Mumbai: Real estate may be down in the dumps right now. But even so, compared with most other big businesses, real estate remains one of the best to put your money into . At its core, real estate is the coolest even in failure. You build an airline on leased planes and if it fails all that the lenders are left with is a brand with which they can have ‘Good Times’ while humming Oo La La, La, La, Le, Oo. If real estate fails, lenders to the project still have the land and nothing as an asset gets as real as this.

Yet, it’s been a business that most respectable entrepreneurs have so far shied away from because it’s a trade vilified—mostly for the right reasons. For one, real estate has been the coolest way to generate and park slush funds for political parties. Much of the surging value of real estate springs from picking obscure land on the cheap and watching the location turn into gold after everyone else realizes it’s right next to a Metro station. Political interests in the sector and the need for cash in the business to pay bribes in order to get the dozens of required approvals gave real estate in India a bad image.

If real estate fails, lenders to the project still have the land and nothing as an asset gets as real as that

The change agent

That’s changing now with the implementation of The Real Estate (Regulation and Development) Act, 2016 or RERA. RERA has a requirement that no project can go to market without approvals and that 70% of the money received from customers has to be spent only on projects for which they have been received. This has knocked the bottom out of the earlier realty business model, which if transposed to another industry would look ridiculous.

In the automobile business, for instance, car manufacturers are the big boys with deep pockets and their rivals are other companies with similar traits, not roadside garage owners. But in real estate, until RERA, anyone with enough gumption could turn a “builder".

View Full Image Embassy Golf Link Business Park in Bengaluru. Embassy Office Parks expects to list its investment vehicle next year. Photo: Ramegowda Bopaiah/Mint

In the short-term, RERA is bringing more pain than joy just as a major surgery does until convalescence and a journey to full recovery. The pain is being felt mainly by homebuyers whose projects fall into default as their borderline builders are unable to cope with the stringent conditions of the Real Estate Act.

Once this phase is over, real estate in India will reflect its true place in the country’s economy. Real estate accounts for about 7% of India’s gross domestic product (GDP) which is now at about $2.5 trillion, which means the sector creates $180 billion in wealth annually. In China, real estate accounts for 14% of the country’s GDP and India will follow that pattern in a market well-regulated by RERA.

Political vested interests

It’s clear that the vested interests of political parties in real estate delayed for decades the formation of a regulator. India’s stock markets were opened to foreign investors for the first time in 1992 and the Securities and Exchange Board of India (Sebi) was given teeth to tackle insider trading in the same year. The Telecom Regulatory Authority of India (Trai), to control voice and internet connectivity, was formed 20 years ago in 1997; the Insurance Regulatory and Development Authority of India (Irda) came to life in 1999.

Political interests gave real estate a bad image. But all that is changing now with the implementation of RERA

The size of India’s insurance market is currently about $60 billion, the telecom market is half of that. Real estate generates twice as much as both telecom and the insurance industries put together. The learning from this is that successive governments have preached reform to all sectors, except those where their funding is tied. The flip side of this coin is the belated and half-hearted efforts to make political funding transparent.

RERA and the consequent sweeping away of unprofessional builders will help the entire ecosystem, including the non-banking financial companies (NBFCs) whose stocks are in a meltdown since 21 September after Infrastructure Leasing and Financial Services (IL&FS) loan defaults and the sale of Dewan Housing Finance Corp. Ltd’s (DHFL) commercial paper by DSP Mutual Fund at a deep discount.

View Full Image Tishman Speyer, which developed WaveRock complex in Hyderabad, is looking to exit the project. Photo: Kumar/Mint

Analysts have mostly laid the blame for investor concern on the asset-liability mismatches at these NBFCs. It’s worth looking at how many of these NBFC loans been given to developers who had little capital, no risk management practices and existed only because they could play the perverted system—getting land, using that as leverage to get advance booking money, diverting most of it to buy yet another plot of land and doing that cycle all over again. That sustained in an irrationally exuberant market where potential homeowners rushed to book flats at current prices in the belief that prices would keep rising.

The bubble blown by Y2K

Until 2014, surging prices that almost doubled the value of an apartment every five years was not just a belief but a fact. That happened for two reasons—Y2K, the Year 2000 problem, and the opening of foreign direct investment (FDI) in 2004 with the first flow of dollars coming in two years later.

Once the clean-up phase of RERA is over, real estate will reflect its true place in the country’s economy

Y2K was a simple problem to fix, changing vintage computer programmes that abbreviated four-digit years as two digits to save memory space. These computers could recognize ‘98’ as ‘1998’ and it caused hysteria for the world to think that at the midnight stroke of the millennium computers around the world would assume we were back in 1900. It needed hordes of programmers to fix it in systems around the world. Indian software companies, which had those millions of workers, got a foot into the door at Fortune 500 companies. Moving on to higher and more complex jobs was a natural evolution.

Indian information technology (IT) caused a tectonic shift as millions of 20-plus girls and boys chose to leave their parents’ homes to take up jobs in the tech cities of Bengaluru, Pune, Hyderabad, Mumbai and Delhi. They needed places to stay and they had the high salaries to back them in their quest. That was also a time when the benefits of India’s 1991 economic liberalization had filtered through and finance companies began lending money freely to buy new homes.

View Full Image Elbit Imaging developed one shopping mall in Pune and exited all of its assets at distress value.

The lunatic overdrive

The entry of foreign investments into the real estate sector sent the market into lunatic overdrive and some big global names made hurried investment decisions that ended up in dismal failure. Elbit Imaging Ltd, Israel’s leading developer in the early part of the millennium, which had big investments across Eastern Europe picked large land parcels in Bengaluru, Chennai and Pune at inflated prices. The firm barely managed to complete a shopping mall at its Pune site and exited all of its assets at distress value. The company went bankrupt in 2014.

New York-based Tishman Speyer Properties bought land in Hyderabad for a 2.5 million sq. ft complex called WaveRock designed by the firm of legendary architect I.M. Pei. That was Tishman Speyer’s only project in the country and the company is now trying to exit it.

Until 2014, surging prices that almost doubled the value of an apartment every five years was not just a belief but a fact

But subsequent waves of foreign investors such as Singapore’s sovereign wealth fund GIC, Blackstone Group Lp, JPMorgan and Chase Co. have been more prudent. They brought in more than just money into India’s real estate business. They brought in governance systems, professional managements and business models that will in the long-term create India’s biggest cities—world-class business districts of the kind seen in New York, Singapore and London.

GIC and Blackstone have acquired millions of square feet of commercial space and are holding it for the long-term. The ability to be patient for 10 years, or even longer, will allow them to exit their investments when they see the following three factors in favour:

■ A fall in the capitalization rate, which has already started to happen.

■ When the rupee appreciates versus the dollar, giving them more bang for every buck.

■ When their Real Estate Investment Trusts (REITs) are formed and listed, which will yield them the wholesale to retail premium.

Bengaluru-based Embassy Office Parks Pvt. Ltd, in which Blackstone is an investor, filed an offer document with Sebi on 24 September to raise ₹ 5,000 crore and expects to list its REIT next year.

Reality of turtle bets

Reading about these marquee global investors bets on India imparts a good feel to real estate here. But the reality is the size of their investments so far have been a pittance and the flow of foreign funds can easily go up by three to four times once RERA is fully implemented. FDI in real estate in 17 years from April 2000 to December 2017 has totalled just $24.67 billion, data from the Department of Industrial Policy and Promotion (DIPP) shows.

RERA is a rare win for all concerned. Good for the investors and end consumers because it will clear away the clutter of small robbers

Blackstone has over the past eight years invested about $5 billion in Indian real estate, which is a tad more than 1% of the $449.6 billion it manages worldwide. JPMorgan has over the past 10 years invested $600 million in Indian real estate—that is 0.04% of the $1.68 trillion of assets it manages worldwide.

As a bet the size of these investments by Blackstone and JPMorgan are as insignificant as someone wagering on a turtle hatching exercise. For the sea turtles, it’s a big day—they break out of their shells on the banks and dash across the sand to reach the waters before they turn prey to the predators aplenty—wild dogs, foxes and raccoons among mammals and gulls and vultures among birds. Only one out of 1,000 turtles make it to the sea that day.

A cleaner, transparent and well-regulated market will spur the world’s biggest asset managers to look at India more seriously than a turtle on a beach. For now to the world’s biggest investors, earmarking 1%, or less, of what they have to real estate in India is just having a foot in the door. It doesn’t mean they don’t care about these investments, but if they make no profit…no big deal!

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Rupee, risk and reward

JPMorgan and Blackstone’s bets on India would yield Internal rates of return of about 15%, which are rich by any standards. But those are Indian rupee gains—If they were to convert their profit into dollars and take it home today, their gains would whittle down to zero. For now there has been no reward and the risk has been huge—any bean counting investment committee sitting in New York would pull the plug on any further investments into real estate in India. Only perceptive business leaders would see the huge intangible benefits that these foreign investors have gained so far. They have built on ground experience and relationships that will yield rich returns once the Indian economy and rupee turn stable and they decide to increase their bets in a well-regulated and transparent real estate market.

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In real estate, investors put their money on the people running it rather than on the project. That’s because of the quirkiness at the execution level. Development Control Regulations in Thane Municipal Corporation are different from the Mumbai Municipal Corporation, just as it varies widely between Delhi, Noida and Gurugram. Area-specialist developers such as DLF Ltd in the National Capital Region (NCR); Raheja Developers, Hiranandani Group and Wadhwa Group in Mumbai; Panchsheel Realty in Pune and Embassy Group in Bengaluru know how to deal with these nuances.

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In conclusion, RERA is a rare win for all concerned. Good for the investors and end consumers because it will clear away the clutter of small robbers. Good for the big-time politicians too because RERA doesn’t have jurisdiction over long-term price-sensitive information. For example, a new international airport or a multi-modal transport network conceived in connecting main cities like Delhi to somewhere beyond Manesar, or Mumbai to way beyond Palghar and Panvel. These plans are mooted much ahead of the actual execution. A few fattened folk, told about these plans, could buy hundreds of acres of land on the cheap to build vaunted townships of the future. That can be the subject of another piece titled: What they don’t teach you at Harvard Business School.

Uday Khandeparkar is a columnist and an independent investment banker.

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