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A cross-sectional view of the real estate distress universe
Kumaran C

Real estate was the most happening sector in the last decade witnessing more storms (demonetisation, RERA, GST, NBFC crisis) than sunshine (price appreciation, demand growth).  

The aftereffects of such storms in addition to mismanagement have led the sector onto a bumpy stressful path to recovery. Various reports suggest that close to 5.7 lakh homes worth Rs 4.5 lakh crore are beyond the completion timeline.  

Stress Vs Distress Vs Crisis  

Stress is the initial sign of a problem in the project that deviates from the business plan resulting in cash flow deficit.  

Such deficit limits development activity and its pace. Market-influenced stress like GST and RERA is typically short-lived if the cash flow remains intact.  

Builders with no other faults like delayed delivery, financial indiscipline and mis-governance were immune to the larger shock and were the first ones to recover.  

Illiquid debt environment delays the self-recovery path from this stress. Such distressed asset will fall into crisis when the value depletes more than the capital in play. 

The reasons for stress are aplenty starting from delayed approvals, surplus liquidity-led cash leakage from projects and mis-governance. Result is overvalued and over-leveraged asset that warrants structuring to provide time and capital for course correction. Longer duration of distress situation means larger discount to lender and lesser realisable value. 

Recovery Vs Rescue Vs Resolution  

Money is the panacea. However, cost of recovery depends on the magnitude and time of the stress. The longer the situation prevails, the quicker the asset gets into distress mode, which warrants structuring.  

Initial stress can be led to a recovery path with not much value erosion where the deviation is not more than 25% from the budget. Fifty per cent of the delayed projects fall into this category which can be recovered with less capital and time.  

However, as the stress gets into distress mode due to not just market factors but also stakeholders’ (builder/lender/owner) mistakes, the rescue must be carried out to redeem the asset from such distress as the first step.  

After redeeming, the asset must be fed capital to proceed on the value path. Such rescue sometimes comes at a cost of compromises at the stakeholders’ end either through equity infusion or debt discounts. However, discounts are a factor of financier’s balance sheet pressure, size and growth.  

The longer the asset is held in books with no capital lifeline deployed, the value erosion will be higher warranting deep discounts. However, foreign capital managers feel such deep discount cases aren’t too many in India compared to other developed economies.  

This is largely due to the shadow banking system in the country that incubates such risky assets for longer time, government-led capitalisation policy and lack of mature securitisation markets that accentuate fall of the risky asset with multiple layers involvement rather than sweeping things under the rug. When the bubble bursts or such holding time expires, the only path is resolution to salvage the value that is left. 

However, no amount of money can reverse and retrace the value path as the value erodes with time in a status quo market. In a boom cycle, this value erosion can be compensated by value appreciation which is a bet of distressed or opportunistic funds.  

Of all the assets, real estate is the only one that carries certain value even in case of distress partly due to its tangibility, larger market, and ever-appreciating nature. 

Addressable market and available options  

With challenges come the opportunities. The downplay of conservative domestic credit market is being compensated by the interests of other alternative sources including foreign institutional play with wide strategy of core plus, value add, distress and opportunistic themes.  

Flippers, who buy the asset at a discount, hold, and resell at a premium, are essential for the growth of the distress market in addition to the hold-till-maturity funds.  

With the timelines of projects stretched due to the pandemic and other ripple effects, there is a large need for flexi-capital to enable credit and sector growth.  

Such flexi-capital is structured depending on the stress level of the asset that is well within the boundaries of inter-party resolution. Of late, there has been an emergence of loan-to-own funds like Blackstone and Brookfield at a time of high uncertainty today.  

Much of the financial (structural) problems can be solved by the right frame of capital which is forthcoming in the current market both from domestic and foreign fund houses. 

Kumaran C manages real estate-focused alternative investment funds of Sundaram group. Views are personal.

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