The Rising Tiger

By Ronald Evans,2014-11-22 13:43
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The Rising Tiger

Executive Summary

    If the twenty first century belongs to Asia, then India alongwith China has to lead the way. The success of these economies is imperative not only for it‟s combined population of over 2.2 billion people but also to ensure that the developed world at large remains cost competitive and able to secure enough jobs for it‟s citizens. The increasing confidence of international investor community and business leaders was further reinforced, courtesy the well received paper from Goldman Sachs „Dreaming with BRICs: The Path to 2050‟. The paper concludes that come year 2050, these BRIC economies (Brazil, Russia, India and China) would by far be larger, actually surpassing the G6 by sometime around 2040, than the combined economies of the G6 (USA, Japan, UK, France, Italy, Germany). A more startling scenario is one which projects the pecking order of the world‟s largest economies with China leading the pack, followed by USA, India and Japan followed by none other than Brazil and Russia.

    Relevant to India, this dramatic conclusion seems more sensational when one looks at the current rankings which place India at No. 12, below China and Brazil which rank at no. 7 and 8 respectively and above Russia which comes in at no. 16. The conclusion is obvious, ceterus paribus, India will in all probability deliver the highest rate of growth over the next 4-5 decades and that makes the Indian economy a story to watch out for in the coming future and an „must-not-miss‟ opportunity for global investors.


    During the late 1980s India relied increasingly on borrowing from foreign sources. This trend led to a balance of payments crisis in 1990, which began to infect every aspect of the Indian economy. GDP fell from 6.9% in 1989 to 4.9% the following year and down to 1.1% in 1991. That same year, inflation hit 17%. Pundits, forecasters, and economists all predicted doom for the Indian economy and its nearly one billion people. They were nearly right.

    Fortunately a new government came to power in June 1991, committed to economic reform. The new government allowed limited capital convertibility and began to throw off the socialistic impulses that prevented the Indian labor pool from fully demonstrate its prowess.

    The pessimists may argue about the slow pace of Indian reforms, but the direction unquestionably has been clear and unambiguous. Growth during 1990s was a moderate 5.6% to 6%, and has since accelerated to 6% to 7% per year since the year 2000. Further acceleration is likely as excess capacity in the economy gets rapidly absorbed.

    India has made headlines as one of the emerging economic global powerhouses. Offshoring of corporate services in the banking, financial, telecom, and IT sectors helped to push India's GDP growth over 7% in 2004. The country is now the fourth-largest global economy, second-largest emerging market economy, and the world‟s second-largest

    English-speaking population. The country provides a cost-effective and extremely skilled labor base.

    Some sources suggest a startling new re-ranking of the world's largest economies is in the offing, with China leading the pack, followed by the USA, India, and Japan, with Brazil and Russia following closely behind.

Unlimited Potential, Limited Capital

    The government has recognized the opportunity, but there is a great chasm between India of today and the India of tomorrow. The government‟s plan is to double per-capita income

    at least once a decade. To do so, India would need to grow from 8% to 10% every year. A new action plan seeks to attract foreign investment to bridge the gaps:

    1. Infrastructure: Attract more than US$150 billion within next 7-10 years to

    upgrade roads, airports, ports, hospitals.

    2. Power generation: Attract US$85 billion over next 10 years to bridge current

    existing electricity generation shortfall.

    3. Housing: Attract more than US$40 billion within a decade to create sufficient

    urban housing by 2015. There is a current urban shortage of more than 12

    million homes, in a total of 45 to 50 cities with a population of more than one

    million people each. This increases by approximately 1.5 million homes every

    year. Total demand for apartments in Bangalore is estimated at 24,000 units

    each year, with an expected annual growth rate of 20% over the next several


    4. Office Space: Attract net investment of more than $1.5 billion each year to

    create 25- to-30 million square feet of new office space needed to meet the

    increased demand from the IT and technology sectors.

    5. According to Cushman & Wakefield estimates, office space demand will reach

    80 million square feet over the next three years alone. Over the next 10 years,

    an estimated 3- to-3.5- million jobs may be outsourced to India, with Bangalore

    the most likely destination.

Regulatory Framework for RE Investments

    New Approach to Real Estate Investing

    In February 2005, the Indian government got the ball rolling by announcing landmark legislation allowing FDI into Indian real estate. Previously, FDI was limited to integrated townships and only on land parcels of 100 acres or greater. Now, India allows 100% FDI in the construction sector. Land parcel minimum has been reduced to 25 acres, which has opened up more opportunities for international investors and developers.

This legislation is anticipated to inject more than US$1 billion annually into India‟s

    development and construction industry. Less than two months after passage, international real estate company Tishman Speyer Properties and ICICI Venture Funds Management Company, India‟s largest private equity funds management company and a subsidiary of

    India‟s second largest bank, announced the formation of a joint venture to develop real estate projects in India.

    FDI in India remains “controlled,” but the opportunities now available are in themselves immense. For example:


    1. Non-resident Indian investments allowed under all categories.

    2. Direct FDI allowed in residential townships of more than 25 acres, with minimum

    paid-up equity capital of US$10 million, and US$5 million if invested in a joint


    3. Direct and automatic approval for IT park and hotel investments.

    4. FDI allowed in construction with approval for projects offering built-up area of more

    than 3.5 million square feet.

    5. Foreign and domestic venture capital investment in real estate allowed with prior


    6. Dividends can be freely repatriated; three-year lock-in for equity repatriation.

    7. Within special economic zones, akin to foreign trade zones in the USA,

    developments, free capital, and dividends allowed with many specific tax

    exemptions on profits (5 to 10 years), and local taxes.

    8. Foreign investors allowed invest positions in greenfield/brownfield developments.

    The Indian debt market has also rapidly matured and increasingly buoyant. A robust secondary market for commercial real estate paper is also forming. It is estimated that more than 60% of the growth in mortgage lending was due to increased exposure of financial institutions to commercial real estate. In addition, India largely follows English law in practice and spirit, thus ensuring a great level of comfort for foreign investors.

The Risk Return Snapshot

    If the impact of inflation is indeed hardest on the poorest, the Indian policy makers have rightly adopted a benign interest rates regime coupled with anti inflationary measures. Currently the 5- year G-Sec (government security) paper trades at between 6.2 6.7 %,

    and 10 year G-Sec between 7.1 7.4%, with wholesale inflation between 4-5.2%, down

    from historic highs of 8%, 10% and 8-10% respectively.

    The current regulations allows foreign investors to participate in fixed income opportunities as well as take positions in green-field/brown-field developments, each with it‟s own risk-

    return trade offs.

Risks and Mitigation

    In spite of the new legislation and growth in capital markets, investing in India remains filled with risks and hurdles for a foreign investor. Some examples:

    1. Absence of title insurance and digitized land records.

    2. Corruption - plethora of regulations and non-transparent bureaucratic processes.

    3. Mortgage recourse often to promoters rather than pure project risks.

    4. Absence of hybrid financial structures.

    5. Undercapitalized developers and projects.

    6. Limited lease tenures - typically 9 to10 years for commercial office space.

    7. Some retail tenancies can be for up to 20 to 25 years, but typically an exception.


    Most suburban areas, which present the vast majority of the investment opportunity to foreign investors, are newly developed, which means historic land title and regulations need to be thoroughly investigated. Typical areas for due diligence include nature of business conducted from premises, cost of tenant improvements, stability of business historically, lease price as benchmarked to market, vacancies, etc. Conversely, most new land supply in India is freehold in nature and government ownership/title of land is shrinking, though slowly.

    Hence, partnerships with local partners with access to clear land banks and with adequate knowledge of local regulatory nuances is often critical and at a premium.

    This problem coupled with the maze of regulatory approvals at the project level, necessitates the help of qualified and reputed solicitors and consultants.

    The Indian debt market has rapidly matured and increasing buoyant. Instruments such as RMBS, CMBS and CDOs are increasingly being used to make capital work more efficiently and de-risk project incomes from promoter risk while also creating a robust secondary market for commercial real estate paper. It is estimated that over 60% of the growth in mortgage lending was due to increased exposure of financial institutions to commercial real estate.

    Constrained by archaic laws (ULCRA, etc.) which mandated holding of assets under multiple legal entity ownerships, large developers are now rapidly consolidating balance sheets to make them more bankable. This also increases the attractiveness of such entities while either raising substantial debt quantum to fuel further growth else invite stakes either at the project SPV or holding company level. Rating and audit of developers is now common and increasingly reliable.

Assuming typical cost of construction in suburban areas to be US$ 30 35 psf, with FSI

    costs being in the range of US$ 18-25 psf, hence overall projects costs being normally within the range of US$48-60 psf., it becomes important for an investor in India to conduct a proper due diligence on underlying tenancies and those related to the micromarket. Typical areas for investigations are nature of business conducted from premises

    (corporate office user else R&D/third party outsourcing Vs. captive backoffice, etc.), cost of tenant improvements, stability of business historically, lease price as benchmarked to market, supply positions in the micro-market, vacancies, etc.

Possible Entry Vehicles & Market expectations

    In light of the regulatory frame work and the underlying opportunity, the following are in brief some of the vehicles by which foreign investors can look to make the most of the burgeoning opportunity which exists in RE investments in India.

    1. Stake in either project specific SPVs or holding companies of developers.

2. Direct stake in hotels/IT parks operating entities.


    3. Fund in-fund route with either other established foreign funds or by subscribing to the dollar component of Domestic Indian funds, the latter having already raised over US$ 1 billion in last 12 months for RE investments.

    4. Directly listing with SEBI else through AMC structures for pure off shore investible funds.

5. By evolving suitable Convertible debt plays.

6. As pure Construction partners.

    Once foreign investors understand the risk/reward tradeoffs, most decide to find a local partner who has access to clear land, adequate knowledge of local regulatory nuances, and the ability to run the gamut of project-level regulatory approvals.

    The challenge of finding the right partner, both from both a bankability and cultural-fit perspective) is increasing. Local partners want partners who can go beyond merely cutting checks. Instead they want partners who can transfer better and more efficient construction technology and who have:

    1. better planning and design skills

    2. access to capital sources

    3. enhanced property and facility management know-how and processes

    4. international branding, and

    5. access to relevant customer markets and forums.

    A thorough understanding of local practices and cultural nuances will make most of the difference between being able to successfully forge local partnerships in India and the ability to rapidly extend relationships in the market.

Conclusion & Path Forward

    Given India‟s apparent insatiable need for funds to drive and sustain the nascent economic growth, it is more a matter of time than conjecture on possibility as to when capital convertibility would be fully allowed and vehicles such as Mutual Funds and REITs allowed to operate. The current regulatory framework allows for a measured dose of foreign capital and seeks to prevent rampant speculation, and rightly so.

    However, as build up in stock positions and investor interest gathers momentum and India as an investment destination gets better understood, it is unmistakable how high this country would list in the foreign investors‟ priorities come the next 5-10 years. Hence,

    whilst the market would keep evolving and continue to offer immense opportunities, there would be a premium to be built for first movers into this market, ones who have come in early, built up a track record and created necessary a bank of goodwill which they can encash in future as the market growth continues both in terms of the overall value and

    depth and breadth across the India landscape.


Parallels to the „wild west‟, would be poor and unintelligent, rather comparisons to the

economies of the USA and UK in their 1960s and 70s more relevant for the India today.




    ; Residential sales account for over 75% of the total market, in terms of value. Archaic

    land acquisition and conversion norms, amongst other factors, have steadily lead to the

    estimated housing shortfall to hit astronomical figures of 22 million homes, growing by

    additional over 1.5 million homes each year.

    ; Residential mortgages as a percentage of GDP is just over 2.21%, compared to over

    30% for South East Asia, 45% for Europe and over 70% for the USA. The mortgage

    market will have to grow in excess of 25% over the next 5 years, to be at par with Asian

    peers. Hence, clearly the opportunity is enormous both for development and lending

    businesses in housing over the next couple of decades. Retail market for mortgages,

    currently valued at slightly over $ 5 Billion.

    ; Scope exists for 400 Township projects over the next 5 years spread across 30-35

    cities, each having a population of 0.5 Million.

    ; Total project value dedicated to Low/Middle income housing in the next 7 years

    estimated at $40 Billion


    ; Office property markets in India, boosted by success of the Off-shoring phenomenon,

    are expected to sustain current growth levels. Across the 8 major cities in India, which

    are considered centers of commercial business activity, demand for new office space

    alone has grown from an estimated 3.5 million sq.ft. in 1998 to over 16 million sq.ft. in

    2004. Cumulative demand for office space in India between 2005 & 2008 is estimated

    in excess of 85 million square feet. This represents a Compounded Annual Growth

    Rate (CAGR) of 14.5% over the next three years.

    ; Approximately 80% of this demand on a pan India basis is expected to be created by

    the new economy representing IT & BPO sectors. These broadly include all IT and IT

    driven operations as well as research and development facilities. Capital flows in to

    corporate real estate estimated at over $ 5 Billion over the next 3 years ; The driver of the growth has been steady demand in already established markets like

    National Capital Region, Mumbai, and Bangalore and continued emergence of newer

    markets like Hyderabad, Chennai, Pune, Kolkata and Chandigarh. There is also a

    renewed interest in other untapped locations as well, mainly in tier III cities such as

    Jaipur, Coimbatore, Ahmedabad, Lucknow etc.

    ; IT Parks constitute a growing segment of the overall office property market with

    potential absorption of close to 43 million square feet over 2005-08.


Retail / Hospitality / Entertainment

    ; Organized retail while growing at 20-25% per annum, will still not likely account for

    more than 8-9% of the total retail industry in terms of value by year 2010. ; While this would still be a virtual quadrupling of the current share of close to 2%, the

    absence of more radical and penetrative growth of organized retail across the value

    chain would continue to mean vast inefficiencies in the supply chain with resultant

    higher costs to consumers across board and across categories of merchandise. ; Estimate of 46 million sq.ft of space for malls and multiplexes is being added in Tier I, II

    and III cities in the next 24 months.

    ; Hospitality, Leisure & Entertainment projects in major metropolitan & emerging

    business locations. Based on past private equity deals in the market, the expected

    Cash on Cash returns are in excess of 25% owing to the operating risk characteristics

    of such investment.

    ; Recent FDI guidelines and subsequent news of the proposed gradual opening up of the

    retail industry are most welcome changes and certainly in the right direction. Just in the

    first year itself, we estimated FDI in-principle commitments to aggregate over $ 1 billion,

    predominantly as equity in project SPVs for Greenfield developments. As the market

    gets more broad based and mature, these figures could see exponential growth.

    Ancillary benefits accruing from such investments would be enchanced corporate

    governance standards, more transparency in accounting and hopefully better customer

    focus and orientation.



    Property tenure/Ownership

    Land administration in India is generally related to British law and practice. There are 3 types of tenure

1. Freehold title

    2. Perpetual leasehold title up to 99 years

    3. Statutory tenancy

Major Property Legislation

    Notable laws governing the real estate sector in India include the following

    1. Transfer of Property Act, 1882: This law details general principles of realty, like part-

    performance and lis pendens, sale, exchange, mortgage, lease, and gift of property.

    2. Indian Contracts Act, 1872: This is the law relating to contracts in India. It is based on

    English common law and includes concepts of proposal, promise, consideration,

    voidable contracts, void agreements, free consent, undue influence, fraud,

    misrepresentation, etc. similar to those found in English Law.

    3. Registration Act, 1908: The purpose of this Act is the conservation of evidence,

    assurances, title, publication of documents and prevention of fraud. It details the

    formalities for registering an instrument.

4. Specific Relief Act, 1963: Specific Relief Act is complimentary to provisions of

    Contract Act and Transfer of Property Act, as it applies both to movable property and

    immovable property. The Act applies in cases where the Court can order specific

    performance of a contract or act.

5. Urban Land (Ceiling & Regulation) Act: The legislation was intended to reduce land

    speculation and distribute land to the poor in urban areas by imposing a ceiling on the

    amount of land which could be owned by an individual. This ceiling limit ranges from

    500-2,000 square metres (sq. m). Excess vacant land is either to be surrendered to the

    competent authority appointed under the Act for a small compensation or to be

    developed by its holder only for specified purposes. The Act that was an impediment to

    the consolidation of land parcels for private development was repealed by the centre in

    1999. However the repeal of the Act has not been carried out in all states. Initially the

    repeal Act was applicable in Haryana, Punjab and all the Union Territories.

    Subsequently, it was adopted by the State Governments of Uttar Pradesh, Gujarat,

    Karnataka, Madhya Pradesh and Rajasthan. Andhra Pradesh, Assam, Bihar,


    Maharashtra, Orissa and West Bengal have not adopted the repeal Act so far.

    (information of states that have adopted /repealed all these acts can be put in a

    tabulated form)

    6. Land Acquisitions Act, 1894: This Act authorizes governments to acquire land for

    public purposes such as planned development, provisions for town or rural planning,

    provision for residential purpose to the poor or landless and for carrying out any

    education, housing or health scheme of the Government.

    7. The Easements Act, 1882: This law deals with restrictive and prescriptive easements,

    and licenses (general, irrevocable, and coupled with interest).

    8. Indian Evidence Act, 1872: Under the Act, whenever the status of any person as the

    owner of a piece of immovable property of which he is shown to be in possession is

    questioned, the burden of proving that he is not the owner lies on the person who

    asserts that he is not the owner.

Real Estate Taxes & Transaction Costs

    1. Property Tax: Property tax is levied as a percentage of the Rateable Value (RV) of the

    property. The calculation of RV and the tax rate payable varies between states. The

    property tax payable also varies depending on whether the property is owner occupied

    or leased out. The RV is calculated on the basis of actual rental if the property is leased.

    If the property is owner occupied, the RV is calculated on the basis of the comparable

    rental that the property can achieve.

    2. Stamp Duty & Legal Costs: Stamp duty and registration charges are payable on most

    instruments associated with the transfer of property, including sale, long lease and

    mortgage instruments. The actual rates vary as per state directives in the country.

    Stamp duty and registration charges applicable on property sales in the main cities in

    India are as below.


    8% 1.25% Delhi

     5% 1% Mumbai

     8.56% 1% Bangalore

    8% 1% Chennai

3. Corporate Taxation:

o Budget 2005-06 revisions on Corporate Tax: As per provisions of Budget 2005-06,

    the rate of tax on domestic companies has been reduced from 35% to 30%. The


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