Residential space continuing to mature as a sector backed by visible consolidation, robust demand, reducing uncertainties, increasing returns and improved governance, the stage is now set for more inclusive and increased reach of equity capital across wider base of developers.
The Lows!
Not very long ago, the residential real estate market in India was called a laggard by many. Perceived governance issues in project acquisition/execution, changing policies/taxes amid complex regulations, uncertainties in project performance and limited set of ‘investment worthy’ developers were highlighted by capital partners as hurdles to evaluate project equity based investments in residential real estate. Subsequently, a few more events led to the residential real estate asset class having lower wallet share among segments of real estate. These include:
- Demonetization impact
- RERA implementation
- Input tax credit changes in GST
- Credit crisis among NBFCs with real estate exposure
- Perception of project risks/liabilities on investors
- Other critical media soundbytes on the sector
Finally, characterized by high unsold inventory and expected construction delays followed by Covid-19, it seemed like the proverbial last straw on the camel’s back.
The Highs!
Today, after a dramatic recovery, the segment is closer to witnessing a paradigm shift. It is seeing addition and sales of housing by the lakhs every year, and this trend has continued strongly into first half of 2022 despite global headwinds. Housing sales are at record levels over the last many quarters.
A clear observation in this recovery cycle is emergence of a wider and stable set of regional developers who were resilient and emerged stronger through the past few years. The consolidation got visible and the sector now appears more mature with 10-15 developers in each market having more than 50% of market share. The markets today are characterized by:
- Consolidation in sales
- Improved governance and sustainability
- Adoption of tech across key project functions
- Demand fuelled by end-users/ new buyers
- No major impact of 140bps increase in housing loan rates
- Inventory overhang among decadal low
- Streamlining of NBFC systems/regulations
- Reducing leverage among top players; accelerated pre-payments
- Higher returns seen in residential projects compared to commercial RE
The MIAs!
Notwithstanding the makings of a festival as listed above, one thing conspicuous in the residential segment is limited equity transactions in growth/early stage projects. The chunk of capital available today for the residential sector is chasing special situations like thematic stress funds lending at high interest costs/covenants (with exceptions like SWAMIH fund), or high cost funding in advanced/de-risked project situations. Then there are larger funds willing to invest like a JV in projects of handful of established balance sheets deriving more comfort on the corporate over the strength of underlying projects.
While the funding opportunity to meet growing demand is huge, the segment seems to have limited investor options for growth which largely are debt financing, harking back to the situation post the global financial crisis in 2007, where high cost mezzanine debt funding was main recourse for all situations, be it land, construction or takeout. Few of the funds which off-late did participate in smaller ticket sized early project situations, have seen healthy returns and exits.
Barring a few select big-ticket platform deals or small ticket size investors (which are handful in number/book sizes), investors still appear to be wary of project-based growth funding, and the fatigue from past experiences seems to be still lingering.
Time to Partner?
It is well documented now that residential real estate has moved considerably on the maturity line and base premise for long-term revival is set. Sector is now providing opportunity to fund projects with wider base of more bankable developers having healthy market shares and matured outlook on partnerships.
Property markets in major cities like Bengaluru and Mumbai have seen the highest sales since 2013 with the H1 of 2022 growing by 60% in YoY terms. The sale of 158,705 units in H1 2022 was 19% more than the preceding six months, despite all the headwinds and uncertainties, according to a JLL India report.
This momentum is expected to continue in coming years, as experienced in the aftermath of past slowdowns. The recoveries seen post the 2007, 2012 and 2019 bumps, hold some indicators. Moreover, it is seen in the past that the quality of investment returns move in tandem with reforms and the maturity of the sector. There is an obvious and clear opportunity:
- Population of 1.3 bn and high rates of urbanization inadequately supported by lagging public infrastructure
- Largest working population in the world, record recruitments in metros at higher compensations
- Sustained office leasing, a lead indicator of housing demand
- Data analytics, PropTech, better underwriting and monitoring tools now available for managing uncertainties
- Significant demand-supply gap between the type of capital available vis-à-vis type of capital required
- Self-liquidating, lower debt due to pre-sales and progressive returns nature of the investment, pushing up IRRs compared to commercial RE
- More reliable exit structure to provide investor comfort without impacting project performance
- Wider base of developers across geographies with healthy market shares available for partnership driven capital and are willing, matured and equipped for the same
The residential sector is now prime for equity/equity-like funds being channelled in a more inclusive and universal manner and the sector seems more prepared and equipped for it than ever.