Real Estate Sector Capital Availability & Deficit

Ashish Khandelia - Founder - Certus Capital The Indian Real Estate Sector contributes up to ~10% to GDP, and its annual housing demand (rural + urban) being is pegged at 10MM+ homes per annum. However, the sector has had a volatile past decade of capital availability and deficit. The capital need of the housing sector alone is pegged at US$100Bn+ over the next 7 to 10 years. Coupled with demand from other real estate asset classes (office, warehousing, retail, hospitality, etc.), total need is almost US$130Bn. Factors leading to this need:   

1. Opening of FDI in Real Estate: With the new century, the Indian RE sector opened up for foreign investment for the first time in 2005 and was soon flushed with capital, thanks to the exuberant pre-GFC environment. Post GFC (late 2008), after the physical markets took a hit, residential markets re-bounded handsomely, clocking a ~15%+ price CAGR for close to five years before starting to cool off in 2014. During the same period, capital availability was severely restricted, pushing returns to 20%+ for debt like investments.
2. NBFS’s/HFC’s and the RE Debt: The high returns on residential real estate attracted new players to the sector. Initially these were ones with an expertise in real-estate investing/ lending. However, by 2013/2014, high-yields lured non-focused / retail lenders into wholesale RE lending business. This led to a scenario where NBFCs / HFCs accounted for 75%+ of the AUM growth in wholesale RE debt, between 2013 and 2018. Cheap and easy liquidity for NBFCs / HFCs also aided this buildout. During the same 2013 - 2018, debt mutual funds grew their AUM by US$100Bn and accounted for 80% of subscription to NBFCs’ Commercial Paper (CPs).
3. Shut Down of Credit Flow: Although there had been a positive lending environment prior to 2018, issues of Asset Liability mismatch were cropping up, with NBFCs/ HFCs financing long term loans to developers through short term debts. And then, it all came to a shutdown when ILF&S defaulted in September 2018, highlighting ALM / over leveraging concerns. Accordingly, the credit access to several NBFCs / HFCs was frozen. Since then, several other institutions have defaulted (DHFL, Altico, Reliance Home Finance, etc).  
4. Re-alignment of business Models: Immediately after the ILF&S default, the debt MF redemptions rose to 2.5 times of what it was during the same period, in the previous year (Sept-Dec 2017). Bond prices dropped, credit flow reduced to a trickle and Banks/ MFs exposure to NBFC’s/HFC’s ran at an all-time high. 
5. Exit of Financiers & Investors: The , non-focused/ retail financers began facing the heat from lenders and rating agencies, forcing them to exit or scaling back from the wholesale RE business. Focused investors also were cautious and playing it safe due to the non-availability of growth debt capital. Banks, on the other hand, were also not enthusiastic to fill the growing capital deficit due to various factors, like regulatory restrictions, higher risk weightage, which demanded higher capital allocation, as per the RBI mandate, and limited u/w focus on wholesale RE. All of this, eventually led to freeze on sectors capital access, especially for development projects. 

  Tight Liquidity Environment Continues To Stifle Growth The sudden exit of a large part of non-focused players has created a vacuum in the Indian RE sector, leading to tough access to capital, even for fundamentally strong projects and a spike in yields to 20% +/- for senior debt type capital. This has also led to over 263K units / 250MM sf+ of projects being put on hold / delayed due to financing / liquidity related issues* Additionally, up to USD 50 Bn+ of funds with existing exposure, is stuck with NBFC/HFC’s and needs to be invested soon. Since the onset of credit crises with IL&FS default in Sep 2018, foreign investors have invested / are in discussions to invest ~US$2.0Bn towards such exposure, which is a miniscule amount, considering the overall outstanding exposure. Even as the sector is undergoing intense consolidation, the COVID impact has put a premium on home ownership. Currently, affordability is at levels last seen in 2004, mortgage rates are at their lowest in 15 years, and property price growth has trailed the income growth and inflation rate, over last 7 years. Further, there has been a shift in consumer buying preference, who now opt for near completion / completed projects, increasing the demand for working capital requirements. Under such circumstances, the tight liquidity environment continues to stifle growth while sector consolidation is leading to a supply discipline in both quality and quantity. Having said that, it still remains to be seen how the massive gap left by retreating incumbents would be filled, even as we see an urgent need and an opportunity.