While lately interest around the e-commerce and fintech sectors is extremely high (including on account of covid ridden situations), real estate continues to remain a priority amongst a lot of investors, especially those looking at fixed income returns. ‘Hard assets’ being available as security interest to secure downside risks, in addition to equity like features in terms of returns and control rights make debt funding (especially structured debt funding) in Indian real estate an extremely lucrative proposition for international investors.
Increasing stress on the real estate sector, especially due to the seasonal nature of the sector, lack of monetization options and the slow growth of the REIT regime has also prompted developers to look at non-traditional modes of funding such as banks and non-banking financial institutions. International investors have been playing an extremely important role in the Indian RE sector.
While the sector saw interest in the residential sector earlier, over the last few years interest in commercial RE has increased. In addition, retail housing has also seen substantial interest in the recent past.
In our ‘Real Estate Funding’ series, we shall be looking at various aspects of the RE sector relevant for investors, especially global investors.
In this piece, we discuss the various routes for investment into Indian RE and some key funding structures.

INVESTMENT ROUTES
Global players looking at Indian RE can explore multiple routes for investment into Indian RE:

• FOREIGN DIRECT INVESTMENT/DIRECT EQUITY STRUCTURES: Under this option, investors invest directly into the project developing company (for single projects) or holding company (for multiple projects). Investments could be either in equity shares or compulsorily convertible instruments (preference shares/debentures). The investments are largely with an intent of long-term appreciation of value of the property, and consequently the investment. Considering redemption of the investments are not permitted and buy-back/reduction of capital are cumbersome processes in India, exits are generally by way of sale of shares to a third party / promoter. In cases where the investments are into holding companies with multiple projects, listing of the holding company provides another viable exit for investors at times. While this mode used to be the preferred mode of investment traditionally, lack of liquidity for the investments (including lock in restrictions on investors), lack of downside protection and tax inefficiencies have resulted in this option being sparsely used of late. Blackstone’s acquisition of portfolio of assets from Prestige group is one of the largest recent transactions under the FDI route in the RE sector.
• NON-CONVERTIBLE DEBENTURES: One of the most commonly used structures is the non-convertible debentures (“NCD”) structure and is commonly used across lending classes and is largely agnostic to the residency of the lenders barring a few requirements that foreign investors need to comply with (discussed below). Broadly, the NCD structure (i) permits lenders to have adequate security interest (including on the project and its receivables), (ii) permits variable returns including ‘equity-like’ upsides, (iii) is efficient from a tax perspective, (iv) is most flexible to repatriate cash from India, and (v) is largely tenure agnostic and can be used for short term funding (say 12 months) and for longer tenures as well. NCDs can be invested by offshore and onshore investors both.While there are various structures for investments through NCDs, the most common ones are:
  • DIRECT PROJECT LEVEL LENDING: Lending to the special purpose vehicle (“SPV”) developing the project directly is one of the most common structures. The structure is preferred since the lenders are ‘closest to the asset’, i.e. the property being developed, and have a mortgage over the same, in addition to the lenders having direct control over cash flows. However, in case the group / holding company of the SPV undergoes insolvency, the lenders may be restricted in their ability to monetize the asset, and this poses significant concerns. Japanese investor Marubeni Corporation’s investment into a Wadhwa group project last year was a direct project level lending undertaken by way of NCDs.
  • HOLDING COMPANY LEVEL LENDING: Another structure that has been used extensively by lenders is lending to the group holding company. The SPVS developing the projects are ‘housed’ under the holding company. The investment can be structured to provide the lender the security over the project that it has invested for, control over the projects’ cash flows and be a lender at the holding company, thereby reducing the lender’s rights being compromised in case the holding company undergoes insolvency. While this may be preferred by lenders, borrowers are reluctant to borrow at holding company, since this exposes their entire portfolio of assets to the lender under law, which may not be the commercial intent. Oaktree’s investment last year into M3M was structured as NCDs at a group level.
  • APARTMENT FUNDING: Another common structure is the ‘apartment funding’ structure, where the lender lends funds to the developer, and in return is provided all cash flows emanating from specified units in a residential / commercial project. From a borrower’s perspective, (i) this provides easier monetization of units of the project, (ii) is efficient from a stamp duty (transfer tax) perspective, and (iii) restricts the rights of the lender to actions specific to or impacting the identified units / apartments only. From a lender’s perspective, (i) transfer tax is avoided; (ii) the lender is not required to take over the units; (iii) minimum sale prices can be put in place; and (iv) the structure provides the same benefits of the NCD structure mentioned above (although limited to the identified units only). Additionally, earn-out structures for the developers are often built in to ensure that the developers are incentivized to market and sell the identified units, in addition to their own inventory, if not in priority over their own inventory. These are done by providing developers a revenue share that is proportionate to the sale price of the units, above a certain benchmark. While the introduction of the Real Estate Regulation and Development Act (covered in the next piece of this series) has created some significant challenges for such transactions, investors still have looked at this structure to align the commercial and legal objectives.
• RETAIL REAL ESTATE LENDING: The regulatory framework in India restricts retail lending to select financial institutions. However, considering that the retail real estate lending space has lower delinquencies, large institutional investors have been taking a keen interest in this space. Investors who look at this space could be looking at a yield play or a growth play.
  • NON-BANKING FINANCIAL COMPANIES: Some investors have preferred to acquire / set up their own non-banking financial companies (“NBFC”), an RBI regulated entity, or take majority stakes in NBFCs. The NBFC undertakes retail lending, and the investors provide capital to the NBFC for its on-lending business. The capital may be provided as equity investment, or as debt investment (NCD route), or a mix of both. The debt portion of the capital funding is more tax efficient, and structures involving equity and debt investment both are quite common. The captive NBFC model is generally a growth play, where the NBFC is listed once the books are substantial enough. Blackstone’s majority stake acquisition in Aadhar Housing Finance Limited is one such example.
  • SECURITISATION TRUSTS: As opposed to the NBFC route, investors looking at a pure yield play prefer the securitisation trust route. In this structure, the investors invest in units issued by securitisation trusts, referred to as pass-through certificates or ‘PTC’. Banks and NBFCs securitise a portfolio of loans and become collection and servicing agents for these securitisation trusts. The unit holders ultimately benefit from the collections and becomes a form of stable yield on their investments. The benefit of these structures being bankruptcy remote from the bank / NBFC creating these is an added advantage in the structure. The banks / NBFCs also prefer these structures since it helps them monetise the loan portfolio prior to the stated maturity. These are generally mortgage or asset backed securitisation and have additional credit enhancers as well.
• PLATFORM LEVEL FUNDING
  Another emerging trend for real estate investments are ‘platforms’. Under this structure, the investor partners with an Indian developer for its current and/or future projects. The developer is provided an on-tap availability of construction finance (albeit subject to meeting specified project level conditions); and the role of the developer as a developer and as a shareholder / investor is segregated. The investor on the other hand, in addition to most of the benefits of the NCD structure mentioned above, is assured of good investment opportunities by the developer, since there is generally a right of first refusal / look or an exclusivity provided by the developer to the investor. The structure often encompass a mix of debt and equity investments, with debtinvestment forming major portion of the investment. Platform level structures are generally long term arrangements ranging from 4 to 8 years on a basket basis. Godrej- APG, Phoenix- Xander and Godrej- Allianz are some platforms that have been formed in India.
• REAL ESTATE INVESTMENT TRUSTS
  After years of evolution to the real estate investment trust (REIT) regime introduced in 2014, India saw its first REIT in 2019. REITs are trusts registered with the securities regulator, Securities and Exchange Board of India, which hold real estate assets. The REIT regulatory framework mandates distribution of a certain portion of the revenue, resulting in a good investment product for investors.
  In our next piece in our ‘Real Estate Funding’ series, we will be dealing with some key considerations in real estate investments.

Authored by:
Dipanshu Singhal (dipanshu @bombaylawchambers.com)
Karan Kalra ([email protected])