[T.S.R:17893] Macquarie-Systematically Destroying India Real Estate

 

The foreign investment policy update was released last week by the Indian government. An innocuous clause in the document changes the classification of any investment with an option from FDI (Foreign Direct Investment) to ECB (External Commercial Borrowing). This has far-reaching implications for the Indian real estate sector since ECBs are not allowed in real estate in India and most foreign equity investments have built-in options.

 

Impact

 

Clause reflecting the revised FDI policy stance: The clause in the policy document says that "Only equity shares, fully, compulsorily and mandatorily convertible debentures/ preference shares, with no in-built options of any type, would qualify as eligible instruments for FDI. Equity instruments having in-built options or supported by options sold by third parties would lose their equity character and such instruments would have to comply with ECB guidelines". We present the implications of this move.

 

Future flows would get impacted: ECBs are not permitted in Indian real estate. Put options in private equity or compulsorily convertible bonds are the norm while investing in real estate projects as they offer some protection and an exit avenue. We think many investors would re-consider investing or change their return expectations if these options are not offered.

 

Policy has been a moving target: This move is the latest in a series of changes which has started to frustrate foreign private equity investors. Last week we attended a real estate industry conference. The encouraging aspect was that a few funds have un-deployed capital. However they are finding it tough to invest due to an "elevated risk profile". Two private equity fund managers mentioned that this is due to the fluid scenario of regulations and their interpretation. They mentioned that the consistent news flow on the anticorruption protests and "policy inaction" had led to their foreign investors starting to re-consider their intention of deploying money in India. (See our series of notes from 30 September to 3 October 2011).

 

Typically, a private equity investor would be very active in the prevailing stress. But the environment is making it tough for them to pull the trigger.

 

Will past deals get impacted? Importantly, it is not clear whether this reclassification will be applicable with retrospective effect. If that is the case, barring very few exceptions, all private equity deals done in the real estate sector since 2005 would be affected. Some examples of developers who have received FDI are DLF, Ansal, Parsvnath, Nitesh, Prestige, Ackruti and Godrej Properties. This would also involve many unlisted developers. While we think this will get resolved eventually, there may be near term concerns/ overhang regarding change in the structure of deals or pressure from private equity investors to exit.

 

Outlook

 

This latest change leads to further stress and uncertainty for the Indian real estate sector, in our view. We would avoid players with high leverage and weak cash flow yields.

 

Safe Harbor Statement:

Some forward looking statements on projections, estimates, expectations & outlook are included to enable a better comprehension of the Company prospects. Actual results may, however, differ materially from those stated on account of factors such as changes in government regulations, tax regimes, economic developments within India and the countries within which the Company conducts its business, exchange rate and interest rate movements, impact of competing products and their pricing, product demand and supply constraints.

 

Nothing in this article is, or should be construed as, investment advice.

 

 

 

 

 

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