Investing in the Indian RE Maket

Still too spicy for some?

A presentation by Sharad Gohil, Managing Director of Arpan Real Estate Limited (10 September 2009).

The main summary of the talk confirmed that Indian property market is not for an unseasoned investor as local partnerships and legal structures need to be watertight to protect an institution’s interests. Too spicy for some – probably!

General Overall Economic

Sharad confirmed that prior to previous thought; no market was immune to a global crisis that we have just been through. Earlier optimism that India and China will save us has not happened. This was an interesting point so when was the last time you heard the term ‘decoupling’ ?? (No such thing!)

Sharad mentioned the following key statistics:

• Main Indian stock exchange (SENSEX) down 40% from its Jan 09 high
• $6bn of foreign funds had flowed out of India during this period, reacting both to slowing growth and perceptions that the market was over-valued. Probably this was also a result of the west having their own problems as cash was needed to sort out their balance sheets!
• Indian GDP was 6% pa for 2008-09 fiscal year, but the World Bank is now forecasting 8% pa for 2010, ahead of China at 7.7% pa for the same period.
• Inflation was negative for the year to the end of June 2009, the first time in 30 odd years.
• 2009 onwards has seen more optimism and the Indian government has seized on this in planning $559 bn of infrastructure upgrades over the next five years of which 70% would be state funded, and the other 30% to be funded by the private sector. I would question whether this will all happen. India is running a massive budget deficit and this could have been just political posturing to get the Congress Party re-elected which happened.

For institutional property investment there are three main areas on which to focus:

1. Capital Structure

2. Due Diligence

3. Knowing your Partner

Sharad discussed each of these in detail.

1. Capital Structure

Joint ventures (JVs) tend to involve a local partner who is already the landowner. It is usually only the land which constitutes his equity contribution to the JV. The historic owner can make huge profits by just entering into the JV from day 1. Local partners are unwilling to dilute their stake or provide more equity in the downturn. In the boom times, pre-sales of residential were the general model. As this dried up and Indians began to lose their jobs, the residential market crashed overnight. Local developers have been adverse to cut prices/rents. The reason is a BIG EGO! They cannot be seen to be the first to slash prices as it is perceived to have a knock on effect on their other developments and their reputation.

A JV should be structured so that both parties put in a mix of capital and land to ensure that the building completes on-time as well as interests being aligned in the upcoming sales period.

2. Due Diligence

Indian Bureaucracy is a minefield. Legal due diligence can be long and protracted and proving title can be very difficult. Much of land has fragmented ownership as well as charges which banks use as collateral. A relic of the feudal system and numerous family disputes!

Foreign investors need a good local lawyer to unravel all the ownerships in an effort to obtain a clean title. The key pitfalls are:

• Floor Space Index (FSI) – This is a local law different by region, which mandates development densities. It must be checked in advance in case your 200,000 sq ft office block you were planning to build can only be a 50,000 sq ft office on the foot print of the land you have just purchased!
• Zoning – This is essentially planning, but many Zones have complex hidden covenants – eg timing and land restrictions that your lawyers need to be aware as part of due diligence.
• Arbitration – It is essential to have an arbitration clause in place with all contracts to settle disputes. It must be in a foreign jurisdiction such as Singapore or the UK. To take the matter to and Indian court could take up to TEN years!
• Title – It must be held at the local registrar.

3. Knowing Your Partner

Knowing your partner is the key to a successful development and investment. The local partner should have a better grasp of planning issues, neighbouring property disputes and local government liaison (involving brown paper envelopes?)

The local partner is usually the most powerful one. Investors should be under no illusion that they are the lead partner! There is the need to agree ‘tagalong’ and ‘dragalong’ rights so partners can exit together. The local partner should be a large scale developer with a good regional or national track record to greatly minimise the risk.

There is a definite need to further educate Indian partners further about Western business and institutional investment needs such as risk return profiles. Foreign investors were merely perceived to be expensive sources of debt!

Conclusion

There was a definite Indian property bubble (as with the rest of the world) and the weight of money chasing potential 35% pa plus returns added to this.

The Indian property investment market is a difficult market to understand and crack. However, returns are there for investors who want to be educated in dealing locally and are prepared to do proper due diligence and not just rush into deploying capital quickly with another eye looking at launching their next fund!

Property values are likely to still continue to ease across the board for at least another six months. When values improve, it will be on the capital market side first. Occupier demand will continue to remain weak for some time except for certain residential sectors (mass urban/suburban low to middle income housing).

There are good long term prospects for India generally based on a five to seven year strategy. However, a lot of reforms are required and the business and legal infrastructure needs to be much improved.

Shailendra Shah MRICS

Investment Fund Manager

Canada Life UK