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Indian Real Estate Sector

At Crossroads: Finding Direction?

Dec-08

Paradigm Advisors
Setting Exemplary Standards

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Contents
Indian Real Estate Sector: A Snapshot Liquidity Crunch Equities Loose Sheen Residential IT / ITES and Commercial Offices Hospitality Land Valuations Outlook About Paradigm Advisors Private Equity Fund Raising Process Contacts 3 4 5 6 7 9 11 12 13 14 15

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Rise of the Phoenix

Real estate sector witnessed constant rally from 2003 to 2007 (5 Years), fuelled by:

Table: Indian Real Estate Market

Product Residential Offices - Commercial - IT / ITES Others (Retail, Hospitality, Warehousing, Education, Healthcare, etc)
Source: Industry

Share (%) 80% 11% 2% 9%

Increasing residential demand on the back of nuclear families, double income households, and easier availability of debt Increased outsourcing resulting in rising demand for IT Office Overall economic growth and expansions by Corporate India resulted in increased demand for commercial offices Advent of organised retailing paved way for more than 600 Malls aggregating to around 600 Mn Sq Ft across the country

9%

Backed by strong demand and higher investor interest, property prices moved up across all cities Government allows FDI in real estate, with funds initially concentrating on Tier I cities Fund focus expands from only Tier I cities to Tier II cities and towns With rising activity levels in the sector, RBI restricts ECBs by real estate developers Developers resorted to offshore borrowing in the guise of Preference Shares, and then Convertible Papers. SEBI paves way for REITs and REMFs

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Liquidity Crunch
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Figure: Bank PLR rising

Rising Inflation and Interest Rates

rate (%)

14 12 11 9
-0 Ju 5 n05 S ep -0 5 D ec -0 M 5 ar -0 Ju 6 n06 S ep -0 6 D ec -0 M 6 ar -0 Ju 7 n07 S ep -0 7 D ec -0 M 7 ar -0 Ju 8 n08 S ep -0 8 M ar

Inflation has significantly shot up to 12.1% in Sept 08 from around 8% an year ago. Interest rates also moved up from around 10% to around 14% - 15% in a year. Problem is further aggravated with banks not able to fund developers, due to: Banks hitting their sectoral advances limits, prohibiting them to lend more to the sector Banks asking for higher margin requirements, whereby reducing their exposure in the project This has led to developers resorting to Junior Debt Increasing Junior Debt borrowed at very high cost (between 30% - 40% pa) - on the balance sheet would further increase interest burden.

SBI PLR

Figure: Inflation and Interest at Peak

14.00% 12.00% 10.00% 8.00% 6.00% 4.00% 2.00% 0.00% Mar- Mar- Mar- Mar- Mar- Mar- Mar- Mar- Mar00 01 02 03 04 05 06 07 08 W PI Inflation (LHS) SBI PLR (RHS) 14% 13% 12% 11% 10%

Figure: Falling Growth in real estate loans

120% 100% 80% 60% 40% 20% Mar05 Jun06 Oct06 Mar07 Aug07 Feb08 60% 50% 40% 30% 20% 10% 0% Growth in Mortgages Growth in Real Estate loans

Real Estate Loans

Mortgages (RHS)

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Equities Loose Sheen

Figure: Realty Stock Prices take a beating Raising equity is now a challenge Realty Stocks Valuations have contracted significantly, in anticipation of: Fall in prices due to affordability Concerns over execution and absorption Increase in WACC Significant decline in investor interest
Amount raised (USD m)
14,000 12,000 10,000 8,000 6,000 4,000 2,000 0 M ay-08 M ay-08 Jan-08 Dec-07 Dec-07 Sep-07 Aug-07 Aug-07 M ar-08 Apr-08 Sep-08
357 1 QFY 09

40% 30% 20% 10% 0% -10% -20% -30% Feb-08 Feb-08 Aug-08 Nov-07 Jul-07 Jun-08 Jul-08 Oct-07 Oct-07 Jul-08 Date

BSE realty

BSE realty relative to Sensex

Figure: Fall in IPOs / FPOs

1 4,000 1 2,21 4 1 2,000 1 0,000 8,000 6,048 6,000 4,000 2,000 FY 03 FY 04 FY 05 FY 06 FY 07 FY 08 1 QFY 08 1 ,500 4,976 5,71 4

With overall market weakening, public offerings are now a pass However, FDI in real estate in Q1FY09 stood at INR 51.4 Bn (12.3% of total FDI) compared to INR 87.5Bn (8.9% of total FDI) in FY2008. This could however be due to structured paper and / or junior debt coming under the guise of equity
100,000 90,000 80,000 70,000 60,000 50,000 40,000 30,000 20,000 10,000 0

7,095 5,643

Funds raised in Primary market

Figure: FDI in Real Estate Surges?

14% 12% 10% 8% 6% 4% 2% 0%

2005 - 06

2006 - 07 FDI in RE (Rs Mn)

2007 - 08 Share (%)

2008 - 09

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Residential Sales Slowdown

Figure: Customer collection of five companies
250,000 200,000 INR m 150,000 100,000 50,000 2006 C ustomer advance 2007 Sales 2008 C A as % sales (RHS) 80% 40% 0% 160% 120%

Figure: Income hikes have matched EMIs

20% 15% 10% 5% 0% -5% 2006 Change in EMI (yoy) 2007 Change in Income(yoy) 2008

Figure: Mortgage Growth for ICICI Bank tapering

Mortgage disbursals in INR bn 90 80 70 60 50 40 30 20 10 0 May-05 May-06 May-07 Aug-05 Aug-06 Aug-07 Feb-06 Feb-07 Nov-05 Nov-06 Nov-07 Feb-08 40% 30% 20% 10% 0% -10% -20% -30% -40% YoY Growth of disbursals

Figure: Higher prices makes it unaffordable

2,000

1.60

1,500

1.20

1,000
0.68 0.45 0.27 0.33 0.21

0.80

500

0.40

Mumbai Suburbs Delhi Suburbs Bangalore Suburbs Pune Suburbs Chennai Suburbs

Mortgage disbursals

YoY grow th (RHS)

Per capita income (US$)

Prices (US$ PSM)

Affordability ratio (RHS)

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IT / Commercial Offices
Slowing Demand Macro economic concerns is reducing business confidence ET NCAER Business Confidence Index for July 08 is back to 5 Year Low of 126, which was earlier witnessed in July 03 NASSCOM expects revenue growth for IT / ITES Companies to slow down from 29% in FY2007 to 21% in FY2008, which could hurt expansion plans IT Companies, which are primary demand generators for Grade A office space, ideally require 100 Sq Ft / Employee IT Companies have started reducing headcount, resulting in reduced real estate demand Going forward, this may affect volumes and margins of IT companies, reducing their capability to pay higher rentals, as well IT Companies prefer to spend USD 1 / Sq Ft on rentals, which has increased substantially (beyond these limits) in various cities Saving grace is weakening of rupee from around INR 40 / USD to INR 45 / USD, increasing IT companies rental limits up by around 11% 7
Source: The Economic Times

Figure: Business Confidence Index

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IT / Commercial Offices
Increased Supply Expected demand of 600 Mn Sq Ft (to seat 600,000 employees) over the next five years Notified IT / ITES SEZ would create supply of 1,286 Mn Sq Ft. Most of this supply may not come up in foreseeable future, due to lack of liquidity, weaker investor sentiment, and lack of occupier interest Quite a few SEZs may not generate leasing interest due to lack of developers experience and Source: Ministry of Commerce track record in developing Grade A Office Space and tenant relationships Rentals coming under pressure Grade A Office Space Rentals are coming under pressure on the back of increased supply and slowdown in demand Smaller Grade B Office Space developers with lower efficiency would further lead to a fall in rentals Market Mumbai, Powai Mumbai, Andheri Mumbai, Lower Parel Mumbai, LBS Marg Rent 125 210 225 90 Market Chennai, OMR NCR, Gurgaon Bangalore, CBD Bangalore, Whitefield Rent 50 85 90 24 Market Mumbai, Navi Mumbai Pune, Eastern Pune, Hingewadi Hyderabad, Hitech City Rent 80 41 38 42 8 Table: IT / ITES SEZ Supply

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Hospitality
Industry at a Glance Table: Occupancy Levels in Leading Cities

Source: HVS

Table: Average Room Rates in Leading Cities

Source: HVS

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Hospitality
Acute Shortage of Rooms According to HVS, Indian Hotel Industry has been growing at 20% - 22% YoY, since 2004 According to HVS, India needs additional supply of 160,000 rooms in top 25 cities Rising inflation, rising air travel costs, increased concerns, reduced business confidence, and focus on cost cutting has paved way for reduction in business and leisure travel. Oversupply: A Myth or Reality? Hotel projects may get stalled or scraped due to liquidity crunch and absence of investors According to HVS Survey, Active Development Ratio (ADR) which indicates actual construction vis a vis announced projects is around 55% to 60% This translates in actual supply of around 55,000 60,000 rooms over the next 3 5 years Room shortage would be around 100,000 rooms, and would increase with increasing room demand In leisure segment, Jaipur, Goa and Kochi continue to remain attractive investment destinations In business category, Mumbai and Delhi continue to remain attractive investment destinations Exits continue to remain a concern, in current market scenario, due to lack of clarity of primary markets and Hotel REITs buying out PE investors 10
Source: HVS

Table: Hotel Supply

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Land Valuations
Mark Twains quote Buy land, they are not making it anymore is now all words and no action, at least for real estate developers Land valuations have not yet corrected, in line with falling product prices Developers opting for JDA with landlords instead of outright purchase of land Investors (including developers) would be require land prices to move down further, as they have to further infuse equity for funding construction deficit, and achieve expected returns DTZ survey of land brokers in Sept 2008 concludes that land prices continues to hold on, despite around a 40% drop in transactions Paradigm quick analysis indicates that land prices need to fall in order to justify returns for the developers
FSI cost at various return expectations and

Table: Project Attributes

Size Efficiency Construction Period Construction Cost FSI 2.6 Mn Sq Ft 80% 4 Years Rs 2,000 psf 2 Product Rentals Exit Yield Exit Year Occupancy IT SEZ Rs 40 psfpm 12% Year 5 90%

Table: Expected FSI Cost (Rs / Sq Ft)

Debt / Const Cost (%) 55% 25% IRR (%) 30% 35% 432 213 59 60% 445 232 82 65% 457 251 104

Table: Actual Land Cost - Ask

Location Navi Mumbai OMR Gurgaon Rs / Sq Ft 1,500 950 800 Rs Mn / Acre 160 100 70

extent of construction cost funded by equity is as per table Land cost (ask prices) in various cities are as per table This shows a disconnect and indicates a fall in land prices, going forward

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Silver Lining in Dark Clouds

Huge unmet demand exits at reasonable levels Shortfall for housing units continues to remain at high levels Key drivers for demand growth would be: Right Product: Developers need to shift from Premium and Super Premium Apartments and Second Homes to Affordable and Mass Housing Right Pricing to address affordability and absorption Office space requirements, decisions for which has been postponed given uncertain economic climate, would continue to grow on the back of growing real economy and demand for Grade A office space Emerging Asset Classes which would attract investments and benefit from shortage in quality supply would be: Warehousing Education Healthcare
300 250 200 150 100 50 0 1971 1981 1991 2002 2007E 2012E

Figure: Buoyant residential demand

23.4 24.7
30

21.8 14.6

22.4

25 20 15 10 5 0

Usable Housing Stock (LHS) Num ber of Households (LHS) Shortfall (RHS)

Figure: Short Supply of Office Space

2000 1750 1500 1250 1000 750 500 250 0 India* Singapore Bangkok Hong Kong New York 450 400 350 300 250 200 150 100 50 0

GDP-PPP (US $ bn)

Office Space (mn sft)

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About Paradigm Advisors

Founded by Sumeet Mehta in Oct 2008 Sumeet Mehta is a Chartered Accountant by qualification and brings with him 8 years of experience in investment research and investment banking Team comprises of professionals with rich experience in real estate and financial services sectors Firm brings with itself 20 man years of experience in real estate advisory, feasibility and best use studies, demand assessment studies and capital raising Team has worked on fund raising aggregating to around USD 100 Mn, across various asset classes, in their previous organisations Experience predominantly in real estate private equity space with experience in debt syndication for other sectors
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Private Equity Fund Raising Process

Deal Origination Valuations and Financial and Market Analysis Preparation of Information Memorandum Deal Marketing and Presentations to potential investors Management Meetings and Site Visits Assisting in Negotiations and Term Sheet Signing Assisting in Due Diligence, Deal Structuring and Preparation of Definitive Agreements Handling coordination between tax and legal counsels and accountants of developers and investors

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Contacts Sumeet Mehta

Chief Executive Officer Paradigm Advisors 1-2, Laxmi Bldg, Sir P. M. Road, Fort, Mumbai, 400 001 Email: sumeetnmehta@yahoo.com Phone: +91 98704 38983

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