India’s Capital Flow in Times of Crisis
May 11, 2020Real Estate
COVID-19 has hit all markets, and the real estate market is no exception. Yet, India has shown resilience and may catch investor’s eye if it continues to make prudent decisions to counteract COVID-19’s impact. During the last GRI Real Estate India eMeeting, members discussed the current status of India’s capital flow and funding into the real estate sector. As well as the challenges asset classes will face to secure funding in the future.
Uncertainty Flows Throughout Markets
Uncertainty continues to hover over all markets and confidence levels have suffered greatly in the last months. Recovery seems far away for most players to be in the near-term horizon, which has created an atmosphere where decisions are not being made. Investors are analyzing the duration of the crisis in India, along with the costs. To hope to relieve some of the uncertainty and pain, the Indian government has searched for packages to help the demand and supply side, nevertheless its main focus will be in managing the major health crisis. The incentives on the demand side for the mid-segment from the government are a main concern for the sector. Although it is currently not suffering distress, this is not likely to happen before the 3Q-4Q of this year, and will most likely kick- in by March 2021.
As for the public markets, they are currently highly volatile and are not coordinating as they did in the past, and therefore not much traction has been seen within the private markets. The INR has held up reasonably well to this crisis as it has depreciated 9-10 percent in the last two months, which is much less compared to other currencies. The NBFCs have played a crucial role between banks and developers in the last months, and have greatly helped the sector but have generated some side-effects along the way. There are pools of capital within the domestic market, but without there being a clear demand or supply for this capital. At the moment liquidity levels are supporting global markets and even on the public sector side, government entities such as the Fed are entering the market and buying high-yield bonds directly.
India Presents Opportunity for Global Investment
The Indian market is quite peculiar and its real estate market does not portray a negative image. The philosophy attached to India is to first analyze both the geography and growth rates, and then fully believe in that growth.
Near-term priorities, in terms of opportunities to be pursued, of global institutional capital is likely to be in:
There are two different capital pools: Asia capital for opportunistic deals and global capital for credit transactions. Therefore the risk-reward spectrum can be played from credit to equity. When seen from a relative value basis, there are not many great bargains available in the US and Europe based on the prevalent price levels. COVID-19 has not made India any less attractive, if anything it has done the complete opposite. The extraordinary measures taken in the West have resulted in increasing levels of debt and low interest rates indicating that there are not that many opportunities there. If you take away the short-term noise and focus on the long-term picture the fundamentals in India are very strong and the price discovery process is better, leading to better capital allocations and opportunities for investors.
When it comes to pricing risk, not enough information is available to have a good understanding of the trends and what the outcome will be. Market dislocations have happened for short periods of time before, but recently windows have grown narrower. Making projections for the medium-term horizon will consist of various uncertainties and contingencies. Market prices have yet to catch up with the fundamentals and it will be a slow process.
Liquidity in the Indian Market
Concerns around liquidity, leverage and job losses are at the top in any sector. Once it is clearer as to what measure the government will take, it will help create an idea on how the markets would stabilize. In the current narrative, India seems to have stepped away from the dire outcomes like the ones witnessed in Spain and Italy, relieving pressure off the government regarding the fiscal deficit and pressure off operating businesses currently facing liquidity challenges. The longer the crisis runs ,the greater possibility of it turning into a solvency problem. As an outcome it will also create challenges for the banking sector.
In the past months, vast amounts of stimulus have been injected into the economy through LTROs by the RBI, which create short-term liquidity. Yet even with all the interventions made by the RBI, its measures are not close to those taken by the ECB, the Fed or Japan. The irony is that India has never had more liquidity in its banking channels as it does now. There is $80 billion of domestic liquidity and two-thirds of that is sitting with RBI at 3.75
percent. Banks on the other hand are not as likely to lend due to the unpredictability in risk pricing. Every other sector be it MSMEs, exports or real estate is clamoring toward liquidity. With liquidity, banks can ease the pressure as the biggest question for businesses is whether they have the liquidity to survive the next year. Global funds also have a great amount of liquidity and will increase the amount of available funds in the market. This increases the likelihood that money will flow back into the market, but not until 2021.
Residential Developers’ Dilemma
While global investors are adopting a wait and see approach, developers do not have that luxury and must act rapidly. It is essential for the investors that the construction of their projects continue. Although some sites in the periphery of the cities have been permitted to resume construction, the developers are eager to see more sites opening up in the next 15 to 20 days.
One of the main challenges the real estate sector is facing are residential assets. The issue is over-leveraging and when equity will return to the market is the big question. Residential has not seen equity flowing in for the past 11 years, except for a few instances. Commercial assets, however, have seen a lot of equity in the past 5 years. The counter-cyclical opportunity for investors is now, whether in case of debt or equity players. The debt player can retire the existing debtor with a haircut and the equity receives distress and safety margins. Residential developers are giving 10-15 percent price discounts, three financial schemes, interest subvention, 10-90 payment plans, NRI and are digitisation focused. Yet even by combining these elements, developers will be lucky if it meets 50 percent of the annual operating plan for this financial year. Some GRI members believe that to attract FDI inflows into the completed residential inventory, it would take 25 percent discount off the current retail price on projects where the current velocity of scale provides a clear line of sight of the exit timeline in the next two years.
Another challenge that is arising is that residential properties cannot be bought below the ready reckoner rate and providing this 25 percent discount may violate this regulatory requirement. A concern is that if this discount would in the end be able to provide the push needed to boost the sector. Members believe that the sector would have to go back to the basics and decide for themselves as to what really is the investment thesis? The Swamih investment fund launched by the government would prove to be the right market participant to buy these completed residential inventories.
Real Estate Funding Outlook
Prior to COVID-19, accessibility to capital was already a concern and was just accentuated by the pandemic. Office and co-working spaces will continue to do well, as India continues to offer much cheaper alternatives to the multinational companies looking to cut cost. Office may be the safest bet as prices have not crashed, no real distress has yet to be seen, and cap rates have expanded materially. Bond yields have not lost their value while the cost of capital has gone up. Overall, growth has de-accelerated and the near-term cap rates have expanded. As to commercial real estate, the true impact of working from home will need to be figured out. It is likely that the first pool of capital is likely to move toward grade-A office assets to tide over.
The affordable housing segment is expected to perform much better, especially as more people will aspire to purchase larger homes instead of what will fit at the moment or based on future projections of their income. The residential market however will not do as well, not just because of the capital crunch but also due the lower possibility of attracting buyers. Players are concerned with when the consumer will return before deciding the next course of action on residential assets. Another interesting question that arises for the lenders and mortgage lenders, which are the part of the strongest consumer finance markets, is when default rates will be injected in the market?
Uncertainty Flows Throughout Markets
Uncertainty continues to hover over all markets and confidence levels have suffered greatly in the last months. Recovery seems far away for most players to be in the near-term horizon, which has created an atmosphere where decisions are not being made. Investors are analyzing the duration of the crisis in India, along with the costs. To hope to relieve some of the uncertainty and pain, the Indian government has searched for packages to help the demand and supply side, nevertheless its main focus will be in managing the major health crisis. The incentives on the demand side for the mid-segment from the government are a main concern for the sector. Although it is currently not suffering distress, this is not likely to happen before the 3Q-4Q of this year, and will most likely kick- in by March 2021.
As for the public markets, they are currently highly volatile and are not coordinating as they did in the past, and therefore not much traction has been seen within the private markets. The INR has held up reasonably well to this crisis as it has depreciated 9-10 percent in the last two months, which is much less compared to other currencies. The NBFCs have played a crucial role between banks and developers in the last months, and have greatly helped the sector but have generated some side-effects along the way. There are pools of capital within the domestic market, but without there being a clear demand or supply for this capital. At the moment liquidity levels are supporting global markets and even on the public sector side, government entities such as the Fed are entering the market and buying high-yield bonds directly.
India Presents Opportunity for Global Investment
The Indian market is quite peculiar and its real estate market does not portray a negative image. The philosophy attached to India is to first analyze both the geography and growth rates, and then fully believe in that growth.
Near-term priorities, in terms of opportunities to be pursued, of global institutional capital is likely to be in:
- Toward public credit or public equity
- Providing rescue financing or bridge financing to existing portfolio companies
- Taking on new opportunities (likely to be seen 1Q-2Q21)
There are two different capital pools: Asia capital for opportunistic deals and global capital for credit transactions. Therefore the risk-reward spectrum can be played from credit to equity. When seen from a relative value basis, there are not many great bargains available in the US and Europe based on the prevalent price levels. COVID-19 has not made India any less attractive, if anything it has done the complete opposite. The extraordinary measures taken in the West have resulted in increasing levels of debt and low interest rates indicating that there are not that many opportunities there. If you take away the short-term noise and focus on the long-term picture the fundamentals in India are very strong and the price discovery process is better, leading to better capital allocations and opportunities for investors.
When it comes to pricing risk, not enough information is available to have a good understanding of the trends and what the outcome will be. Market dislocations have happened for short periods of time before, but recently windows have grown narrower. Making projections for the medium-term horizon will consist of various uncertainties and contingencies. Market prices have yet to catch up with the fundamentals and it will be a slow process.
Liquidity in the Indian Market
Concerns around liquidity, leverage and job losses are at the top in any sector. Once it is clearer as to what measure the government will take, it will help create an idea on how the markets would stabilize. In the current narrative, India seems to have stepped away from the dire outcomes like the ones witnessed in Spain and Italy, relieving pressure off the government regarding the fiscal deficit and pressure off operating businesses currently facing liquidity challenges. The longer the crisis runs ,the greater possibility of it turning into a solvency problem. As an outcome it will also create challenges for the banking sector.
In the past months, vast amounts of stimulus have been injected into the economy through LTROs by the RBI, which create short-term liquidity. Yet even with all the interventions made by the RBI, its measures are not close to those taken by the ECB, the Fed or Japan. The irony is that India has never had more liquidity in its banking channels as it does now. There is $80 billion of domestic liquidity and two-thirds of that is sitting with RBI at 3.75
percent. Banks on the other hand are not as likely to lend due to the unpredictability in risk pricing. Every other sector be it MSMEs, exports or real estate is clamoring toward liquidity. With liquidity, banks can ease the pressure as the biggest question for businesses is whether they have the liquidity to survive the next year. Global funds also have a great amount of liquidity and will increase the amount of available funds in the market. This increases the likelihood that money will flow back into the market, but not until 2021.
Residential Developers’ Dilemma
While global investors are adopting a wait and see approach, developers do not have that luxury and must act rapidly. It is essential for the investors that the construction of their projects continue. Although some sites in the periphery of the cities have been permitted to resume construction, the developers are eager to see more sites opening up in the next 15 to 20 days.
One of the main challenges the real estate sector is facing are residential assets. The issue is over-leveraging and when equity will return to the market is the big question. Residential has not seen equity flowing in for the past 11 years, except for a few instances. Commercial assets, however, have seen a lot of equity in the past 5 years. The counter-cyclical opportunity for investors is now, whether in case of debt or equity players. The debt player can retire the existing debtor with a haircut and the equity receives distress and safety margins. Residential developers are giving 10-15 percent price discounts, three financial schemes, interest subvention, 10-90 payment plans, NRI and are digitisation focused. Yet even by combining these elements, developers will be lucky if it meets 50 percent of the annual operating plan for this financial year. Some GRI members believe that to attract FDI inflows into the completed residential inventory, it would take 25 percent discount off the current retail price on projects where the current velocity of scale provides a clear line of sight of the exit timeline in the next two years.
Another challenge that is arising is that residential properties cannot be bought below the ready reckoner rate and providing this 25 percent discount may violate this regulatory requirement. A concern is that if this discount would in the end be able to provide the push needed to boost the sector. Members believe that the sector would have to go back to the basics and decide for themselves as to what really is the investment thesis? The Swamih investment fund launched by the government would prove to be the right market participant to buy these completed residential inventories.
Real Estate Funding Outlook
Prior to COVID-19, accessibility to capital was already a concern and was just accentuated by the pandemic. Office and co-working spaces will continue to do well, as India continues to offer much cheaper alternatives to the multinational companies looking to cut cost. Office may be the safest bet as prices have not crashed, no real distress has yet to be seen, and cap rates have expanded materially. Bond yields have not lost their value while the cost of capital has gone up. Overall, growth has de-accelerated and the near-term cap rates have expanded. As to commercial real estate, the true impact of working from home will need to be figured out. It is likely that the first pool of capital is likely to move toward grade-A office assets to tide over.
The affordable housing segment is expected to perform much better, especially as more people will aspire to purchase larger homes instead of what will fit at the moment or based on future projections of their income. The residential market however will not do as well, not just because of the capital crunch but also due the lower possibility of attracting buyers. Players are concerned with when the consumer will return before deciding the next course of action on residential assets. Another interesting question that arises for the lenders and mortgage lenders, which are the part of the strongest consumer finance markets, is when default rates will be injected in the market?
