Stressed Real Estate Asset Investments in India - Challenges and Opportunities?

Credit: Leungchopan / Envato Elements

India’s AIF Opportunity

• Amidst a liquidity gap, Alternate Investment Funds (AIFs) have emerged as a genuine alternate option to traditional lenders. Traditional lenders (banks, NBFCs and housing finance companies) facing rising non-performing assets (NPAs) are adopting a risk-averse approach.  

• AIF investments in distressed assets bring the expectation of high returns as distressed assets can be acquired at a discount without constraints of NPAs and extensive regulation applicable to traditional lenders. These aspects lead to increased flexibility. 

  • One of the many ways in which AIF investments are flexible is the range of investment avenues and asset classes. AIFs can be undertaken by way of investments in the form of debt, equity and/or quasi equity. 

  • AIF investments are also flexible in terms of their duration, and AIFs comparatively have the potential to be held for a longer term. 

  • AIFs also have flexibility in terms of project oversight, including by offering loan moratoriums to developers if necessary.

• As the preferred investment vehicle for the new wave of distress and last-mile financing, the AIF structure has given greater access to the market and to offshore and domestic investors. 

Credit: Maxxyustas / Envato elements

Room for regulatory reform

• In the wake of the pandemic, the Indian government launched measures such as stamp duty reductions, steep cuts in construction premiums and the emergency credit line guarantee scheme (ECLGS) facility, to provide relief to the various stakeholders. With the industry moving towards recovery, a pushback from the government on these measures would be detrimental.

• However, there is room for regulatory reform in making the environment more conducive to AIFs, developers and the larger real estate sector. 

  • The current regulatory hurdles in foreign portfolio investment (FPI) and debt investments continue to constrain foreign credit flows into the real estate sector.

  • From a tax perspective, developers are at a setback in their ability to claim the GST input tax credit vis-à-vis other industries.

  • Under SARFAESI, the ability to foreclose on the underlying asset is restricted to listed debentures. This approach is not in aligned with real estate transactions where the funding is often secured at the level of a project specific unlisted special purpose vehicle (SPV).

• Certainty of capital structure: The investment risk stands escalated when the legal and regulatory regime cannot guarantee a certain capital structure.

  • There is a need to recognize inter-creditor arrangements and the “last in first out” principle whereby investors who step in at the same stage would be treated as pari passu and equal in terms of seniority.

  • A possible way forward is to treat AIF funding as interim financing with precedence over existing lenders.

• Limits under current insolvency framework: The IBC has been designed more particularly for non-real estate companies undergoing resolution and then functioning as a going concern generating long-term cash flows. However, in the context of real estate – 

  • A last-mile residential project is a finite cash flow item. The success of a last-mile funding is also contingent on a developer stepping in to turn around and complete the project.

  • The residual value in a semi-sold and semi-constructed residential project or a real estate SPV is negligible.

  • The inclusion of homebuyers as financial creditors with disproportionate voting right can potentially lead to deadlocks on resolution plans.

• These factors lead to a question on whether the IBC or RERA is a suitable forum for insolvency of real estate SPVs, or there is a need for the government to legislate a new forum that would be tailored in the context of real estate insolvency matters.

Credit: Olivier_Le_Moal / Envato Elements

AIF investments going forward

• As per the present market trend, global and domestic investors are more inclined to take an asset-level risk in the commercial sector as opposed to the acquisition and development risks inherent in the residential sector, while deploying equity.

• However, with increased demand in the housing sector, funds may slowly explore equity financing opportunities in the residential sector.

Stressed asset investments and last-mile funding for projects has recently emerged as one of the greatest opportunities of the Indian real estate sector, aided by an increased demand for residential assets as the economy rebounds. Accordingly, it is imperative that the regulatory regime is responsive to this change for long-term sectoral growth that will outlive the pandemic and uplift the sector in the years to come. 

This is a summary report of our last GRI eMeeting: Stressed Real Estate Asset Investments in India - Challenges and Opportunities? co-hosted by Trilegal.  

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Trilegal

Trilegal is one of the leading law firms in India, providing innovative and quality legal services across the spectrum of corporate law. With over 400 lawyers spread across Bengaluru, Delhi, Gurugram and Mumbai, the Firm consistently advises many of the world’s leading corporations, financial institutions, and fund houses on their complex and first-to-market transactions. Trilegal has been recognised as the ‘Law Firm of the Decade’ at the RSG Grow India Awards.

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