Ind n real estat 20 0 dian te 010

Regu ulatory | Gov vernanc | Fin ce nance

February 2 2010

The information and opinions contained in this document have been compiled or arrived at from published sources believed to be reliable, but no representation or warranty is made to their accuracy, completeness or correctness. This document is for information purposes only. The information contained in this document is published for the assistance of the recipient but is not to be relied upon as authoritative or taken in substitution for the exercise of judgment by any recipient. This document is not intended to be a substitute for professional, technical or legal advice. All opinions expressed in this document are subject to change without notice. Whilst due care has been taken in the preparation of this document and information contained herein, neither CII nor Grant Thornton nor other legal entities in the group to which they belong, accept any liability whatsoever, for any direct or consequential loss howsoever arising from any use of this document or its contents or otherwise arising in connection herewith.

Contents
Foreword 01 02 03 11 24 Indian Real Estate | Industry Snapshot Executive summary Regulatory environment Governance & transparency Financing & capital

About CII About Grant Thornton

Foreword

Dear Friends, Wishing you a very happy and prosperous new year 2010. The year 2009 will be regarded as a unique year for Indian realty. A year that brought both despair and hope. The real estate boom that went bust in 2008 saw real estate players, investors and property consumers experiencing its pain with the onset of 2009. The global economic slowdown added to their woes. But then, luckily this pain, much against expectations did not last long. The second half of the year brought in a glimmer of hope. In the third quarter, there were clear signs of realty revival while the fourth quarter has brought the much needed relief to the real estate players, with demand for property picking up. One hopes that the real estate sector emerges from the crisis. Let the bitter memories be a thing of the past and the New Year bring in sanity, paving a way for systematic and sustainable growth of real estate in the months ahead. The Eleventh Five Year Plan envisages a total investment of US$514 billion in the infrastructure sector for bridging the infrastructure deficit and for sustaining a growth momentum of 9% per annum. This ambitious target requires 30% of the total investment, i.e. US$154.17 billion, through private sector participation. Over a period of time, the Government of India has taken several initiatives to accommodate and accelerate private investments in the infrastructure sector. These include sector specific policies, providing incentives and tax holidays to attract private investments, permission of 100% FDI in the infrastructure sector, special provision of Viability Gap Funding (VGF) and PPP approach. In order to gauge a better understanding of the macro environment surrounding this sector, a survey was conducted by the Knowledge Partner Grant Thornton. The compiled analysis from the survey is included in this Background Paper which also focuses on broad themes for discussion of this Conference - the regulatory environment, transparency & governance, and financing options available for this sector. CII has been actively involved with the Real Estate Sector addressing their key issues relating to policy matter and developing a roadmap for the growth of this Sector. As part of its initiatives, CII organises various focused interactions, seminars, conferences and expositions to provide an ideal platform for deliberations, and showcasing of emerging trends and technologies for various stakeholders. REALTY 2010 is one such initiative. We thank all the respondents associated with the survey for their immense support and vital inputs. We hope that you find this Background Paper enriching and meaningful. Looking forward to a fruitful association. Thank You

Madhukar Tulsi President IREO Management (P) Ltd.

As expected the year 2009 pro oved to be an eventful one f the real est industry i India. The for tate in nds n ocusing on core-competenc whilst it rei ce, inforced the c centrality of recessionary tren resulted in a return to fo o ce, cy e an matters related to the regulatory environment, governanc transparenc and finance for the India real esta industry. ate The process of in e ntroducing a regulatory bod for the Indian real estate industry is no under focu A r dy ow us. disc cussion draft o the Real Es of state (Regulati of Develo ion opment) Act h been releas by the uni ministry has sed ion of h housing and u urban poverty alleviation. her ficant financia reporting an taxation changes are also round the co al nd o orner, all of wh hich Oth very signif coll lectively add s significantly to the already c o challenging bu usiness environ nment facing the Industry. Con nvergence of Indian accoun nting standard with Interna ds ational Financ Reporting Standards (IF cial g FRS) from 1A April 2011, en nactment of th proposed D he Direct Tax Cod and the pro de oposed implem mentation of G Goods and Ser rvices Tax (GS are three major propose changes, w ST) m ed which have add further un ded ncertainly to th already he flui business en id nvironment fac the Indus cing stry. The Global finan e ncial crisis star off as a U real estate c rted US crisis which qu uickly hit the U financial s US system and the virtually par en ralysed the Wo orlds financia system. In India, however the crisis sta al r, arted off as a f financial syst crisis but very quickly hit the real est market. T situation a tem h tate The arising out of t upheaval p the provide littl choice but t introduce measures to en le to m nsure survival- restructure short term bor rrowings, reth project hink foc review target markets an critically ex cus, nd xamine all cos Most peop will agree t the recent times sts. ple that t hav seen some i ve improvement in the areas related to finan and capita raising, as w as consum demand nce al well mer for residential rea estate. Dem al mand for comm mercial and re real estate is still lagging in most part of the etail e g ts cou untry. The Asia-Pacific region is clea seen to be leading the G e arly Global recover As per indu ry. ustry reports, J Japan, Sin ngapore, Hong Kong, Malay Taiwan, S g ysia, South Korea and New Zea aland showed signs of recov in the very thir quarter of 2 rd 2009. The Res serve Bank of India (RBI), i the first week of Februar raised the e f in ry, economic gro owth forecast f India to 7. for .5%, for the current fiscal a this is cert and tainly not unim mpressive con nsidering the recent crisis. e Thi paper aims to analyse the matters that have the pote is e ential of drivin growth in th industry but also ng his stif it badly if n addressed. In our role as knowledge p fle not s partners for th CII Realty 2010: 6th Inte he y ernational Con nference on R Estate Changing Con Real C ntours: Leadin the Shift, w have broad categorised these ng we dly d issu around the three topics of Regulatory environment Governance & transparen and Finan ues e y t, e ncy, ncing. nior nals stry have also expr ressed their vie on some of these matte ews ers, Sen profession and indus veterans h thro ough an onlin survey cond ne ducted jointly by Grant Tho ornton and CI I thank eve II. erybody who h has con ntributed to th document and the CII R his Realty 2010, an made them possible. nd m

Vis shesh Chandiok k Nat tional Managing Partner Gra Thornton, Ind ant dia

Indian real estate | A snapshot

The real estate sector of India, just like most other sectors of the economy, has now started making its way out of the downturn. The period of slowdown had provided the industry with an opportunity of introspection and the signs of leaning are quite apparent in the industry. The sector, once identified as an unorganised sector, has been evolving quite well, in terms of project planning, size, technology, quality and financial management. A host of real estate companies now have access to organised financing through primary and secondary markets, financial institutions and alternative financing routes such as private equity. According to a latest ASSOCHAM report, Foreign Direct Investment (FDI) in the Indian real estate sector will increase to US$25 billion in the next 10 years, from present US$4 billion. The capital inflow from the routes of FDI, IPO, QIP and bank loans have increased from US$15,795 million in 2008 to the tune of US$25,977 million in 2009. Also, transparency on customer services has also improved vis--vis delivery schedules, information sharing on issues and after sales. We also cannot ignore the positive developments on the fronts of policy reforms and the increasing recognition of real estate as an infrastructure service driving the economic growth engine of the country. With so many positive signs, the sector has gained in a short period of time, the concern in the present perspective, however, arises as how to deal with the challenges posed by multi-pronged pressures on the front of regulatory environment, governance and of course, finance and capital management. There is an opportunity of high growth, yet again, in the approaching times, and a planned and strategic approach will help seize this opportunity, at an optimum level.

Executive summary

The path from crisis to recovery is opening up. While the mature markets are struggling to make their presence on this path, the emerging economies such as India are wellplaced. According to International Monetary Fund (IMF), the developed economies are likely to grow by an average of 1.3% in 2010. The Indian economy, on the other hand, is expected to grow by over 6% in this year. This position of leadership calls for more responsibility and the world is definitely looking at us. In this environment, it has become imperative that we consolidate our fundamentals and emerge as a force to beckon with. Real estate had been amongst the fastest growing sectors in India in the few years before recession, and now with the positive signs of recovery witnessed in the economy, it is the opportune time to address issues that will help boost growth in the long term.
Regulatory environment

This paper discusses an array of such significant matters, and considers the customers point-of-view along with the industry. It touches upon the critical aspect of transparency and governance, with an impact analysis of new tax regimes and also the home loan interest rate scenario. The opening up of new avenues such as Real Estate Investment Trusts (REITs) and funds will translate in further refinement, and with this and other dimensions, the Indian real estate sector would proceed towards making it a globally competitive marketplace. Meanwhile, the analyses are further supported by a comprehensive online survey being taken by industry expert and highly experienced real estate professionals, including industry captains, market professionals, research analysts, consultants, investors and end users.

Governance & transparency

Real estate bill FEMA/ ECB Direct tax code/ GST

Valuation metrics Affordable housing 2010 & Indian Real Estate

Traditional sources New avenues Policy issues

Financing & capital

Regu tory R ulat y envi nme e iron ent

Significant developments

More than any other sector, the regulatory environment and procedures have a significant impact on the real estate sector. In this section we have covered the draft Real Estate Regulation Bill, Direct Tax Code, the Foreign Exchange Management Act, 1999 (FEMA) and the proposed introduction of GST.
The real estate bill

Single window clearance

The Union Ministry of Housing and Urban Poverty Alleviation has released a discussion draft of the Real Estate (Regulation of Development) Act (referred to as the Real Estate Bill). The preamble to the Real Estate Bill states that its objective is to establish a Regulatory Authority and an Appellate Tribunal to regulate, control and promote planned and healthy development and construction. However, the following aspects need to be considered:
Role of the regulator

Registration of all projects with the Regulatory Authority as suggested under the Real Estate Bill may result in project delays. Instead, a single window clearance system (which includes such registration) may be introduced for real estate projects. This will not only reduce the time involved in obtaining approvals but will also avoid the need for the proposed restriction in the Real Estate Bill on developers advertising the project without such registration. To restate, once the single window clearance has been obtained, the condition in the Real Estate Bill restricting developers from advertising their projects will not be relevant.
Bank guarantee

In order to ensure that the regulator efficiently achieves its objectives, it is critical that the regulator should have sufficient authority with respect to laying down guidelines for state governments and other agencies concerned with approval of real estate projects. The issues such as Floor Space Index (FSI), verification of land title, standardisation of construction norms, civic and social amenities, disclosure norms, etc. should fall under the purview of the regulator.
Streamlining land records

The condition to furnish bank guarantee equal to 5% of the estimated cost of development with the Regulatory Authority will increase the cost of project. There is a need for examining other viable alternatives as well.
Real estate agents

Currently, almost anyone can become a real estate agent. Regulations may be introduced for certification of real estate agents that lays emphasis not only on procedural and business knowledge, but also on ethics and best practices. While the Real Estate Bill requires details of agents or dealers to be furnished by the promoter, it does not specify any requirements in order to qualify as a real estate agent.
KYC

One of the key requirements for the real estate sector is to computerise land records and more importantly, establish a comprehensive procedure for verifying the title to land. Apart from increasing transparency, this will ensure that there is adequate land with clean title available for development.

While it may not be possible to carry out any detailed Know Your Clients (KYC) of the buyers, at least a preliminary background check may be carried out to reduce future defaults on payments and to reduce speculation.

Market view

Figure 1: A single statutory body should regulate real estate developers and agents (similar to IRDA for the insurance sector)

Figure 2: The real estate bill would enable the common man in India to breathe easier

3% 28% 24%
Strongly Disagree No Opinion Slightly Agree

13%

9%
Disagree

12%

Slightly Disagree No Opinion

7%

Agree Strongly Agree

12% 41% 13%

Slightly Agree Agree Strongly Agree

38%

Figure 3: The proposed Real Estate Act prohibits launching a real estate project without appropriate sanctions from the local authorities. Given the numerous linear approvals required for commencing a project, is this provision feasible

The draft Real Estate Act has hit the nail on the head in proposing a mandatory requirement of real estate developers to obtain all sanctions and approvals required to undertake a project prior to marketing it externally. This is especially so for housing projects. Only by stipulating such criteria will the inherent uncertainty and delay that the home buyer invariably faces in the execution of projects be minimised. An important off-shoot of this will be that the authorities will come under pressure to release approvals in an efficient manner to the right projects. State governments will also be forced to make the current hugely cumbersome processes simpler and more developer-friendly.

50%

50%

YES

NO

If this requirement is not brought in, I am afraid the present unacceptable state of affairs will continue to flourish. Single window clearances are a must. Only such laws will enable this to happen, if only in the not so near future. Ravi Ramu Director and CFO Purvankara Projects Limited

Direct tax code

The Direct Tax Code (DTC) has proposed significant changes to the existing law on income tax. While there are key changes which impact all industries, certain changes would specifically affect the real estate industry.
Key implications of DTC relevant to all industries

In case the above provision is made effective, basically all the tax treaties signed by India till date could potentially be rendered otiose in so far as the DTC specifically provides. This will have a far-reaching impact for foreign investors who have invested in India, taking treaty benefits into account.
Key implications of DTC specific to real estate developers/ corporates

DTC proposes to introduce General Anti-Avoidance Rules (GAAR) provisions to plug tax avoidance. Under these provisions, if the tax authorities are satisfied about lack of commercial substance in any arrangement, then the tax authority may declare the arrangement as an impermissible avoidance arrangement and disregard, modify, nullify or re-characterise the arrangement including re-allocation of any gross income, receipt or accrual of a capital nature, expenditure or rebate amongst the parties or disregard the provisions of any tax treaty. The onus has been shifted on the tax payer to prove that availing of tax benefits was not the main purpose of entering into the arrangement. The proposed rules are sweeping in the power conferred to the tax authorities and are likely to lead to excessive litigation.

Taxability of income under the head income from house property DTC proposes that the income from all properties held for earning rentals shall be computed under the head income from house property. This proposal aims to do away with the litigation on classification of rental income as business income or income from house property which is a welcome move. Besides, an asset based computation of Minimum Alternate Tax (MAT) at the rate of 2% has been proposed in DTC, which will be a significant tax burden where the rents are low due to unfavorable market conditions. It has also been proposed that there will be no credit for MAT which will only compound the burden. This levy and deletion of a credit mechanism should be revisited.

Under the current provisions, any tax treaty entered into by Central Government with another country overrides the provisions of the Income Tax Act, 1961 to the extent they are more beneficial. The DTC proposes to replace this principle with the concept of whatever is later in time shall prevail.

Special economic zones

levy of MAT and Dividend Distribution Tax (DDT) SEZ developers are currently exempt from levy of MAT and DDT as per the changes introduced by the SEZ Act, 2005. DTC proposes to override the provisions of SEZ Act and levy MAT @ 2% of gross assets and DDT @ 15% on SEZ developers. Further, there is no proposal to amend the provisions of SEZ Act. There seems to be a lack of clarity in the policy and this need to be addressed. taxability of SEZ developers income Under the current provisions, the profits of a SEZ developer as well as co-developer are exempt for a period of 10 years (out of 15 years). DTC proposes to replace this exemption with investment based tax incentive. The profits of a SEZ developer will be taxable after allowing deduction for certain capital (including land cost) and operating expenses. Further, it is unclear whether such deduction will be available to codeveloper. This imposes a severe disincentive for SEZ developers/ co-developers. the current tax incentive available to SEZ units has not been specified under DTC under the grandfathering provisions. This appears to be an inadvertent error and should be clarified.

could result in a higher tax impact, in the periods where due to the market conditions the lease rentals are lower compared to 6% of ratable value or cost of construction. Further, rent usually varies significantly with the city (area) where the property is located and therefore, the cost of construction (which is likely to be similar across geographies) does not seem to be a logical basis for determining ratable value. no deduction will be available for unrealised rent under DTC deemed deduction on account of repairs, maintenance and other expenses is currently allowed at 30% of gross rent. This has been proposed to be reduced to 20% under DTC which will lead to higher tax. presently, interest paid for capital borrowed for acquisition, construction, repairs, renewals or interest on repayment of fresh loan is also allowed on self occupied house properties as a deduction, the upper limit being Rs. 150,000. This has been proposed to be removed from DTC, thus resulting in higher tax for individuals occupying the properties that they own. interest for the pre-construction period (interest paid during 3 years prior to completion of construction is currently deductible in 5 equal annual instalments) will not be allowed under DTC. This will result in further hardship in the case of individuals.

Implications of DTC on computation of income from house property

currently, if a property is vacant for a part of the year and the actual rent receivable is lower than the expected rent, such lower amount is taken as gross rent. Under DTC, it appears the gross rent will be computed at 6% of ratable value without any concession, even if the property is let out only for a part of the year. Where ratable value has not been fixed, 6% is determined with respect to the cost of construction or acquisition of the property. This

Implications of DTC specific to individual investors

tax rebate on repayment of home loan has not been provided explicitly. Currently, principal repayment of home loan qualifies for deduction up to Rs. 100,000 for investments under Sec 80C of ITA. While the DTC proposes to raise this overall limit for such deduction to Rs. 300,000, the repayment of home loan is not expressly provided for, which should be included. the DTC proposes to eliminate the distinction between long term and short term capital asset and instead classify capital assets as investment assets or business assets. Capital gains from sale of house property will now be taxed at a uniform rate of 30% regardless of the period of holding for individual taxpayers (currently, taxed at 20% plus surcharge and cess for property held for over three years). The base date of indexation is shifted from 1 April 1981 to 1 April 2000. In order to encourage long term investment in real estate (which acts as a stabilising factor), the distinction for period of holding should be maintained. exemption for house rent allowance has been proposed to be eliminated. Currently, a salaried individual residing in a rented accommodation is eligible to avail exemption for HRA as per specified limits. This would impact employees whose place of work is not their hometowns.

FEMA The opening up of the real estate sector to foreign investment under the Foreign Exchange Management Act (FEMA) was a significant step in the growth of the sector. In order to maintain that growth, certain further changes may be considered: Project and investor related conditions The Department of Industrial Policy and Promotion (DIPP) under Press Note No. 2 (2005) permitted FDI of up to 100% under automatic route in real estate projects subject to satisfying project-related and investor-related conditions. In order to increase FDI inflows in the sector, some of the key conditions could be relaxed. For instance: reduction in minimum built-up area stipulation for projects which currently stands at 50,000 square metres reducing minimum capitalisation levels which stand at US$10 million for a 100% subsidiary and US$5 million for a joint venture permitting investment through optionally convertible instruments the mandatory three-year lock-in for foreign direct investment in the real estate sector may be reconsidered. At the very least, it should be clarified that the lock-in will not debar the non-resident investor to sell his stake to another non-resident investor

ECB guidelines

Currently, overseas loans in the form of External Commercial Borrowings (ECBs) are not permitted for real estate projects, other than those qualifying as infrastructure. The following relaxation to these norms may be examined: in order to ensure that ECBs are availed for viable projects, the amount of ECB may be limited to a specified percentage of the overall funding requirement for the project certain minimum eligibility criteria may be specified for borrowers and / or projects the funds may be held in a separate bank account through which development expenses may be incurred directly, subject to satisfaction of conditions prescribed by the authorised dealer

the Centre and States would have concurrent jurisdiction over the entire value chain the value of the goods / transaction on which CGST and SGST would be levied would be the same for both components. This will ensure that there is no cascading effect of the double levy i.e. no tax is charged on the amount of CGST / SGST.

Impact of VAT on real estate sector

The above would equally apply to real estate developers raising funds through the issue of Foreign Currency Convertible Bonds (FCCBs).
Impact of GST on real estate sector

Introduction of GST is one of the most important steps in streamlining the multiple indirect taxes structure currently in existence. The first discussion paper regarding implementation of GST was issued on 10 November 2009 and a subsequent draft on 15 December 2009. The salient features are as follows: GST shall have two components, i.e. one GST levied by the centre (Central GST or CGST) which will cover all indirect taxes being levied by the Central Government. The Central Government will administer and frame a separate law with respect to CGST other levied by the States (State GST or SGST) which will subsume all indirect taxes being levied by the State Government. The respective State Governments will administer and frame a separate law with respect to SGST.

At present there are various schemes under which a builder (civil contractor) can discharge VAT liability, such as: composition scheme under which tax liability has to be discharged on entire value of contract but at a lower rate generally 2-4%. Depending on the specific state, input tax credit may or may not be permitted (either in full or partially). adhoc deductions towards labor costs irrespective of actual amount incurred in this regard. The concept paper issued by the empowered committee is not clear about specific schemes for the real estate sector, which should be specifically included. However, considering the existing framework of GST, the implications for the real estate sector would be as follows: both CGST and SGST would be charged on the entire amount of contract since both taxes, SGST (representing VAT) and CGST (representing Service tax/ Excise duty), would be simultaneously levied, the existing complexity in bifurcation of the contract into goods and services would be done away with civil contractors would continue to be registered with the VAT authorities of the respective states even in the cases where only services are provided by the civil contractor in that state

10

In light of the above, the following issues need to be addressed prior to the introduction of GST legislation: 1. based on the existing draft for implementation of GST, the real estate sector would effectively suffer double taxation, i.e. both CGST and SGST would be levied on the entire value. This is because CGST would be charged on the entire value but input tax credit would be available in very few cases since most suppliers of building material operate in the unorganised sector. In order to reduce this burden, CGST for the real estate sector could be levied at a nominal rate 2. since there will be a levy of both CGST and SGST, the burden of levy of SGST may be reduced by taking into account the following: a. clear provisions for non inclusion of free supplies, even where they are supplied after finalisation of contract b. increase in the threshold limit for levy of SGST in the real estate sector. Optionally, civil contractors may be permitted to pay SGST at a lower blended rate of tax instead of determining the tax rate on each and every item. 3. there should be a provision for single registration instead of multiple registrations in each State

11

Gov nan G vern ce & Tran T nsparen y ncy

12

Transparency in valuation metrics

Land or property deals in India have had a notorious reputation during the past two decades. Indian real estate development rode the economic growth wave till about three years back only to slow down to a realistic level. Incessant money pumped into the real estate industry, coupled with thriving demand helped the sector grow at an unsustainable growth rate from 2003 to 2007. The past few quarters witnessed a slowdown, thus creating a considerable gap between the demand and supply of real estate. India has always lacked the presence of a registered and official land evaluator for land and property, and hence provide an official benchmark for various real estate deals in the country. Local level property dealers, and more dangerously on some occasions, market rumours have been responsible for the going market rate. What is needed are consistent and prescribed valuation mechanisms for all real estate deals in India. This requirement is also felt by the industry as reflected in the response of the survey participants, wherein more that 50% of the respondents felt a strong need to introduce independent ratings for real estate projects. Property valuation in India is essentially a function of critical characteristics of the property under consideration. The characteristics themselves can be divided into property specific and developer specific.
Property specific factors

of construction has a direct correlation with the property valuation per unit as well. A fair factor that is decisive in this process is the maintenance, if provided by the developer. Locational preference also results in a higher quote by the developer. The factors rightly determine the importance of a particular property but do not necessarily determine the price of one. Proximity of a property to an upscale market or the floor on which it is situated is seldom translated justifiably to a cost per unit of measurement. The most logical factors that can and should be used for assigning a monetary value to a property should be the quality of construction. A lack of required awareness on the part of the buyer as well inconsistencies in the market do not allow the buyer to be a good estimator of the per unit cost of construction. An overall cost of construction amount by the buyer can be made available to the customer. However, this would not only be unsuitable for the developer but also be difficult to provide to the buyer. Most of the developers today are unlisted and for the ones that are, it is not mandatory for them to divulge this information. Therefore, a centrally introduced and explained valuation metric is warranted from the government. The metrics should be able to estimate the future earnings of the property in question and also take in to consideration, the other critical aspects of the property, possibly through weights attached to them. The proposed solution only shows a direction and there is a significant work that needs to be done both by the government and by the industry, and independent service providers who can audit this information.

Real estate developers and buyers alike, value property based on some critical features of the property: amenities, connectivity, quality of construction, maintenance and location. Condominium developments usually contain group amenities, a fact that reduces the per unit rate. High quality

13

Developer specific factors

Finance for real estate has been, for long, a topic of much debate in India. The real estate developers often talk about unjust soft terms and extremely high rates of interest for the projects that they undertake. Lines of credit have a tendency to be short and abrupt for property developers. Mysterious to the developers, this approach by the financial institutions is often upheld strongly by them as a move that curbs excess supply as well as a balancing point with their retail disbursements. RBI has defended the high rates offered to the developer to keep property speculation in check. Beaten by limited lines of credit in India, certain developers have been forced to finance their own projects through external debt raised through binding instruments such as Compulsory Convertible Preference Shares (CCPSs). These instruments, convertible into equity within 2 to 5 years, compelled the developers to pass on the cost of debt to the ultimate buyers to redeem the shares before they turn in to equity. This contributed to the unrealistic pricing/ valuation of properties. The property boom has also left its effects lingering in the real estate sector even today. During the boom, the developers grabbed land to cater to the burgeoning demand. Much sooner than expected though, the demand started to dry out, burdening the developers with unsold projects. To service the debt undertaken for these lands, the valuations of properties still remained high and unfair. Lines of credit in India need to increase in duration as well as in magnitude, in order to protect the ultimate consumer from bearing the brunt of low liquidity.

Developers cannot be allowed to pass on the cost of operations to consumers without justification. A performance index such as the ones maintained by the NSE and BSE for listed players, should also be maintained for the unlisted players. The ultimate buyers should be able to decide prudently with the help of all the necessary information about the developer.
Conclusion

Scarcity of important information like land registry details, and building codes has led to the lack of consumer awareness. The availability of the same through a government initiative like a Centralised Real Estate database is warranted. Real Estate Regulators at the national and state level can also be active in maintaining a legitimate watch over the real estate transactions that take place in the country. Using the RTI in such matters may provide information to the individuals but what is required is a more concentrated and holistic effort.

14

Utilisation of external development charges

In the onset of the 20th century, only 1 out of every 91 Indians lived in towns or cities. After nine decades the situation had experienced remarkable changes. In 1901, the sum total of people living in urban areas was a meagre 26 million, by 1991, the number of people living in urban areas had reached 218 million, a figure that far exceeds the total population of Russia, Canada and Australia taken together. By 2001, Indias urban population had reached 286 million, a decadal growth of 31.2% with net additions of 67.81 million in urban areas. In 2009, nearly 2/3 rd of Indias total urban population lives in class I cities. Yet another fact of immense significance is the fast development of "Million Plus" cities. In 1981, there were 12 such cities, by 1991, the number had risen to 23, and by 2001, the number had grown to about 351. This has put tremendous pressure on the town planners and infrastructure developers.

The Constitution of India has allocated primary responsibility for urban infrastructure in India to the state governments. Types of urban infrastructure include public health centres, roads, bridges, ferries and other means of communication and logistics including municipal tramways, ropeways, and traffic, water supplies, drainage, land, industries, gas and gas works, markets and fairs, theatres, cinemas, entertainment and amusement parks. It is estimated that the requirement of funds for development of urban infrastructure is about Rs. 40,000 crore annually, inclusive of the capital requirement for light rail transit, mass rapid transit and new township development projects. The state governments, municipalities, urban development authorities and local town planning and boards are faced by a double-edged sword. On one end, there is a massive urban population growth and concentration; and on the other hand, the cost of services has been increasing at an incessant pace. To balance the act, various authorities have experimented with new ways of strengthening their financial resource base. The Constitution Act of 1992 (74th Amendment) provided a push to local efforts by according a constitutional status to the Municipalities as the third tier of Government. The Act mandated an institutional framework in which the Municipalities are to function as effective democratic institutions of local self-government, preparing and implementing plans for economic development and social justice. The emphasis was placed on decentralisation as a means to improve service delivery as a key factor responsible for the surge of local efforts to improve the system of urban development financing. This note assesses the usage and governance of one such practice External Development Charges (EDC). The note will touch upon topics such as: assessing the current usage of EDC, should utilisation of EDC funds be made public? should external development be completely outsourced to private bodies, allotted through tenders? Or, should EDC be waived for private developers, developing more than a certain acreage of land? what should be the time frame for development of the external facilities, and if EDC payments should be development linked?

15

EDC, a noble idea to develop urban infrastructure accountability still an issue

Accountability in EDC is a topic that needs to be discussed amongst all stakeholders in the Real Estate industry; we have taken an example of Haryana Urban Development Authority (HUDA) to explain the concept and the concerns. The same is true for most of the other development agencies as well. Section 2 and 3 of Haryana Development and Regulation of Urban Areas Act, 1975 included both internal and external development projects in the definition of "development works". These charges were levied on colonies, defined as areas of land less than 1,000 square metres, divided or proposed to be divided into plots or flats for residential, commercial or industrial purposes. The coloniser would eventually enter into a bilateral agreement with the Director, Town and Country Planning, Haryana, such that, the conditions of the agreements regarding the payment of "proportionate development charges" if the main lines of roads, drainage, sewerage, water supply and electricity are to be laid out and constructed by the Government or any other local authority, were laid. Payments are calculated over the gross saleable area.
The EDC in respect of a development area are levied to meet the costs of Master or city-wide infrastructure facilities required to be laid or developed as per the stipulations of the Development Plan. The external development work includes: Nominal maintenance of roads: first five years, and upto 10 years

Water supply

Sewerage

10

Resurfacing of roads after five years, and upto 10 years

Storm water drainage

11

Maintenance of public health services for first five years and up to 10 years

Electrification including 26.5% operation and maintenance and supervision charges

12

Maintenance of street lights for first five years; and up to 10 years

Horticulture including first five years maintenance

13

Maintenance of Horticulture and beautification of entry points, junction improvements and levelling after 5 to 10 years

Street lighting

14

Development of recreational and communication zones

Community buildings 15 Protection works, etc.

Diversion of high tension (HT) lines;

16

These EDCs, meant to meet the costs of external development works, are calculated on project basis for the total urban estate. By 1998, the HUDA was able to recover a sum of Rs. 560 crore from private colonisers on account of EDCs. Till date, HUDA has collected in excess of Rs. 3000 crore and, as per their statements, spent only about Rs. 1800 crore. The lack of development and underutilisation of these funds is not questionable. Further, the pace of development is slow and has not matched the pace of urbanisation. Numerous Public Interest Litigations (PILs) have already been filed against the local municipalities regarding collection and questionable utilisation of the funds. One such example was SURGE filing a PIL against the HUDA, where they took over a 100 photographs of the local municipality (parts of Gurgaon) and submitted them to the Judge along with a filed affidavit. Convinced that HUDA had been making unsubstantiated claims, the Judge directed that the Government of Haryana must file an affidavit which must include the following: total money collected as EDC total expenditure reports audit reports plans to improve basic structure periodical reports on the above

Public vs. Private development Who should do the job?

To make the development process transparent, the local builders should be contracted for time bound development assignments of urban infrastructure allocated through tenders. This would make the process transparent as well as more accountable, further, it will also give an impetus to the small local developers in the region. Real estate players proposing to develop large townships and industrial parks should be incentivised for developing large infrastructure projects. They should be provided concessions on EDC, based on development proposed. Alternatively, the responsibility for developing external infrastructure in a region in a time bound manner, as per master plan of the region, should be given to the developer, in lieu of the EDC payable.
Time and milestone bound external development

Similar legislation should be made applicable to all the local municipalities, around the country, where justifiable usage of funds is published for public use from time to time. Currently, the increase in the EDC rates is the hot topic which has been disputed by the developer community. We think apart from the quantum of EDC collected by HUDA and its utilisation, we should also talk about the arbitrary increase in the EDC rates.

The EDC charges payable should be made time and milestone bound, such that the status can be constantly tracked. Milestones should be penalty linked to ensure proper, effective and time bound completion of the projects. Alternatively, the EDC can be made development and milestone linked, such that, the residents in the region pay pre-agreed amounts, from time to time based on the actual infrastructure development, as certified by an independent body.
Conclusion

In a country such as India, with a forecasted GDP growth rate of over 7% over the next 5 to 10 years, the need for urban infrastructure is undoubted. It is the utilisation of the funds such as EDC that has come into the scanner as it is perceived that the infrastructure development is either not matched with urban growth or that the development lacks transparency. Measures such as Public Private Partnership (PPP), time bound and KPI based development should provide for the required justification and quicken the urban infrastructure growth in the urban cities in India.

17

Role of government and builders in creating affordable and quality housing

A challenge that every growing economy has to deal with

Housing the economically weaker sections the challenge

Roti, Kapda aur Makan, not a line from a hindi movie, but fundamental necessities that every government strives to provide its citizens, and yet is unsuccessful. The significance of a house is larger than the immediate need for four walls and a roof; home ownership is often referred to as the fulfilment of a dream. Undoubtedly, free markets unleash productivity and innovation, but they are still bound by economic laws. The market price always reflects market demand, and in markets such as India, where half the population is below median income, market-quality housing commands market prices. Hence, as a result, the markets alone will never adequately house the country's poorest citizens. Thus, whether people buy or rent, housing will typically be affordable to only half of the population.
Barriers to affordable housing

The fact remains that the citizens who flood the country's growing metropolitan areas, however, are overwhelmingly poor. They migrate to cities that were built for smaller populations, and whose formal-sector housing producers only build housing that these urban immigrants cannot afford. Consequential to unavailability of homes, the metropolitan cities have since long, witnessed a spontaneous community of self-built or informally built homesthe shanty towns, settlements, and ever-expanding slums that sprout like mushrooms on the outskirts of cities or adjacent to large-scale work locations. People who move to the city act by an impeccable economic logic: they follow the money. They seek to maximise their incomes; these citizens are willingly consuming the least expensive space they can, which is often just a room in a larger informal structure. Left alone in the marketplace, the impoverished create and inhabit slums because that is their only available and economically viable option.

High cost of developing new housing, including cost of land, infrastructure, and construction cost. (High end housing is built as there is more margin in it for builders)

Insufficient information and understanding about affordable housing

Attitudes and stigma: fear of change, growth, higher taxes, higher crime, higher traffic, rising burden on infrastructure, negative impact on property values, etc. Economics: Lack of employment opportunities near the proposed sites and low income of the target consumer Need to combine groups/agencies/business efforts to provide more resources and mobilise micro credit

4 5

Lack of incentives/subsidies to build low cost, affordable and quality housing

18

A major barrier that haunts the public and private bodies towards development of affordable housing is the cost of land. In most metropolitan areas, the land costs have risen to such high rates, that building low cost housing is uneconomical. The conventional wisdom continues to portray homelessness as a problem of individuals. This myth completely ignores the reality of Indian joint families, the working poor who can't afford a full month's rent, seniors who have lost their housing due to gentrification, all of which have reduced the supply of affordable housing. Further, most developers in India today, are against developing housing for EWS as a part of their large township projects, as it drastically devalues land, which restricts their margins and at times even sale and resale of property in certain pockets.
The practical issue

Role of government & private players

The private sector and the government have to work in tandem towards the common goal of providing housing for the middle class and lower middle class which has not been given enough importance in the last two decades. The demand and supply mismatch has created a great opportunity in the real estate space in Tier I, Tier II and Tier III cities. The governments role in facilitation of EWS housing is not limited to making the residential units available, providing subsidies and monitoring correct use of the units, but extends to aspects such as job creation, infrastructure development, etc. On the other hand, it becomes imperative for large private players to develop EWS housing not just from a project cost perspective (through government incentives) but also from a Corporate Social Responsibility (CSR) perspective. Affordable housing should also be made a part of integrated developments such as large-scale townships, SEZs, MRTS corridors and industrial clusters to ensure better connectivity for low earning population, which is critical for such segment.

According to a World Bank estimate, 42% of India's population falls below the international poverty line of US$1.25 a day. Given the situation, when the poor slum dwelling families are provided free housing, it has been observed that they tend to rent them to others and return to their slums. It is often considered a source of income to families that cannot make their both ends meet. Thus measures have to be taken to avoid such practices. Some other issues relate to increase in crime rate, fall in the level of local sanitation, sudden rise in need for road infrastructure and public transport, etc.

Striking the right balance

19

The profit margins in affordable housing projects are typically low and a strategy to cater to the market has to be based on cost minimisation. The developer can reduce cost by developing a value chain oriented strategy of backward integration.
Conclusion

Affordable housing can become a potential growth driver for the Indian real estate sectorboth in the near and long term. There is a huge latent demand for affordable housing in all parts of the country, however, this opportunity is not much leveraged, at present. The developers would certainly also require a policy-level support in order to reduce the cost of housing, while the end-user shall be provided more exemptions, in order to enhance the affordability factor.
Ajay Mangal Director, The Uppal Group

The government should strive towards providing its citizens the basic necessities; on the other hand, it becomes a social obligation for the private builders to develop low cost housing as a part of their larger plans. In order to achieve positive results, the two entities must work together to achieve a common goal.

Role of the government

Some of the interventions from the government in lieu of facilitating EWS homes can be:
1 Researching existing income supplements to increase affordability including down payment assistance, mortgage insurance/other interest rate reductions, etc.

Start notification/involvement process early in neighbourhood/communities that will be home to affordable housing development

Help in acquisition of land/allocate land for development of EWS housing. Also alter, by-laws such as FAR, etc to facilitate drastic increase in number of households

Subsidised house rental and leasing scheme, through public private partnerships

Encourage reform in the banking industry to allow occupancy in unfinished units that meet local government health and safety standards for occupancy

Control land-use through planning and zoning to avoid wasteful or environmentally detrimental uses

Tax SOPs including reintroduction of income-tax benefit to developers under Section 80IB, cuts in duties and levies for the real estate sector reduction/removal of multiplicity of taxes, stamp duties, VAT, service tax, and other duties and levies

The government should provide special tax incentives for those interested in affordable housing. Building plan approvals should be made easier and simpler

20

Market view

Figure 4: Low cost housing and SEZs will be viable even in the absence of tax holidays as proposed in the Direct Tax Code

Figure 5: Full/ Part of EDCs should be given to the developer for external development with defined expectations on development

21%

22%

Disagree Slightly Disagree

16% 28% No Opinion Slightly Agree Agree 34% 22% Strongly Agree

7%

No Opinion Slightly Agree

29%

21%

Agree

Figure 6: It will help to have a commonly defined basis for calculating super area/ built up area/ carpet area

Figure 7: It is useful to have independent ratings of real estate projects on defined benchmarks

3% 6%

3%
3%
Slightly Disagree Slightly Agree No Opinion

12%

Slightly Agree No Opinion Agree Strongly Agree

44%

28% 60%

Agree Strongly Agree

41%

21

The vagaries of home loan interest rates

The end customer of the residential sector has over the years seen the interest rates on their loans vary significantly, resulting in significant changes in disposal incomes and resultant lifestyles. These rates also have been inconsistent across stage of entry and timing of both the end user and the institution providing the loan. The key issues regarding this variation are discussed as below:
Structural problems

For banks and financial institutions that admit to a diversion from the PLR for their interest rates, the internal rule or method used for arriving at an interest rate is still mysterious from a customer perspective. Projections and backward analysis based pegging is also not consistent across markets. Banks are also able to charge different rates due to the fact that the customers either suffer from lack or inconsistency of the information that is available in the market. The PLR, it is recommended, should be made the official basis for all home loan rates subject to a 50 basis points variation across banks. The brochure containing the soft and critical terms of the loan should also contain the process used for arriving at the rate of interest for the loan. To avoid the inconsistencies, the already effective Banking Codes and Standards Board of India (BCSBI) should divulge the information on rate determination, at least of its members. Fixing this problem would help the customers fill the gaps in information and would help turn the market from an inconsistent one to one that facilitates perfect competition.
New and lower rates only for new loan takers

The financial downturn had turned the liquidity situation in the real estate industry on its head. The erstwhile days of abundant cash were replaced by a squeeze from both sizes for the real estate developer, with financers having lost a lot of money and therefore being very apprehensive and customers being unable to take any decisions regarding asset creation. Though the crisis has crossed its inflection point now and businesses have started to come out of the red, the way the interest rates have behaved has been far from consistent. It would be presumptuous of us to say the recent financial upheaval is responsible for the inconsistent or unjust interest rates that are determining the limits of individual aspirations of now. These limitations have been posed essentially by the inconsistencies found in the real estate or housing finance market in India. There are three structural problems that come to the fore through some deep digging.
Unclear methods used for fixing interest rates

The Indian housing finance market still lacks clarity with respect to fixing interest rates for home loans. There is an evident difference between the home loan offers given by private and public sector enterprises. The mechanisms used for fixing interest rates are still not entirely transparent. It is believed that Prime Lending Rate (PLR) is the peg for determining all interest rates, private and public financial institutions alike, but a meaningful correlation cannot be found between the two, on a deeper analysis.

Another structural problem that the housing finance market has been reeling under relates to the convenience offered only to new loan takers. Dips in interest rates, as and when they happen, only favour the new loan takers and not the existing ones. Such unequal rate charges to different customers of the same institution, also leads to added confusion. A possible solution would be the retrospective adjustment of interest rates for the old customers as well. This might lead to a considerable loss of future earnings for the financial institutions. However, such sophisticated institutions are better placed to hedge their interest rate risks than a consumer.

22

Interest rates the deceptive Rise and Fall

Conclusion

The third structural problem is entirely observation based. It relates to the movement of the interest rates. Consumers seeking loans for houses have been made to believe that the peg for the interest rates has always been the 90 day Treasury Bill from the Government of India. This has always been debated as the historical trends have shown that the interest rates and the T-Bill interest rates do not move in tandem. Banks and other financial institutions have been quick to raise the rates whenever there has been a rise in the rate of the T-Bill, but have failed to reduce their interest rates at the same speed in case of a fall. This problem stems from the fact that there is still no clear mode for fixing the rates of home loans. Introducing an official mechanism for rate determination would help. Also, deciding upon the movement per basis point of the mean or median interest rate with respect to a movement in the 90 day T-bill will help maintain a good balance between the consumers interest expenses and the financial institutions earnings.

Interest rate wars and movements in India are primarily the result of the fulfilment of mandatory requirements by the banks and other financial institutions. For instance, the Cash Reserve Ratio (CRR) or the portion of cash that banks have to compulsorily keep with the RBI. The regulatory requirement helps drain out the excess money from the financial institutions. Unfortunately, this concept of excess money is used by the financial institutions as a justification for charging high interest rates from the home loan takers. The banks are believed to be in a comfortable position with respect to CRR and industry experts are of the view that the interest rates are considerably higher. Governance in the form of the BCSBI has to be increased. The membership still remains voluntary and it will be beneficial for the consumers to make this membership mandatory for banks. The industry members stress on more clarity in arriving at the interest rates and also the equal treatment of the old and new customers alike.

Figure 8: The home loan rates should be benchmarked against a common RBI defined ratio (CRR, etc.) rather than individual bank rates

16%

6% 13%
Disagree Slightly Disagree No Opinion Slightly Agree Agree Strongly Agree

10% 32% 23%

23

Figure 9: Streamlining land title records in an organised and accessible registry will aid in:

(a) removing ambiguity on ownership and title

(b) increasing the land bank available

3%

16%

97%

84%

YES

NO

YES

NO

(c) eliminating unregistered transactions

(d) enforcing full and accurate reporting of the transaction value

19%

25%

81%

75%

YES

NO

YES

NO

24

Financing & Capital

25

An insight

Background

The real estate sector in India has emerged as a significant driver of economic growth in the last decade, rather than being a derivative of the global upturn seen till end 2008. In terms of GDP contribution, the sector has grown from 4.5% in 2007 to 5% in 2009. Expansion in sources of capital has been a critical catalyst in the sectors progression towards a more organized play with closer linkages to the macro economic conditions of the country. The sector received capital flows of around US$26 billion in 2009 (Exhibit 1). However, the sector started facing acute capital scarcity towards the end of 2008 with slowdown in absorption, increase in home loans rates, declining internal accruals, commercial banks cautious approach and expensive FDI/ Mezzanine funds. The overall credit situation got amplified by the global economic downturn leading to classification of Real Estate on the negative list of the already limited universe of institutional investors.
Comparative Evaluation with Mature Markets

Globally, the maturity of the Real Estate sector is gauged by the availability of and access to institutional funding. While institutional funding alternatives have expanded considerably in the last 5 years (Exhibit 2), the domestic Real Estate industry continues to be at a nascent stage when compared to a mature market like the US (Exhibit 3)

Exhibit 1: Capital inflow through the following routes

In US$ million FDI Bank loans ECBs IPOs FCCBs AIM QIPs Total

2005 -

2006 38 5740 334 393 2438 415 9358

2007 467 9479 157 3251 322 13,676

2008 2179 13,616 15,795

2009 2801 19,694 166 3316 25,977

Source: FDI: DIPP; Bank Loans: RBI Annual Report 2010; ECBs: RBI website; IPO: BSE website; FCCBs: RBI website; AIM: AIM, LSE website; QIPs: Media Reports

26

Exhibit 2: Channels of financing in India

REITs

REMFs

IPOs
Active channels Less active channels

IPOs

IPOs

QIPs

QIPs

RE funds

RE funds

RE funds

ECBs

ECBs

ECBs

Bank finance

Bank finance

Bank finance

Bank finance

Private loans

Private loans

Private loans

Private loans

Pre 2004

Pre 2004-07

Pre 2008-09

2010 onwards

Exhibit 3: U.S. Equity Sources (US$ billion)

PrivateInvestors(Larger Porperties) PensionFunds

U.S. Debt Sources (US$ billion)

Banks,S&Ls,MutualSaving Banks LifeInsuranceCompanies 178.5 15.8 1.1 REITUnsecuredDebt 673.5 PensionFunds 31.4 110.2 300.3 1809.7 CommercialMortage Securities GovernmentCredit Agencies MortagageREITs

20.1 167 33.9 26.3 46 130.2

ForeignInvestors 441.8 LifeInsuranceCompanies PrivateFinancial Institutions REITs PublicTradedFunds

Source: FDI: DIPP; Bank Loans: RBI Annual Report 2010; ECBs: RBI website; IPO: BSE website; FCCBs: RBI website; AIM: AIM, LSE website; QIPs: Media Reports

27

Determinants of capital requirement at various stages of the RE value chain and current financing environment

For a sector which has linkages with various sectors of the economy (associated with 250 industries) and accounts for a multiplier effect generating 5x income for every unit of expenditure, the importance of maintaining a robust institutional capital flow cannot be over emphasized. Though significant policy changes have been initiated in the recent past such as opening of the FDI window under automatic route and the ECB window for integrated townships & infrastructure development in SEZs (Exhibit 4 for current financing environment), the next leap for the sector would require the policy framework to be driven by the following: creation of a conducive ecosystem for debt funding, domestic and external calibrate policy framework to align with Real Estate Value Chain, for e.g. the current build up in projects under construction requires favourable debt environment to support construction completion facilitate faster capital churn through opening of the REITs/ REMFs window
Exhibit 4: Sources of capital at various stages of the RE value chain

Fragmented land

Developed land

Approved land

Under development

Developed asset

Leased asset

Foreign

DEBT
Domestic

Foreign

EQUITY
Domestic

28
Sources of capital
Source Nature Issuer Regulator

Loans Domestic

Debt

Any entity Private, Public, Listed or Partnership

Governed by RBI Monetary Policy

FDI - equity shares/ Compulsorily convertible preference shares or debentures (CCPS/CCDs)

Equity

Any corporate -- Private or Public

FIPB, under the automatic route, subject to fulfillment of conditions*

Qualified Institutional Placement (QIP)

Equity

Listed company

SEBI guidelines

Capital Markets

Equity

Public company, Red Herring prospectus, approved by the SEBI

SEBI guidelines

External Commercial Borrowing (ECBs)

Debt

Any corporate Private or Public

ECB guidelines recently opened for integrated townships and infrastructure development in SEZs

Overseas Offerings - ADR/GDR

Equity

Listed company

SEBI and FIPB guidelines

Overseas Listings - AIM

Equity

Any corporate

AIM/ LSE

*FDI Guidelines
Conditions for Development Conditions for Investment Minimum capitalisation of USD 10 million for wholly owned subsidiaries and USD 5 million for Joint Ventures with Indian partners Miscellaneous Conditions

Minimum 10 hectares for serviced housing plots

Investor not permitted to sell undeveloped plots

For construction, development projects, minimum built up area of 50,000 sqmt

Infusion of funds within six months of commencement of business

Project to conform to norms and standards laid down by respective state authorities

In case of a combination project, any one of above two should suffice

Original investment cannot be repatriated before a period of three years from completion of minimum capitalisation

Investor responsible for obtaining necessary approvals as prescribed under applicable rules/ bye laws/ regulation of the State

At least 50% of the project to be developed within five years from the date of statutory clearances

Investor may be permitted to exit earlier with prior Government approval

Concerned authority to monitor compliance of above conditions by developer

*Now allowed for integrated townships and infrastructure development for SEZs

29

Comparative evaluation of available sources of capital & key issues

Domestic debt

Exhibit 5: Return expectations of Real Estate PE investors Deal structure Pure equity deals Improvised equity deals 2006-07 Targeted IRR: 22-25% Preferred return: 15-18% Targeted IRR: 20-25% 15%+ equity upside 2008 Targeted IRR: 25-30% Preferred return: 18-20% Targeted IRR: 22-27% 18-21%+ equity upside

between February-August 2009, total bank exposure to RE sector increased by Rs. 59 billion to Rs. 967 billion in August 2009 in the mid year credit policy review for FY10, the RBI enhanced the provisioning requirement for real estate loans from 0.4% to 1%. real estate still accounts for less than 4% of the total bank credit creation

Mezzanine deals

Key Issues: With the current inventory build up in projects under development, construction focused relaxed lending norms could accelerate revival of the sector. These measures could include (a) rescheduling / rollover of construction loans (b) priority status to housing sector to help remove disparity in risk weights for easier access to real estate loans.
Foreign direct investment

Qualified Institutional Placement (QIP)

majority of FDI investments through Real Estate Private Equity/ Venture Capital funds, the more expensive form of FDI (Exhibit 5) deployment of FDI in the Indian real estate sector witnessed an increase of 29% y-o-y in FY09 during FY06- FY09, FDI in the sector registered a CAGR of 193% and witnessed an increase from US$38 million in FY06 to US$2.8 billion in FY09 (Exhibit 6)

is a capital raising tool, whereby a listed company can issue equity shares, fully and partly convertible debentures or any securities other than warrants, which are convertible into equity shares, to a Qualified Institutional Buyer (QIB) it does not involve many common procedural requirements, such as the submission of pre- issue filings to the market regulator So far, a total of US$2.76 billion has been raised by the real estate sector in India through QIPs, accounting for ~26% of the total QIPs announced in the Indian equity market in recent months at least another US$2.45 billion is expected to be raised by real estate developers in the future (Exhibit 7)

Key Issues: There is clearly an investor preference for project level investments which mitigates Developer Risk. However, to accelerate equity investments in the sector, a defined framework needs to be installed for FDI at entity levels. Capital repatriation norms also need to be relaxed with respect to original capitalization for faster churn of capital in the sector.

So far, a total of US$2.76 billion has been raised by the real estate sector in India through QIPs, accounting for ~26% of the total QIPs announced in the Indian equity market in recent months. At least another US$2.45 billion is expected to be raised by real estate developers in the future (Exhibit 7)

30

Exhibit 6: Trends in FDI growth

3000 2801 13 14

FDI Equity Inflows in Real Estate (USD mn)

2500 2179 1797 8.9 1500

12

6 1000 3 500 0.7 0 38 FY06 FY07 FY08

FDI Equity Inflows

467

0 FY09 FY10 till August

Source: DIPP

Exhibit 7: Trends in QIPs

900 800 700 QIP Issue Size (USD mn) 600 500 400 325 300 200 110 100 0 Ansal Properties Unitech Purvankara Akruti City Unitech II Parsvnath Omaxe Sobha HDIL IBREL Orbit DLF 60 350 300 550 575 500 500 400 788 750

April September 2009

Expected in Near Term

Source: Media reports

Share of Real Estate (%)

2000

10.2

10

31

Comparative evaluation of available sources of capital & key issues Initial Public Offerings (IPOs)

townships and infrastructure development in SEZs has been permitted. Key Issues: Facilitating availability of low cost long term capital needs to be a priority for accelerating sector growth. Opening of the ECB window beyond integrated townships could emerge as an attractive financing option for the sector
Foreign Currency Convertible Bonds (FCCBs)

IPOs enable privately owned companies to issue new, publicly traded common stock or shares to the general public. Property firms picked up 42.7% of the total funds generated via IPOs in 2007. However, it is believed that most of the raised capital was used to build land banks instead of developing property or improving the capital structure of the firm. With several real estate players having submitted a red herring prospectus to the SEBI, a total of US$3.31 billion is expected to be raised in the coming months (Exhibit 8). Given that the SEBI has recently allowed anchor investors to participate in this fund- raising channel, IPOs can be an attractive vehicle to tap domestic, as well as foreign institutional investment. Additionally, they provide a good exit option for most PE investors that have a short- term to medium- term investment horizon.
External Commercial Borrowings (ECBs)

FCCBs are bonds that allow the bond holder to redeem them after the maturity period or convert them into equity at a pre determined price. Until then, they carry a nominal rate of interest not a single precedence of issue of such instruments in the sector early last year, RBI wanted the such issuances to be removed from the automatic route and investments be routed through FIPB

As per the existing policy, the utilisation of ECB proceeds for real estate is not permitted. However, as a sector- specific measure, since January 2009, the use of ECB proceeds for the development of integrated

Key Issues: Confusion over the 3 year lock in clause applicable to FDI persists owing to discretionary conversion in the hands of the bond holder. Unitechs aborted attempt to issue FCCBs of US$700 million with the exemption of the 3 year lock in is a case in point.

32
Exhibit 8: The IPO story so far
2500

2006
2000 IPO Issue Size (USD mn)

2007
1976

2009-2010

1500

1000

828

742

645 323 323

500 122 0 D.S.Kulkarni Purvankara Maytas Infra Parsvnath Sobha 214 29 70 185 167 130 IVR Prime Urban Omaxe

367 22 HDIL Orbit DLF 78 Akruti Nirman Lodha Group

242 108

Sunil Mantri

Ambience

Emaar MGF

Sahara Prime City

Global Depository Receipts/ Amercian Depository Receipts (GDRs/ ADRs)

REIT models: Key to faster capital churn

no precedence of issue of these instruments due to limitations in tradability

Key Issues: Lock in under cap on FDI needs to be removed for free trading of these instruments Lack of institutional support for debt finance for construction and lack of an appropriate exit mechanism on Yield Assets encouraging retail participation in asset portfolios have clearly emerged as the key challenges accompanying the changing real estate paradigm. Several developers are seeking equity as an expensive alternative to debt in their pursuit of discharging repayment obligations which cannot be restructured. The market today is characterised by an increased dependence on consumer financing as a means of construction finance leading to delays in completion in case projects are not sold, which perhaps has a higher possibility of creation of an Asset Bubble rather than relaxing of lending norms for the sector. Availability of construction debt coupled with stricter framework for project launches could contribute significantly in accelerating execution & improving consumer sentiment to strengthen market fundamentals in the long term.

The Indian Real estate market currently lacks any monetisation vehicle for capital intensive verticals such as commercial offices and retail malls asset classes which create identifiable cash streams in the form of rental/ fixed incomes. Real Estate being a relatively illiquid asset class requiring a high resource allocation from a retail investors standpoint has remained practically out of reach for an investor looking at portfolio investments in real estate. Though there is conceptually a consensus on REITs as an attractive instrument to complete the RE cycle and create a liquid platform for investor participation, the implementation continues to be uncertain with repeated iterations occurring between RBI and SEBI. In contrast to developed institutional exits available for RE assets in mature markets, REITs is only a first step in India, immediate implementation of which cannot be over emphasized in a sector starved for capital and requiring additional US$23.66 billion for construction of undertaken commercial projects and to fulfil the unmet housing demand.

DB Realty

Kumar

33

Market view

Figure 10: Favourable policy initiatives on the following would lead to more sustainable long term growth in the industry
Availability of domestic debt

23%

Ref ining of FDI norms

22%

Faster implementation of REITs/ REMFs

21%

Opening of ECB window

19%

Relaxation in capital market guidelines

15%

Figure 11: Opening of the ECB window beyond integrated townships providing access to low costlong term capital would improve market depth through faster project completion and competitive pricing

3% 25%

9% Strongly Disagree 16% Disagree Slightly Agree No Opinion 13% Agree Strongly Agree

34%

34

Figure 12: Favourable policy initiatives on the following would lead to more sustainable long term growth in the industry

3% 7% 29% 13%

Disagree Slightly Agree No Opinion Agree Strongly Agree

48%

Figure 13: In the last decade, the growth in real estate market is largely attributable to expansion in sources of capital

22%

10% 6% 3%

Disagree Slightly Disagree No Opinion Slightly Agree

25% 34%

Agree Strongly Agree

35

36

About CII

The Confederation of Indian Industry (CII) works to create and sustain an environment conducive to the growth of industry in India, partnering industry and government alike through advisory and consultative processes. CII is a non-government, not-for-profit, industry led and industry managed organisation, playing a proactive role in Indias development process. Founded over 115 years ago, it is Indias premier business association, with a direct membership of over 7800 organisations from the private as well as public sectors, including SMEs and MNCs, and an indirect membership of over 90,000 companies from around 385 national and regional sectoral associations. CII catalyses change by working closely with government on policy issues, enhancing efficiency, competitiveness and expanding business opportunities for industry through a range of specialised services and global linkages. It also provides a platform for sectoral consensus building and networking. Major emphasis is laid on projecting a positive image of business, assisting industry

to identify and execute corporate citizenship programmes. Partnerships with over 120 NGOs across the country carry forward our initiatives in integrated and inclusive development, which include health, education, livelihood, diversity management, skill development and water, to name a few. Complementing this vision, CIIs theme for 2009-10 is India@75: Economy, Infrastructure and Governance. Within the overarching agenda to facilitate Indias transformation into an economically vital, technologically innovative, socially and ethically vibrant global leader by year 2022, CIIs focus this year is on revival of the Economy, fast tracking Infrastructure and improved Governance. With 65 offices in India, 9 overseas in Australia, Austria, China, France, Germany, Japan, Singapore, UK, and USA, and institutional partnerships with 221 counterpart organisations in 90 countries, CII serves as a reference point for Indian industry and the international business community.

Confederation of Indian Industry Northern Region Block 3, Dakshin Marg Sector 31 A, Chandigarh Tel. : 0172-5083099, 6510188 Fax : 0172-2606259, 2614974 Email : chairman.specialevents@cii.in Website: www.cii.in Reach us via our Membership Helpline: 00-91-11-435 46244 / 00-91-99104 46244 CII Helpline Toll free No: 1800-103-1244

About Gran Tho A nt ornton n

Grant Thornton In nternational is one of the ds ganisations of world leading org indep pendently own and manag ned ged accou unting and con nsulting firms. These firms provide assur rance, tax and specialist d ory o ld adviso services to privately hel businesses and p public interest entities. Clients of member and correspo ondent firms ccess the know wledge and ex xperience of can ac more than 2,400 pa artners in over 100 r count tries and cons sistently receiv a ve distin nctive, high qu uality and personalised servic wherever th choose to do business. ce hey Member firms with Grant Tho hin ornton Intern national strive to speak out on issues e that m matter to busin and whic are in the ness ch wider public interest. r

About Gr rant Thornto India on,

Grant Tho ornton India is a member fir within s rm Grant Tho ornton Interna ational. The fir was rm established in India in 19 and is one of the d 935 e oldest and most reputed accountancy firms in d the country y. Today, the firm has grow to be one of the e wn largest acco ountancy and advisory firm in India ms with nearly 1000 profess y sional staff based out of New De Gurgaon Mumbai, Ba elhi, n, angalore, Chennai, H Hyderabad, Pu Chandiga une, arh, Ahmedaba and Kolkata. ad The firm o organises its cl lient services t teams internally in the followin business un ng nits: As ssurance servi ices Ta & regulator services ax ry Sp pecialist adviso services ory

Acknowledgement GrantThorntonIndiaacknowledgesthecommitmentand contributionofthefollowingindividuals:

Anupam Kumar David Jones Deepak Joshi Neeraj Sharma Nidhi Maheshwari Rajul Mathur Siddharth Nigam Sumeet Abrol Vikram Jethwani Vishwas Panjiar

WealsothankMr.PikenderPalSinghand Ms.BhupinderPalKaurofCIIfortheirvaluablesupportin thedevelopmentofthisreport.

Contact us

Grant Thornton offices in India: New Delhi National Office L 41 Connaught Circus Outer Circle New Delhi 110 001 T +91 11 4278 7070 F +91 11 4278 7071 Gurgaon Centre Point, A Block Sushant Lok Phase I Gurgaon 122 002 T +91 124 462 8000 F +91 124 462 8001

Bangalore Grant Thornton House 3274/A, 11th Main nd HAL 2 Stage Indiranagar Bangalore 560 038 T +91 80 4243 0700 F +91 80 4126 1228 Chandigarh SCO: 17 nd 2 Floor Sector 17 E Chandigarh 160 017 T +91 172 433 8000 F +91 172 433 8005 Chennai Unit nos. 13, 14 & 16 31 Thiru-vi-ka Road Royapettah Chennai 600 014 T +91 44 4294 0000 F +91 44 4551 0005

Hyderabad 3rd floor, Uptown Banjara Road no. 3 Banjara Hills Hyderabad 500 034 T +91 40 6452 8666 F +91 40 2354 0224

Mumbai Engineering Centre 9 Mathew Road Opera House Mumbai 400 004 T +91 22 6626 2600 F +91 22 2367 1624 Pune 401 Century Arcade Narangi Baug Road Off boat Club Road Pune 411 001 T +91 20 4105 7000 F +91 20 4105 7099

 Grant Thornton India All rights reserved www.wcgt.in