The multiple policy reforms and structural changes initiated by the government were aimed towards getting the much-needed transparency into the opaque and highly unorganized real estate sector. However, there has been stress of cash flows among market makers. With pressure on sales and the Real Estate Act coming into shape, developers are struggling to re-align their business models as per the new norms. The practice of residential projects being self-funded with interest-free money coming in from the initial pre-launch phase is now a thing of the past. Developers need a huge amount of capital to be infused into each project, thus putting tremendous pressure on the balance sheet. Interest rates have already started to harden, and the banking sector is still wary of funding real estate developers. On the investor front, a number of them depended heavily on cash components for exiting their resale investments and are now left awry post the drive of demonetization.
All these market movements have brought to light a whole new segment for investment – distressed assets. Given the current market conditions, property buyers are showcased with a range of opportunities across retail and office assets, single residential units, and even entire projects at attractive valuations. Smart property buyers can make the most of this opportunity. However, it is extremely important to be cautious before taking the plunge, which might very well even hit a jackpot. Some of the factors to keep in mind while buying a distressed property are as follows:
1. Due Diligence: It is important to bear in mind that the reasons for distress could very well impact the buyer as well if a thorough due diligence is not done. First and foremost, the reasons for the distress sale need to be well-researched. Issues like policy changes impacting the property, title issues, etc. may result in more pain than gain.
2. Leverage: With the current market scenario of increasing interest rates, a buyer must not over leverage himself for buying out the distressed asset. In fact, it is vital to investigate the existing debt against the asset, which the buyer will need to take on post the purchase of the property. This debt should ideally be segregated into short-term and long-term debt, with a complete understanding of any security that may be backing the debt.
3. Legal Compliance: One must ensure that the development of the asset has been done in adherence to all regulatory norms with all statutory approvals in place. Any violation is a risk posed to the buyer. An informed decision will help avoid unnecessary surprises and will give room for an action plan to mitigate any risks.
4. Cost Implications: Depending on the asset type and eventual use, the physical condition of the asset needs to be assessed well so that the buyer can objectively assess the cost outflow over and above the acquisition price. Any litigation against the property must be factored in as well. The buyer should have an understanding, a plan, as well as means of overcoming the litigations, if any. The property eventually needs to be commercially viable.
5. Future growth perspective: Attractive valuations are the crux of a distressed asset acquisition. However, a clear development plan or utilization of the asset with a vision on the eventual monetization of the asset would make the deal worthwhile. The asset must intrinsically have the potential to grow and yield returns for the buyer.
Distressed asset purchases should be done as an informed decision, which should be aligned with the investor’s risk appetite. An inadequately-researched decision of buying a distressed asset can lead to a massive financial setback and, in cases, even legal complications.
(By Divya Seth Maggu, Associate Director, Valuation & Advisory Services at Colliers International India)