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Building India: Future Outlook

Published on Fri, Oct 31,2014 | 21:10, Updated at Fri, Oct 31 at 21:10Source : 

By: Ajit Krishnan, Tax Partner & National Leader-Real Estate & Infrastructure Practice, EY

The Indian real estate sector is India’s second largest employer and slated to grow at over 11% over the next decade. Currently, it is a $ 57 billion industry contributing 6.3% of the GDP, employing 7.6 million people. The sector was opened up for foreign direct investment way back in 2000 with a restrictive policy permitting FDI only in integrated townships of over 100 acres.  This did not find favour with global investors who were dealing with many other challenges globally during that time.

In 2005, the government paved the way by coming up with a very different FDI policy for the sector and the interest of global investors in the India story had picked up dramatically.  This ushered in a tsunami of capital flows which remained unabated till 2010, but a lion’s share got deployed in the top six cities of India – Delhi/ NCR, Mumbai, Pune, Benglauru, Chennai and Hyderabad.  As per DIPP, the total FDI in this sector during this period was ~ US$ 21 billion.

During the last three years, a correction in the industry, a slowdown of the Indian economy, better investment opportunities in mature markets such as US, Europe and Japan coupled with changes in interpretation of the Indian FDI policy, dried up this source of capital for Indian real estate.  Bulk of the capital to this sector instead of taking the equity route preferred to come in through the listed NCD route as debt at a significant cost.

The real estate sector in any economy has a huge cascading impact on employment creation but equally and more importantly has a direct correlation to the cost of doing business in that region.  There is a need to therefore ensure allocation of long term equity capital in this sector as the demand supply gap continues to expand.  It is in this context, that an enabling FDI policy becomes critical. 

Given the projected growth of this sector, its size would grow to US$ 180 billion by 2020 and expected to generate new employment opportunities for over 15 million people during the same period.  In order to facilitate this, there is a need for a clear policy roadmap and equally important to facilitate investment in this sector from both domestic and international sources of capital.

The revisions proposed by the Cabinet to the FDI policy have the makings of being a catalyst for the revival of Indian real estate sector:

A)    The policy now permits FDI upto 100% under automatic route in completed projects for operation and maintenance of townships, shopping complexes, malls and business centres.  This in itself opens the doors for long term equity capital to come into the country to acquire and own such asset classes.  This will in turn free up the capital of Indian real estate developers and also assist in reducing their leverage, thereby freeing up a lot more of their capital to undertake newer projects.

B)    It has now been provided that FDI is permitted in an Indian company which acquires land and sells plots after completing the trunk infrastructure.  This therefore helps to accelerate the pace of development by an Indian company which has FDI and shortens the cycle of investment.  Given this clarity, it is anticipated that a lot of the foreign capital which had been invested during the last nine years will now have an alternate path to exit.  Also, it makes it easier for a new Indian company which has FDI to access this pool of plots to undertake the sub-projects.

C)    Permitting the induction of capital upto 10 years from approval of project makes it much more convenient for projects which are stuck for last mile equity funding to access FDI capital.  Many residential and commercial projects have largely been delayed or stuck for lack of capital.  Their only recourse was to access capital through domestic sources of equity as they had exhausted their leverage capability over time due to increased cost of construction and increased cost of interest.  By permitting FDI in such projects, there is now renewed hope that these projects will be able to raise equity capital needed to re-start their cycle and deliver projects to their customers.

D)    Transfer of investments between non-residents was always regarded and considered to be automatic.  However, there was a lack of clarity on whether such investments would qualify as FDI compliant for the incoming non-resident.  By providing a mechanism of approaching the FIPB for a case specific approval, there is at least clarity on a redress mechanism to seek exit from an investment.  This will hopefully increase the confidence of global investors.

In the backdrop of these changes, it is important to recognise that demand in the residential sector continues to outweigh supply by three to four fold in the middle and low income segments.  Affordable housing has therefore become the dominant focus of real estate developers.  Vacancy rates in commercial real estate had peaked to 19% of total supply in 2012 and now on the decline, reflecting an optimistic mood in a better investment climate.  This is now triggering an investment in creation of additional commercial real estate supply.  

But the big opportunity which will dramatically alter the landscape would be the investment in smart new cities and warehousing as a new segment.

The finance minister, Shri Arun Jaitley in his maiden budget speech said “Infrastructure and construction sectors have a significant role in the economy. Growth in these sectors is necessary to revive the economy and generate jobs for millions of our young boys and girls.”  Increased project activity, coupled with better access to global and domestic capital should only mean “ache din” for this sector and this in itself will be the single largest catalyst for heightened activity across all other sectors of the economy leading to “ache din” for India.

(Views expressed are personal)


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