India-focused real estate private equity funds, which started investing during 2005, have come a full cycle and are looking at exits. The bull market phase vintage funds are exiting with pre-teen internal rate of return (IRR), almost half of expected IRR 6-7 years ago, which has made it difficult for general partners (GPs) to raise their new funds internationally.
Panellists in the session titled ‘Has Indian Real Estate Private Equity Delivered To Its Expectations’ at the VCCircle Limited Partners Summit 2013 said fund managers have learnt a few lessons along the way.
While moderating the panel, Shobhit Agarwal, joint managing director, Capital Markets, Jones Lang LaSalle India, said, “The value of land moved faster than that of the project, so if in 2006 you were sitting on a land you would have now made 5x returns on it than what the developer did by developing a project on it.”
However, the panellists noted that the value proposition has moved beyond the land.
Sunil Rohokale, CEO and managing director at ASK Investment Holdings Pvt Ltd, said, “Most of the developers earlier used to think that buying land cheap is the key to the business and that’s why most of them have such huge land banks. They took their IPO money, went ahead and bought land. Now they have realised that buying land is just a part of the game and that selling the project to customer, getting approvals and bankability of the business model is more important.”
Another change which has come from entry of private equity funds is the steps taken to institutionalise the family owned real estate companies. Although, this is a work in progress and there is still a long way to go to bring more transparency in operations, the speakers said the bar has been raised which would make the funds more interested in doing repeat business with the developers.
Rahul Rai, executive vice president and head real estate business at ICICI Prudential PMS, said: “Earlier, developers used to back calculate how much money will they make from the projects, but now their focus is on balance sheets and profit and loss accounts.”
Prior to the industry meltdown in 2008-09, there was a big mismatch in the funds’ returns expectations, according to the experts.
Earlier, funds were expecting a minimum 25 per cent IRR because they thought that real estate returns are normally sky high in the Indian market and that they will make more money. But in most cases project approvals didn’t come and projects didn’t take off even after two years of investments, making them as good as junk transactions.
This forced fund managers to introduce the mezzanine deal structures or take the non-convertible debentures (NCD) route to bet on newer transactions, where the fund manager is aware of the returns it will make after a fixed period. Such deals have, however, come under regulatory scanner.
ICICI Prudential PMS’ Rai said, “The real estate industry’s return multiples is in the range of 1.8x-2.5x and if the project has not done well it would be lesser than 1.8x.”
Real estate fund managers have seen lower returns as compared to sector agnostic private equity funds in India.
Fund managers say now there is more clarity on return expectations. ASK Investment’s Rohokale added that investors now understand the risk of Indian real estate and that fund managers understand that the key for investment is to first find a good developer with execution capability, experience in handling scale and size and finally governance and transparency of the company.
(Edited by Prem Udayabhanu)