Developers Chase Costlier Private Equity Funds As Banks, NBFCs Stay Away

“We took private equity funding for the first time in January," Rishi Todi, director at Transcon, said. "...they're more robust in terms of processes and systems and understand the business. Decisions were taken faster compared to the public sector banks.”

As funds have dried up, Indian developers are considering every option. Transcon, a mid-sized real estate company, is among a few that alternate investment funds such as private equity firms are willing to back. Such investors largely back the evergreen office real estate in India, having pared exposure to the housing sector in the last decade. But they are selectively choosing residential projects.

Todi declined to reveal terms or other details of the investment. In the last decade some PE funds in India have also run structured financing arms that do debt or hybrid financing- in this case it was structured debt with a coupon. And the interest rate is higher than what banks charge.

Banks and housing financiers are circumspect because of bad-loan risks. And non-banking financial companies have cutback on loans to real estate since the defaults of Infrastructure Leasing & Financial Services Ltd. and Dewan Housing Finance Corp. That caused the stalled projects to spike, forcing the government to set up a rescue fund.

The pandemic worsened the crunch as the share of banks in real estate funding tumbled in FY21. While data for housing financiers and non-bank lenders isn't available yet, ICRA Ltd. said they also stayed away from lending to housing developers.

"For FY21, our interactions and various data suggested that most of the NBFCs and HFCs have focused more on collections rather than disbursements because it was a challenging year," Shubham Jain, senior vice president and group head at ICRA, told BloombergQuint.

"If you look at the data of top 8-10 non-bank lenders, their books shrunk, showing that they collected more than what they disbursed last fiscal," he said. And overall disbursements from banks, housing finance companies and non-bank lenders for real estate were lower in FY21 than in FY20, he said.

Why Banks Retreated

While non-bank funding dried up after two NBFCs went bust, the reason for reluctance among banks and housing financiers is different.

In the past, when a developer launched a project, the real estate company put in 25%, borrowed 60% from a bank and relied on sale of under-construction units for last-mile funding, said an industry expert.

Because of stricter regulations and delayed projects, they didn’t get last-mile funding, said the person who didn’t want to be identified out of compliance concerns. Builders approached lenders for refinancing but the Reserve Bank of India requires such loans to be classified as bad debt and downgraded, he said. Changes are required in regulations to provide this last-mile capital to complete the projects, he said.

BloombergQuint awaits responses on queries emailed to Housing Development Finance Corporation Ltd., Indiabulls Housing Finance Ltd. and State Bank of India.

“There are various guidelines that restrict banks from funding real estate projects because of the risks involved,” Todi said. “They also prefer a more affordable segment compared to the mid-luxury that we are catering to.”

Costlier Funding

Alternate asset managers charge 20-25% to provide this capital and developers will have to increase prices, the person cited earlier said.

Todi agreed that such funding comes at a cost. Yet, it’s worth it, he said. “A real estate project requires cash flows upfront, and later money keeps coming. Given these factors, PE funding is not that cumbersome.”

Shriram Properties Ltd., another mid-sized developer, called alternate funding an "easy alternative. The company gets favourable and competitive terms because of its track record, according to Murali Malayappan, chairman and managing director at Shriram Properties. Private equity investors, real estate credit funds appreciate "realities on the ground", he said, explaining why the developer prefers them over banks.

An Opportunity

Firms like Motilal Oswal Real Estate Investment Advisors Pvt. see the crunch as a short-term opportunity. It launched its first construction finance fund and closed a second round of about Rs 50 crore, according to Sharad Mittal, chief executive officer at the company.

“All our previous funds focused on the land acquisition stage with not much space for private equity funds,” he said. “Construction finance opportunity is between Rs 60,000-85,000 crore a year. Between 2013 and 2018, a large part of that was getting funded by NBFCs. Eventually, a large part will again be funded by banks as the market settles down,” he said. But in the next two to four years, he said, there is a chance for “a fund like us and some of the global funds”.

Most Mid-Sized, Small Developers Struggle

Still, Transcon and Shriram Properties represent a fraction of developers that have managed alternate funding. Banks continue lending to good-rated developers even now. And private equity firms aren't taking a chance with bulk of the mid-sized and smaller developers.

Private equity firms are either backing commercial assets or well-established developer brands who also have access to bank funding, according to Samantak Das, chief economist and head-research and REIS at JLL India.

“Earlier funds used to disburse money to everybody under the sun,” Amit Goenka, chief executive officer at Nisus Finance, a real estate-focused PE firm. “After the NBFC collapse, which also affected the funds in a large way sentimentally, now the total funds available are limited. That helps them to gravitate to the better yields,” he said. “Demand is much higher than supply and that is why they can choose from the top.”

For Niranjan Hiranandani, national president at developers lobby Naredco, the reason behind changed lending pattern is consolidation in the sector. “People taking over the projects through development rights or joint ventures,” he said. “The shift to private equity is overplayed. If you look at the ratio, maybe, 2-5% of lending shifted from banks and NBFCs to private equity players.”

Das agreed that there is a flight to quality, squeezing the mid-level players who are struggling with liquidity. “This is also speeding up the consolidation,” he said. “For a more broad-based industry, liquidity infusion through NBFC recapitalisation will help, but with stringent measures to prevent the mistakes of the past.”