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Private equity players get cautious with realty firms

As scams and controversies loom over the real estate sector, private equity (PE) investors are consolidating investments and opting for tranche-based investments.

business Updated: Dec 13, 2010 22:09 IST
Sachin Dave

As scams and controversies loom over the real estate sector, private equity (PE) investors are consolidating investments and opting for tranche-based investments.

While most of the equity level deals have been put in the deep freezer, deals at project levels through creating special purpose vehicle (SPV), are being evaluated. In most of the cases, the PE players are dishing out new checks and balances to secure them against any risks, say industry trackers.

“With respect to return structures, PE investors are presently biased towards a structured debt model which has some form of capital protection with an assured IRR (internal rate of return) and in some cases, an additional equity kicker,” said Avinash Gupta, head, financial advisory, Deloitte (India).

After the recent allegations against LIC Housing Finance for favouring some developers, banks are extra cautious with disbursing loans. PE investment is an only option out, since not many developers wish to increase cash flows through reduced prices.

“Typically PE investors look at 25% IRR and as of now this may be a problem especially in some projects in Mumbai
and NCR,” said Ashwini

Kumar, chief operating officer, Nitesh Estates, a real estate developer.

“These expectations (IRR) are almost the same as what they were before the downturn — however, the structure has changed, as private equity funds are now focusing more on capital protection. In other words, they seek lower risk even if that means slightly lower returns,” said Anuj Puri, chairman and country head, Jones Lang LaSalle India.

This year till November, around 40 PE deals were struck worth $1.2 billion in real estate. This is a 55% jump over the last year in terms of deals and a 95% jump in terms of deal value. According to the RBI data (year ended March 2010), real estate exposure of Indian banks is around R5.8 trillion, of which around 70% are of the public sector banks. The ticket size of the PE deals in the sector are around R100 crore and most of them happening at an SPV level than at equity level.

“This is representative of investor preference towards SPV level deals as opposed to entity level deals and that too with a bias towards residential projects which have some degree of self-funding by way of pre-sales. In projects that require equity investments of $40 million and above, multiple PE players may co-invest to reduce per investor exposure to a single project,” added Gupta.

“The tranche-based investment allows PE investors to monitor project progress and hold back future tranches if they see significant project risks or concerns. However, in the case of secondary deals where the funds are a cash-out to the developer, upfront payments are the norm. Here also the cash-out may be in tranches linked to achieving certain pre-decided project milestones,” said an industry expert.