The much-talked about Real Estate (Regulation and Development) Act, 2016 (RERA) has finally been in effect since 1 May 2017. Most of the states and union territories in India have even notified rules under the RERA and once the Real Estate Regulatory Authority is set up, it will be fully operational. Needless to say that RERA will impact all market participants—developers, lenders, consumers and private equity investors.
Real estate has always been a promising sector for the private equity industry. Recent trends have shown that the fund requirement of this sector has been fuelled by private equity investment against debt. However, one of the major concerns amongst offshore as well as domestic funds is that the sector is highly unregulated in India. One of the sweeping changes brought about by RERA is the setting up of a separate real estate authority and the requirement of registration of real estate project (including existing projects where occupation certificate is not obtained) with the Real Estate Regulatory Authority. RERA requires developers to market the project only after all approvals, including the commencement certificate, are obtained and the project is registered with the regulatory body. All significant details relating to the developer, its promoters, projects, including previous ones, are required to be uploaded on the website of the Real Estate Regulatory Authority. This is a welcome move for private equity investors as the data made available will protect them from misrepresentations. Further, RERA is expected to promote transparency, accountability, discipline and efficiency in construction of projects, making a conducive environment for investments in the real estate sector.
One of the major challenges faced by the private equity investors in the era of RERA is the wide definition of the promoter. The definition of promoter includes even a person who is instrumental in constructing and marketing the project. Accordingly, this may also hit equity investors since it allows developers to use their brand name to market the project. RERA entails some stringent obligations on the promoter as it is the entity that develops the project. The promoter should ensure that the title of the project is clear and marketable, provide details of the project to the regulator, update it from time to time and ensure timely delivery of possession. Strict penalties are stipulated in case of violation/non-compliance of the provisions of RERA.
Typically, India-focused private equity funds insist on certain specific rights with regard to being proactively involved in marketing and development strategies for projects. Such rights include exercising veto rights and being actively involved in the key decisions related to the project. By virtue of being a shareholder, the private equity investor may get classified as a promoter or there are chances of the risk being passed on to it for the purpose of RERA. Further, details of each of the directors are required to be uploaded on the website of the Real Estate Regulatory Authority. This has made private equity investors that appoint nominee directors on the board of the developer company more cautious. In view thereof, private equity investors are re-negotiating their documents with developers to prevent being labelled as a promoter and to obtain stricter indemnities against incurring any penalties or claims under RERA.
Another significant change under RERA is the enforcement of certain rights of the private equity investors such as step-in rights and dilution of the shareholding of the developer. The step-in right enables the private equity investors to step into the shoes of the developer or appoint a third party to continue the project in case of delays or defaults by the developer. Now under RERA, consent of second and third allottees and the Real Estate Regulatory Authority is required for replacement of the promoter or change of majority shareholding of the promoter. Further, the definition of allottees under RERA includes “a person subsequently acquires the said allotment through sale, transfer or otherwise”. Thus, although the private equity investor is not prevented from enforcing its step-in right, either the investor will be required to work in consonance with the consumers or take into account the time period required for obtaining such consent prior to enforcing its step-in right. Having said that, this may also act as a pressure tactic in ensuring that the developer completes the project in a timely manner.
Exits and returns on investment may also require re-negotiation under RERA. Typically, private equity documents provide that the developer shall first repay and provide an exit to the investor from the cash flows received from the allottees. However, RERA mandates the promoter to deposit 70% of the amount received from the allottees in a separate account which shall be utilised to cover the cost of construction and land. Different states have specified what constitutes the cost of construction. For instance, Maharashtra has specified that repayment and servicing of debt shall qualify as the cost of construction. There is no such provision under the rules framed by the Karnataka government. Having said that, return to private equity investors is not covered within the definition of cost of construction if the investment is in the form of shares. Developers may only be freely permitted to utilise 30% of the amount received from the allottees to repay the private equity investors. The balance may be repaid after completion of construction or other avenues of servicing repayments may have to be examined.
With the notification of RERA, private equity investors may have to re-negotiate documents with the developer. Under RERA, a shift from pure equity to mezzanine or hybrid debt may be seen. Stricter indemnities, default clauses and covenants may be obtained from the developer for penalties under RERA and compliance with RERA, respectively.
The new law is expected to change the real estate regulatory environment in India. Despite certain challenges, RERA shall benefit private equity investors as it is likely to bring in discipline in the real estate market.
Avikshit Moral is partner while Apurva Kanvinde is senior associate at Juris Corp. Views are personal.
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