written undertaking by a bank( issuing bank) given to the seller (beneficiary) at the request and in accordance with the instructions of buyer (applicant) to effect payment of a stated amount within a prescribed time limit and against stipulated documents provided all the terms and conditions of the credit are complied with.

Bank guarantee is a type of guarantee in which a bank promises to repay the liabilities of a debtor in the event that the debtor is unable to.The contract of guarantee has three parties Principal Debtor, Principal Creditor, Guarantor i.e. Bank


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BANK CREDIT - LEASE RENTAL DISCOUNTING Lease Rental Discounting (LRD) is a type of Term Loan offered against

rental receipts derived from lease contracts with corporate tenants. Quantum: Based on the discounted value of the rentals 50% to 75% of underlying property value. Maximum Tenure: 9-15 years ( Linked with lease period, lock in period,

quality of tenant etc.) Repayment Mode: Generally Rentals are payable by the tenant directly to

an escrow account with lending bank. Security: The underlying leased property will be taken as prime security.


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Loan against property is similar to other loans like home loan, Equipment Loan etc.

Quantum of Loan: Depends on type of property & income of the borrowerTenure: Flexible for 1 – 15 yearsInterest Rates: 11%-14%Security: Charge on Property and LTVs are generally at 65- 70% of PMV

BANK CREDIT -LOAN AGAINST PROPERTY

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EXTERNAL COMMERCIAL BORROWINGS ( ECB)

• ECB allow corporate to access the foreign currency loans through commercial bank in the form of loans,suppliers’ credit, fixed rate bonds, non-convertible, optionally convertible or partially convertible preference shares availed of from non-resident lenders.

Since January 2009, ECB route has been opened for the development of Hotel projects, integrated townships & Industrial Parks.

For Industrial Parks ECB is allowed under automatic route while for SEZ & Integrated township development ECBs is allowed under approval route.

Real Estate companies like Jai Prakash Associates, Unitech, HDIL and AMR Construction, etc. have used ECB to raise funds.

ECB - GUIDELINES


Maximum Loan Amount:Corporate engaged in hotel, hospital & software sectors: Up to USD 200 MillionReal sector ( Industrial & Infra): up to USD 750 Million

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Tenure: Up to USD 20 Million: Min Avg maturity of 3 years Above USD 20 Million: Min Avg maturity of 5 years


ECB - GUIDELINES

Cost:Average maturity period All-in-cost Ceilings over 6 month

LIBOR

Three years and up to five years 350 basis points

More than five years 500 basis points

Prepayment:Prepayment of ECB up to USD 500 million may be allowed by AD Banks without prior approval of RBI subject to compliance with minimum average maturity period as applicable to the loan.

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PRIVATE EQUITY- DOMESTIC FUNDS

Private Equity players have been very active in the real estate sector especially in housing from the past few years (2005 onwards).

Besides Equity, structured debt-like instruments are used in light of volatility this industry faces.

Major Domestic Players in India:• ICICI Ventures• IDFC• HDFC • IL &FS • Kotak Private Equity• Urban Infra RE Fund (Jay Corp)• Indiareit (Piramal Group)


FOREIGN DIRECT INVESTMENTS• FDI are investments made

in home country by foreign investors.

• Total FDI in India’s housing and real estate sector till date is about 19 bn USD

• Besides the Foreign Funds there are certain Indian Fund houses which have raised foreign capital and are sponsoring FDI funds- prominent names are Tata, Piramals, Sun Group, ILFS.


Major PlayersSun ApolloWells FargoMorgan Stanley Real EstateGoldman Sachs Real EstateGIC, SingaporeBlackstone

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FDI IN REAL ESTATE Particulars NRI Other non-residents

Direct investment in immovable property

Possible –Purchase of agricultural land / plantation / farm house excluded

Not possible –However foreign companies are allowed to acquire immoveable property with approvals, for branch office & places of business.

Investment in SPVs - Investee entity

Partnership firms / sole proprietorship (on non- repatriation basis)•Companies

•Only companies

Nature of real estate activity

•SPV cannot engage in agriculture / plantation / real estate business (dealing in land / immovable property)

•Housing, townships, infrastructure •Hotels and tourism •Industrial parks•SEZs


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FDI -REGULATIONSParticulars Regulations

Minimum area of development

•Serviced housing plots –10 hectares(1 lakh Sq mtr)•Construction – development projects - 50,000 sq meters•Combination projects – either of above two conditions to be met

Investment limits •WOS – min capitalization of US$ 10 million•JV with Indian partners – US$ 5 million•Investment within six months of business commencement

Lock-in restrictions •Original investment locked-in for 3 years from the date is in brought-in( However, the FIPB has clarified that the definition of original investment is the entire investment)

Project development

•50% of the project to be developed in 5 years from the date of obtaining statutory approvals. (under-developed plots cannot be sold)


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FDI IN OTHER REAL ESTATE ACTIVITIESParticulars Route

Hotels, tourism and hospitals

•100 percent permitted under automatic route•Hotels include restaurants, beach resorts and other tourist complexes providing accommodation and/or catering and food facilities to tourists

Industrial parks

•100 percent permitted as per the Industrial Parks Scheme, 2002

SEZs •100 percent permitted as per the SEZ policy


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PRICING GUIDELINES

• Subscription of shares by Non-Resident– Issue price shall not be less than:

• In case of listed companies- Price worked out as per SEBI guidelines. • In other cases- Fair valuation of shares worked out and certified by a

Chartered Accountant.• Transfer of shares

– By Non-Resident to Resident: Sale price shall not be more than • Listed company

– Transaction through a stock exchange - prevailing market price• Unlisted company

A price which is lower of: – Independent valuation of share by statutory auditors of the company– Independent valuation of share by a Chartered Accountant or

Merchant Banker ( the mechanism prescribed for the valuation is DCF)

– By Resident to Non-Resident – Pricing shall be same as in case of subscription of shares by non-resident

– Non-Resident to Non-Resident : No price restrictions


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KEY ISSUES

Issue Views/ challenges

Minimum capitalisation norms

Would acquisition of existing shares from promoters be considered towards the minimum capitalization norms

Lock-in requirements Meaning of ‘original investment’ for the purposes of lock-in requirements:Would the entire investment be locked-in for 3 yearsWould investment up to the min. capitalization be locked inWould lock-in apply only for the 1st tranche of investmentsFIPB has clarified that the definition of ‘original investment’ is the entire investment and each tranche which is locked in from the date it is brought-in. However, FIPB can grant a specific approval on case to case basis.

Time-limit of six months from commencement of business

Does it imply that investments may only be made in newly incorporated companies- Not necessaryImpact on enterprise-level investments- NoDo all non-FDI-compliant projects need to be hived off - Yes



Execution of projects through step down subsidiaries

Approval required for investment in holding companiesApproval required to form step down subsidiaries for project execution

Project execution through partnership firms

Is this permitted? Not permittedDoes it require approval- Yes

Hive-off / de-merger of projects subsequent to investment

Does it imply that minimum area requirements are not complied with – Need to comply

KEY ISSUES

KEY CHALLENGES

Issue Key challenges

Investment in companies holding agricultural land

• FDI policy prohibits investment in agricultural land / plantations / farm houses – FDI may have to come in only after conversion of agricultural land.(But ok if in development zone of master plan)

Repayment of Investment toNon-resident Investors

• Preference shares / debentures to compulsorily convert – Yes• Buyback of equity – Quantum / pricing restrictions apply

Choice of overseas jurisdiction for routing investments

• A number of treaties believed to be under review• Will Mauritius, Cyprus treaties be renegotiated ????

Return on Investments •Preference shares – coupon rate benchmarked to SBI Base rate•Debentures – Lack of clarity on maximum coupon rate

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FOREIGN INVESTMENTS THROUGH PREF SHARES & DEBENTURES

Particulars Before amendment After amendment

Foreign investment through preference shares

Foreign investment through debentures

• Preference shares that were redeemable and / or optionally/ partially convertible cameunder the FDI regime

Debentures that were not convertible or partially / optionally convertible did not come under ECB regime

Any preference shares issued after 1st May, 2007 to be part of equity only if they are compulsorily convertible. In all other cases, they will be considered as debt and will have to comply with the ECB guidelines.

Also, existing investments in such shares may continue till their current maturity.

Only fully and mandatorily convertible debentures, within a specified period of time, would be reckoned as FDI; all other debentures would be regarded as ECB.


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FCCB/ADR/GDR/QIP(For Listed Co.’s)

Qualified Institutional Placement (QIP) route offers a cost-efficient way of raising funds from the domestic institutional investors, thus offering an attractive alternative when overseas borrowings dry up. This mode of fund raising has lesser procedural requirements. Real estate companies that have raised money through the QIP route includes Unitech, Parsvnath Developers, HDIL, DLF etc.

Foreign Currency Commercial Bond (FCCB) is a mix between a debt and equity instrument issued in a currency different than the issuer’s domestic currency. It acts like a bond by providing regular coupon and principal payments but at the same time gives bondholders the option to convert the bond into stock.


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Real Estate Mutual Funds ( REMF)


Real Estate Mutual Funds – Introduction

In simple terms, Real Estate mutual funds are close ended mutual funds with a lock-in period of 3 years. These mutual funds will invest in real estate properties and being the owners of these properties, they will let out these properties on rent. The rent so earned will be distributed to investors as dividend. When the mutual fund attains maturity, the company can sell its holdings and return your investments.

SEBI has kept the scope of the REMF wide open, as the guidelines allow REMF to invest in the following sectors:• Directly in real estate properties within India• Mortgage (housing lease) backed securities• Equity shares of companies which deal in properties• Other securities like debt instruments

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