Some cash-strapped real estate players turning to private equity (PE) firms for money are walking into a virtual minefield. Though PE firms have come to the rescue of many developers struggling with falling sales and mounting debt, the way some of these deals are structured could add to their problems later.
Industry sources said that most PE players are demanding 30-40% assured returns on their investments in realty projects, failing which the PE firms would get lien over their properties.
The practice raises legal questions as well. According to RBI?s portfolio investment policy and the country?s FDI policy, any equity instrument linked with assured returns or any kind of lien is seen as a debt instrument.
According to Akshay N Chudasama, partner, J Sagar Associates, most domestic PE funds prefer convertible and structured debt instruments as debt is not permissible in foreign PE funds. Since a put option with a fixed time return automatically becomes debt, domestic funds are opting for quasi-debt deals with guaranteed returns over a fixed time frame. ?They are in the range of at least 20% upside. It is a recent phenomenon, Before 2008, a lot of money was chasing a few deals but now, the scale has tilted in favour of investors,? he said.
Saroj Jha of SRGR Law Firms said that in the last one month, 12 such deals with riders of assured returns were clinched between developers and funds. He however, declined to identify deals worked out by his firms and even other law firms.
In the first six months of the year (January-June) PE investments in real estate have touched $444.77 million, 47% more than $303 million in the corresponding period in 2010, according to VCCEdge, the data division of PE and venture capital tracking firm VC Circle. Interestingly, a big chunk of PE investments come from quasi-debt instruments with pure equity shying away from the sector.
The managing director of a Bangalore-based real estate private equity fund which is currently raising funds told FE: ?For debt funding, private equity investors are increasingly looking at fixed returns from developers. These are in the range of 22-27%, and the collateral is in the form of the land or building.
In case of a default, the land/building can be forfeited. These debt options are in the form of convertible debentures, non-convertible debentures and performance shares. Structured returns are offered on debt equity projects as investors are looking for steady returns which have been difficult to come by in the existing real estate scenario in the country.?
Sachin Sandhir, managing director & country head, RICS India echoes that this growing practice is on account of the sector witnessing very few successful exits. ?Delayed exits have added fuel to the fire for the cash strapped sector. Developers have no option but to raise capital from PE and these investors are asking for 20-30% assured returns form developers through the preferred equity root.?
Real estate players also accept that they resort to being hemmed in by PE players in the wake of present economic situation. Niranjan Hiranandani, MD, Hiranandani Group said, ?This assured returns practice is happening on account of soaring home loan interests and loans coming hard for the developers. Developers are left with no choice but to raise money from PE investors on their terms in such a scenario. Such deals with collateral and assured returns are essentially debts in the garb of equity?.
However, Ansal API CEO Anil Kumar is of the view that this practice of assured returns is used by PE players for projects entangled in legal hassles or land acquisition issues or disputes. ?As many projects of many developers face such challenges, the builders have no choice but to complete the project on time with money from whichever structure. However structuring of such instruments can always be challenged,? he said.