Unitech Corporate Parks Results & Leasing Update

Unitech Corporate Parks (UCP) recently released its audited results for the year. The report has very limited disclosure on how the valuations have been computed. The stated NAV is £1.7408 while the stock is quoting at less 50 p (a discount to NAV of over 70!). Obviously, the market assessment of the valuation is very different from Knight Frank's assumptions.

UCP also released a leasing update that indicates the company has been able to lease 11.9% of total leasable area (across all planned projects). Considering the broadbased slowdown in the economy and the huge supply of office space coming on stream, we expect the run-rate for leasing to be much lower going forward.

Earnings Season Nuggets....

As we come to the close of Q1 earnings, a couple of interesting nuggets caught my eye

1. DLF continues to sell a large chunk of its assets to DLF Assets. DLF Assets currently owes DLF Rs. 3,383 crores. To put things in context, so far DLF assets worth Rs. 9000 crores to DLF Assets. Of the Rs. 5,700 crores paid out by DLF assets, Rs. 4,900 crores seems to come from private equity investors. Interestingly, the last tranche of about Rs. 2,000 crores was in the form of convertible preference shares with ultimate conversion price tied to the listing price of the DLF Office Trust in Singapore. Given that Indiabulls Property Trust is trading at a 30% discount to issue price, less than 2 months after issue, the prospects for DLF Assets look daunting to say the least.
2. Sobha Developers has changed its revenue recognition policy. Now, revenues from the land component will be recognized when EITHER 20% of dues from customer are collected or agreement for sale is executed. So, for properties where the land cost forms a large fraction of total price, recognized revenues could be greater than the actual cash received.
   

As the difficulties facing Indian developers intensify, we won't be surprised if developers try other accounting shenanigans to boost revenues/profits.

Indian real estate market catches the attention of Donald Trump

According to this report, Donald Trump Jr, son of the real estate tycoon, is planning to set up a $1 billion real estate fund with focus on India. New York based Trump. His company, New York based Trump Organisation is also looking to set up residential and hotel projects in Mumbai, in cooperation with an Indian partner.

Interesting that his focus for this real estate investment is Mumbai, where valuations have been rather stretched, property prices underwent a recent correction and more is expected with more land being released from archaic bureaucratic control in order to counter the land-crunch.

SUN-Apollo Ventures invests $70 million in Amrapali SPV

SUN-Apollo Ventures, the JV between Delhi based SUN group and US based PE fund Apollo Real Estate advisors, has picked a 35-40% equity stake in an SPV of Noida based realty firm Amrapali group. The funds will be used to develop a 200 acre township in Jaipur and a 15 acre project in Noida. The Jaipur project includes housing, retail and commercial development.

Amrapali group has developed six residential colonies around Delhi and current value of on-going projects is pegged at $1.9 billion.

BPTP Ltd. continues to be a favorite with multi-national banks!

JP Morgan made its entry into the Indian real estate market, through a $60 million (3%) equity stake in BPTP Ltd. This continues the dream run for the Faridabad based developer, following Citigroup's and Merrill's investment in the firm.

Citi Property Investments, realty arm of Citigroup, picked up a $80 million (5.8%) equity stake last year. They also recently plegded $160 million towards four SEZs being developed by BPTP in Noida, Gurgaon and Faridabad. Merrill Lynch made a $28 million investment in IT park being developed in Gurgaon by a BPTP subsidiary.

BPTP currently has 65 residential, commercial, IT parks and SEZ projects. They also made news for picking up the largest ever land deal of 95 acres in Noida for $1.2 billion. In their success, they outbid bigger developers such as DLF and Omaxe. The company has so far paid $222 million towards the Noida deal. The latest round of funding, from Citi and JP, is expected to help pay the installments for this deal.

BPTP plans to build a world class business center here including 45.22 million sq ft of offices, 2.5 million sq ft of retail, and 1 million sq ft of hotels and serviced apartments, in three phases, over a decade. Construction costs are estimated at about $1 billion for this project. BPTP is currently looking for funding from PE sources also. The company expects to cash in from the location of the land and its proximity to Delhi's wealthy suburbs and attract tenancy from banks and law firms.

We will continue to track the developer as well the project.

Alpha Investment Partners raises $1.6 billion for a new fund focussed on Asian real estate

Singapore's third-largest developer, Keppel Land's property management unit, Alpha Investment Partners Ltd (AIP), recently raised $1.6 billion for a new fund that will focus on real estate in Asia. The amount is not only $300 million more than its own target, it is also the largest ever raised by AIP since its inception in 2003.

The funds were raised from 15 institutional investors, including European pension funds and banks as well as sovereign wealth funds. With this new addition, AIP will now have $5.2 billion of assets under management. The success of this fund raising shows the confidence that investors have in AIP's management which is in line with their performance in other funds.

AIP raised $243 million, in 2003, for Asia No. 1 Property Fund with a target of 20% IRR. As of March 2008 they had returned 27% and have begun to return capital to the investors. Alpha Core Plus Real Estate Fund was set up in 2004 with $435 million and a target IRR of 12% -13%. The achieved return was an annualised 40 per cent as at March 2008.

The latest fund, Alpha Asia Macro Trends Fund, has a targeted return of 16 % to 18%. They are looking to invest in real estate in Singapore, Japan, Taiwan, South Korea and Hong Kong, and the emerging markets of China, India and Vietnam.

We had commented earlier that funds flush with money are looking to Asian real estate for investment as the western markets continue to remain in flux. This new fund is testament that there is still appetite amongst blue-chip investors to back funds with strong track records.

Unitech raises $300 million to tide liquidity crunch

In an expected move, Unitech International Real Estate Fund has raised $300 million to fund Unitech Ltd.'s residential projects. The investors are supposed to be Japanese banks and European HNIs.

This latest move is in line with the trend we had commented on earlier in this blog. The downside risks in the property market have resulted in downgrades for many of these developers, including United, making raising funds in domestic markets too expensive. Developers are now looking outside of the country to raise funds for projects that they have already committed to.

Parsvnath Builders pick up 38% stake in Sabeer Bhatia's Nano City project

Parsvnath Developers recently picked up a 38% stake in Sabeer Bhatia's famed Nano city project to be built in Panchakali, Haryana, two hours from Delhi. The government of Haryana has a 10% stake in the project through HSIIDC. Sabeer Bhatia's venture into real estate finally seems to be taking off or at the least it is generating more interest from investors.

The Nano city idea was first approved, in July 2005, to be set up, in collaboration with Trident group, as a $250 million drug discovery facility in Punjab. It was expected to provide job opportunities to the engineers from the area in the fields of IT and bio-technology. The proposal was approved by the Punjab government but nothing further was heard of it.

In late 2006, the current Nano city project was kicked off in a new location - Panchakali, Haryana. The scope of the project was increased to include R&D centers and corporate offices for technology, biosciences and other knowledge industries. The project was initially estimated to be at $10 billion. 11,000 acres of land, some of it farm land, were approved by the Haryana government for the project.

In 2007, Goldman Sachs was quoted to have evinced interest in acquiring a 33% stake in the project. The fund infusion was expected to speed up the multi-year project. The funds were earmarked to help in the acquisition of the farm lands that were priced at approximately $200 million. However, that deal did not go through.

Eventually, Parsvnath developers stepped in. At present, they have 114 ongoing projects across the country. This is by far the biggest and most ambitious project in their portfolio. While they do have experience in building townships, IT parks and developing SEZs, the area of development has been less than 500 acres.

Parsvnath's financial picture is interesting. They reported ~20% and >17% increase in net revenues and EBITDA for FY '08 . They also mention that construction costs increased by almost 7% which were apparently offset by increasing real estate prices. Their latest investor update states that they are currently negotiating for FDI sponsorship of their projects.

Their balance sheet appears vulnerable to any major correction in the property markets. With their interest coverage already less than 2.0, increasing funding costs and declining demand, it seems they may have bitten off much more than they can execute with the Nano city project.. especially when there seems to be no clarity, yet, on the revenue stream from the project...

Trikona Trinity Capital's Preliminary Results

Trikona Trinity Capital (Trikona TC) announced preliminary results for the year ended March, 2008. Details are available here.

Key Points:

1. Company has invested in 12 projects so far
2. NAV as of March 31, 2008 was 151 pence per share - up 22% from a year ago. Significantly, the Weighted Average Cost of Capital (WACC) used for computing NAV was increased from 12.88% to 15.54%. In other words, if the WACC was not increased, the NAV would have been much higher than 151 pence. For reference, the units are trading at 77p, almost a 50% discount to NAV.
   
3. Trikona TC divested some portfolio holdings to SachsenFonds in two tranches in November 2007 & June 2008. Importantly, there was very little change in the valuation between the two divestments - a red flag for future prospects.
4. In Trikona TC's latest investment, SachsenFonds and Trikona have a 55:45 share. Together they own 49% of the project and Rustomjee Constructions owns 51%.
   
5. Trikona TC has shifted focus to the infrastructure market to mitigate current market conditions.

Overall, the report has a degree of detail on the various investments and their current valuation. However, when compared to the Ascendas annual report, the Trikona TC report has miles to go by way of disclosure. We have reservations about the WACC figure used and hope to see more details in their final report.

SatyaVani Projects to raise Private Equity

Economic Times has a report about SatyaVani Projects trying to raise $150 million in private equity for projects ranging from a medical tourism project in Hyderabad to an eco-tourism + housing project in Bangalore. As per the website of SatyaVani, the company seems to be focused on engineering design & construction management. In the backdrop of a sharp slowdown across real-estate segments, it will require a leap of faith on the part of institutional investors to invest in a company that has no prior experience of end-to-end project execution. We will remain on the watch for reports of how the fund raising progresses.

DS Kulkarni selling project stakes

Reuters has a news item on DS Kulkarni selling stakes in a couple of projects

1. 50% stake in a premium Bangalore residential project to ICICI Prudential PMS Real Estate Portfolio for Rs. 350 million. Previous reports stated that ICICI Prudential PMS Real Estate fund had raised about Rs. 900-Rs.1000 crores.
   
2. 50% stake in a unit setting up an SEZ in Pune to GTC Cyprus for $90 million. GTC Cyprus is part of the Netherlands based Kardan group.

We expect the trend of institutional investors taking large stakes at an SPV level to gather further momentum over the coming months. Developers are negotiating from a position of weakness and it is only fair for investors to demand their pound of flesh

PEs to bring execution in-house

Economic Times has an article that discusses the plans of PE firms to execute projects in-house. Key points:

1. Funds such as Trikona Capital, South Asian Real Estate (SARE) and Yatra Capital have started to create in-house teams that can execute real estate projects on their own.
2. Kotak Realty Fund had recently made an enterprise level investment in Lalith Ganga Constructions. Kotak’s stake in the company has not been disclosed. Lalith Ganga Constructions is a start-up promoted by Kotak Realty Fund along with Girish Puravankara, the erstwhile deputy managing director of Puravankara Projects.
3. Apart from the cost advantage, this would also mean a lower dependence on construction companies in a scenario where execution capability bottlenecks are threatening to derail projects.

The trend of PE firms starting in-house development arms comes at a time when real-estate developers are facing tremendous pressures - with increasing input costs and slowing demand. Many developers (Eg. Unitech) have gone on record saying that they are looking for substantial PE investments in their new projects. With some PE firms disintermediating the developers, it would not be a surprise if developers are forced to sell part of the land-banks to PE firms (instead of participating in joint-ventures with them).

While PE firms are only now backward integrating by starting development divisions, most large developers have already taken the step of forward integration by raising large funds - on AIM or otherwise. We don't have a view yet of which model is better overall from an investor perspective. While conflicts of interest are lower with the PE firm adding a development arm model, it remains to be seen if the skill sets for execution can be developed quickly.

Tiruppur poised for potential grandiose

Tiruppur has been acclaimed as the "Knitwear Capital" of India. Since the 80's, this small town has contributed much to the exports ($3 billion as of last year) of the country including tie-ups with some of the world's largest retailers and designer brands such as Walmart and Tommy Hilfiger. Yet, apart from the lure of cheap, skilled labor, this town had little to interest anyone other than a textile manufacturer.

However, recently there has been more attention bestowed on the place by the government as well as, private parties. Prime Textiles, one the leading manufacturers of the area, have unveiled plans to develop 20 acres of land for residential and commercial purposes. Landmark Land Holdings, the property investment arm of the Dalmia's group has taken a 25% stake in this project. Landmark holdings have been acquiring stakes in tier II city projects such as Pune, Gurgaon, Bhubaneshwar etc. So, at first glance the Tiruppur acquisition seems to be outside of this strategy. So we chose to delve deeper into the potential for the project.

The Pros -

• Tiruppur has recently been accorded the status of a "district" with portions of nearby Coimbatore and Erode districts being carved out to form this. There is potential for overflow traffic from these well-to-do districts in residential areas.
• The ruling Tamil Nadu government, DMK, have claimed Tiruppur to be central to their existence and have allocated Rs. 5 crores for the development of the district including currently non-existent infrastructure.
• The textile industry contributes more than 90% of exports in the cotton knitwear segment and is likely to continue to be a major contributor to the world cotton exports.
• In line with the above, many of the textile plants, have expansion plans to increase capacity.
• The TEA, Textile Exporters Association, has plans of hiking prices by 15%.
• The region has a very high literacy rate (70%+) which harbors well for development plans outside of textile. Nearby Coimbatore already has a reputation of BPO setups and Tiruppur could potentially follow in its footsteps, increasing overall living standards.

Cons

• As mentioned, this is a DMK pet project and government patronage can drop significantly on any change in power.
• Current infrastructure leaves much to be desired and a drop in government funds can seriously harm growth.
• Exports from the region have seen a decline this year of more than 15%. With the US economy's future unclear, it is difficult to quantify any future valuation with accuracy.
• Human rights activists have voiced concerns on child labor in the region. Any material ruling supporting them will affect cost efficiencies in the factories.

Given the rising star status of the region, it potentially an interesting diversification of Prime Textiles and a good investment for Landmark if nothing unforeseen derails the plans sketched above. However, the success will depend on not just internal factors but also external ones such as economy and government involvement.

Nevertheless, for the next five years, the wheels set in motion are likely to bear fruit for property investors.

Trikona Capital's New Investment In Bandra

Trikona Capital has announced a $40 million deal for the urban rejuvenation (redevelopment) of a 4 acre property in Bandra, Mumbai. Highlights

1. The deal is a co-investment with SachsenFonds
2. Development partner is Keystone Constructions (Rustomjee), a company with whom Trikona has invested previously also.
   
3. SachsenFonds has previously bought $170 million of assets from Trinity Capital, an AIM listed fund managed by Trikona Capital.

Trikona Capital has been among the first few real estate private equity firms in the country. They sport a wider mix of property types than other firms with investments ranging from Fortis Hospitals and Pipavav Port to hotels, office parks and residential townships.

Their sale of assets to SachsenFonds is the first real-estate private equity exit that comes to mind. The cash-on-cash return on those transactions was north of 100%. While the exit is commendable, one cannot help but think that the exit was partly driven by fine-print in the agreement between Trikona and Trinity. Trikona (the manager) gets paid a performance fee on a project basis and not at an aggregate fund level. In addition, as mentioned in Page 78 of the prospectus, there is no clawback feature for the payment of the performance fee. So, if there are two very-profitable projects and two not-so-profitable projects, the investor may not make returns in excess of the 10% hurdle rate, but the manager rakes in a fee on the two very-profitable projects. It is also pertinent to remember that the percentage of the performance fee increases from 20% to 30% if the IRR is more than 30%. Given that the investment was less than 2 years old and the cash-on-cash returns were more than 100%, the sale to SachsenFonds is likely to have generated a large performance fee for Trikona Capital.

More real estate developers turning to alternate avenues for funds and ideas

With direct retail demand flagging and high interest rates inhibiting access to cash, real estate developers are turning to new ways of funding and more attractive development opportunities.

As far as the first goes, there has been little switching cost to developers, so far, as PE firms and sovereign wealth funds flush with oil money are looking at the Indian real estate market as opportunistic investment. Despite, all indications of potential coupling with US markets, and expectations of further corrections in the Indian stock market, most expect the property markets to remain unaffected and still attractively valued especially outside Mumbai. Increasing transparency in the real estate market and ease for foreign investors in acquiring stakes has only added to this attraction, it seems.

The most recent such investment came from Dubai's Pan Atlantic LLC, which, recently bought a 40% stake in an upcoming Bangalore project developed by Sobha Developer Ltd. Sobha plans to develop a 1.7-million-sq ft residential township at the plot in south Bangalore with construction expected to start next quarter.

It remains to be seen, if the recent corrections in the property markets themselves will be a precursor to further revaluations as was the case in stock markets and scare away these new investors (Here is more analysis on the topic). However, in the mean time, funds flush with money and looking for more venues outside of the traditional capital markets are still a source of solace for developers who have already put down money for their projects. It will be interesting to see the actual terms of the deal and how high a cost, developers will have to pay going forward for such alternate funding.

Urban developers are also looking to expand on their portfolio by branching out into the hospitality industry. The above mentioned Sobha Developers is just one of these opportunistic developers. Real estate companies such as Brigade group, Omaxe Ltd, Prestige group, Sobha Developers Ltd and Value Designbuild Pvt. Ltd, are entering into the leisure segment to build health resorts and spas in the backwaters of Kerala or amid the plantations of Chikmagalur in Karnataka.

India's rising economic capital has increased interest and profit potential for resorts and spas developed in easy commuting distance from major cities. Adding to that, the country's reputation for providing world class medical procedures at a fraction of the cost (compared to US and Europe) has seen an increasing trend in medical tourism with major hospitals forging ties with the hospitality industry to provide a better holistic experience.

While such diversification is potentially inevitable for developers, it is questionable if this is the right time. Such resorts have longer break even time and with increasing costs of funding, they may not be the best investment venue for independent developers currently.

Axis Bank's investment in HCC's Lavasa

There have been numerous reports of Axis Bank's recent investment of Rs. 250 crores for a 2.5% stake in Lavasa Corporation, a subsidiary of HCC and how it implies a valuation of Rs. 10,000 crores for the company. However, we haven't see any comments on the form of the investment. From the article (and the press release):

Axis Bank has infused the funds in the real estate project in the form of convertible preference shares and convertible debentures. This puts the valuation of Lavasa at Rs 10,000 crores.

Based on the language, it is clear that this transaction is a structured investment and not direct equity. So, Axis Bank is probably willing to pay Rs. 250 crores for the 2.5% stake contingent on either events like a development/sales timeline or any future investment/valuations. In addition, since the investment is in the form of preference shares/debentures, Axis Bank will get paid some annual return (which is not true for other equity holders) and till conversion, its securities are likely senior to common stock. It is also important to find out if this investment by Axis is part of a broader transaction (like ICICI Venture's investment in Jaiprakash Infratech). Whichever way you look at it, the math of Rs. 250 crores investment for an eventual 2.5% stake = Rs.10,000 crores current valuation looks hard to swallow

CDC's Investment in Indian Infrastructure & Real Estate

CDC Group has announced a commitment to three Indian infrastructure and real-estate funds. Summary below

1. $ 100 m to IDFC India Infrastructure Fund managed by IDFC Project Equity
2. $ 100 m to Actis India Real Estate Fund
3. $ 50 m to Kotak India Realty Fund

Notes from Hirco (Hiranandani vehicle on AIM)

AIM listed Indian real estate funds have had a rough June, in line with the broader markets and domestic real-estate stocks.

Hirco, the Hiranandani promoted real estate investment company recently filed an update of its sales performance. Summary is below with our comments italicized

1. As of 13th June, 1.69 million sq. ft. of the Hiranandani Palace Gardens residential township in Chennai has been sold at an average price of Rs. 3991/sq. ft. As of 31st March, 1.56 million sq. ft. had been sold at an average price of Rs. 3906/sq. ft. So, the incremental selling price for properties sold in the last two months was Rs. 5019/sq. ft. In contrast, for the previous three month period, the average selling price was Rs.4456/sq. ft. The rise in prices is definitely impressive.
2. The Chennai township has a total buildable area of 30.1 million sq. ft. of which 21.5 million sq. ft. will be residential. So, about 7.9% of the planned residential area has been sold. While the township is planned to be built in three phases, it is kind of disappointing to see that one year of sales (in a relatively robust property market) resulted in only sales of less than a twelveth of the buildable area. With residential property sales slowing down in a big way across the country and interest rates rising rapidly, the outlook for the next twelve months is at best tepid. The Hirco website has a detailed presentation on the company's approach to developing integrated townships. The blueprint suggests that a typical development is a three-phased exercise spanning 84 months with about 15-20% development completed in the first 28 months. Arguably, the current rate of sales is in line with what should be expected, but the changed sentiment in the real estate market suggests that it will take two more years before 20% of the available residential units are sold. As long-time observers of Indian real-estate, we are reminded of the lifecycle of Hiranandani Gardens in Powai. Before it became one of the hottest properties in the area, it was caught in a market-wide slowdown cycle. With our expectations for such a slowdown, we believe investors looking to take exposure to this township should wait till late 2009/early 2010 for an attractive entry-point.
3. Preconstruction sales for the Hiranandani Palace Gardens township in Panvel have been proceeding at a robust pace with 1.44 million. sq. ft. sold at an average price of Rs. 4180/sq.ft. In April, 0.6 million sq. ft. had been sold at an average price of Rs. 4156/sq. ft. The Panvel Township has 18.3 million sq. ft. of buildable space.

Kaupthing to list Indian Infrastructure Fund

Kaupthing, a prominent Icelandic investment bank plans to list its infrastructure vehicle on AIM. PropertyWeek has the story.

Summary:
1. Fund has raised GBP 40 million so far
2. Asset purchases to date include a hydro electric plant, a toll road and a rail freight siding
3. Asset manager will be Bridge Capital Realty from Singapore. Kaupthing has a 20% stake in Bridge Capital. Punj Lloyd also has a stake in the company
4. The fund is called Infrastructure India

We will have more details here once the filings are available

Ishaan Real Estate's Results

The Raheja backed AIM Fund, Ishaan Real Estate has released preliminary results for the year ending March 2008. Full details are available at here.

Key points:

• Portfolio value increased to £810 million from £524#million at 31 March 2007.
• Reported NAV per share at 95.5p.
• Aggregate investment of £159.5 million has been made in nine projects in Mumbai, Hyderabad, Pune and Bangalore with 22.1 million sq. ft. planned for development.2.4 million sq ft of pre-letting secured (including 636,000 sq ft under option).
• Rentals in line with or higher than those anticipated at the time of IPO.In addition to the pre-letting secured, pre-sold approximately 20% of the saleable residential space in premium residential development project, Vivarea, in central Mumbai, at prices above those anticipated at the time of IPO.

We will have a full analysis of Ishaan's portfolio soon. Watch this space.

ICICI Ventures to raise a new $1.5 bn fund

Business Standard has an article about ICICI Ventures raising a new $1.5 bn fund. The interesting aspect of the fund seems to be an option to list the fund on the London Stock Exchange. This innovation will help expand the investor base for real estate private equity funds. In the backdrop of a slowdown in investor appetite for Indian assets and more specifically Indian real estate, it is imperative of fund managers to use every avenue possible to raise capital.

In the current market, when most listed real-estate investment vehicles are trading at a big discount to NAV, it is clear that the option is unlikely to be exercised in a hurry. Investors will be served well to note that till the fund is listed, the investment will remain illiquid and any divestment will likely be at a substantial discount. Of course, even if it is listed, the discount to NAV could be hefty

Indiabulls Property Trust - Update

Previously, I had discussed the IPO of Indiabulls Property Trust in Singapore and how it was floundering in the secondary market. So far this week, the performance continues to be on similar lines. The volume on the counter has come down in a big way - but the core story remains. Only buyer of size remains Deutsche Bank, in their capacity as the stabilization agent. In addition, Farallon filed a notice saying it acquired a further 17 million units in the IPO. We are yet to find out how many units of the IPO went to Indiabulls Real Estate (beyond the 40+% that was already owned by them). In summary, it appears that the IPO had very limited demand even at the lower end of the price band and the clearing price is actually below S$0.9 (where it is being supported right now.

South Indian Real Estate Markets - A view from Ascendas

Ascendas India Development Trust(AI-Trust) recently filed their annual report for the year ending March, 2008. Like many regulatory filings, the report is a goldmine with information on their current rentals, large tenants, new developments in the micro-market and demand/supply. Jones Lang LaSalle Research is the source for a lot of the data. AI-Trust has properties in Bangalore, Chennai and Hyderabad and a large portion of its tenants are IT/ITES companies. An appendix to the annual report has a market research on these markets. Key points and my observations are below

• Property markets in the three cities are divided into micromarkets based primarily on distance from city center. AI-Trust calls these micromarkets Central Business District (CBD), Secondary Business District (SBD) and Peripheral Business District (PBD) in increasing order of distance from city center. All of AI-Trust's properties are in the PBD of the three cities.
• In Bangalore, the Outer Ring Road(ORR) area falls under PBD whereas Whitefield and Hosur Road beyond ORR fall under PBD. Due to new supply in the SBD, primarily eastern stretch of ORR, and excess construction in the Whitefield area, vacancy rates in rose from 3.2% in 2005 to 20.6% in 2007. While leasing activity was strong through 2005, the emergence of ORR as an attractive destination for IT/ITES companies has weighed on properties in Whitefield. ORR is closer to city center, has better connectivity and there are large tracts of land available for development.
• While analyzing competition in the Whitefield area, it is mentioned that rentals in the Whitefield market have seen stagnation over the last year. Also, apart from an SEZ project, upcoming projects are not seeing pre-leasing activity because of competition from ORR. The present stock of space in Whitefield is approx. 10.1 million sq. ft. and an additional 7.5 million sq. ft. of space will be available in the next 18 to 24 months. In 2007, the absorption in Whitefield was about 3.3 million sq. ft. So, on the surface it appears like the demand/supply situation is not terribly off. However, keeping in mind that Outer Ring Road is a preferred destination and that there is a lot of supply coming to market in ORR, it will not be a surprise if the Whitefield market sees a lot of pressure. A large unknown to this equation is the extent to which North Bangalore takes off as a business district. I believe many developers are underestimating the extent to which the locus of activity can shift there - especially given the new airport. It took just 2 years for ORR to displace Whitefield as the preferred location for new offices. In 2009 & 2010, expect North Bangalore - ORR and Bellary Road to be the center of attention.
• In Chennai, Old Mahabalipuram Road and GST Road are the micromarkets that form the PBD. Stock of grade A space went from 1 million sq. ft. in 2002 to 11.75 million sq. ft. in 2007. Vacancy rates bottomed out at slightly below 2% in 2006 and climbed to about 11% in 2007. In 2008, another 8 million sq. ft is projected to become available. Of the 4 million sq. ft. added in 2007, only 70% was absorbed. So, the prospects for the near-term do not appear to be very favorable. Like in Bangalore, pre-leasing activity has slowed down and RMZ Millenia is the only project that has seen some activity. There are large developments planned by DLF, Tata Realty and these could also pose threats to offtake. Different city, same story. As any student of markets will tell you, when supply exceeds demand, prices need to decline till there is a clearing price. Given the evolving demand/supply situation, expect to see projects being delayed even as rents decline. Investors who built up land-banks in these areas will be hit the hardest since land prices will quickly reflect the reduced prospects of these markets.
• Hyderbad seems to the best positioned of the three cities. In the Madhapur area, the vacancy rate is as low as 2% and most buildings are experiencing 100% absorption. While AI-Trust's research seems to be bullish about Madhapur, a look at the numbers indicates reason for abundant caution. Current stock of office space is about 9 million sq. ft. with 2.1 million sq. ft. added and absorbed last year. In 2008, about 7 million sq. ft. of space is coming on line with DLF, L&T and K. Raheja Mindspace being the largest (1.6 m sq. ft., 1.3 m sq. ft. and 1 m sq. ft.respectively). In the backdrop of a slowing US economy and pressure on IT companies, it is hard to imagine a situation where the vacancy rate does not rise materially.

In summary, if I were to grade the PBD markets in the three cities (on a scale of +5 to -5), Bangalore would get a -3, Chennai would get a -2 while Hyderabad would get a +1. Would love to hear any comments readers may have.

Foreign Investors And Indian Real Estate

Business Standard has an article on foreign investors and their expectations with regard to Indian real estate investments. In addition to many quotes from 'experts' without names, there is one from the CEO of Kotak Real Estate Fund

"Real estate developers face a double whammy of slowdown in the overall growth and hardening of interest rates, while the perceived risk-reward equation for India is going down," said S Sriniwasan, CEO, Kotak Real Estate Fund.

In a previous post, I had illustrated the effect of higher interest rates on returns. A related issue is the increase in return thresholds for India investments. In a landscape where US investors can buy money-good mortgage backed securities for 8-9% yield, the target return for an equity investment in Indian real estate will likely be in excess of 20%. Expect investors to be choosy with regard to transactions they pursue and inflexible when it comes to valuations for their chosen transactions. We are also likely to see more structured deals where the developer gets returns only after the private equity investor has reached a minimum level. Needless to say, none of these developments are good for the developer community.

Orbit Corporation - Which way is the wind blowing ?

Reuters has an interview with Orbit Corporation's finance head, Ramashrya Yadav and states that the company expects to add new projects worth Rs.8-10 billion ($400-500 million) in 2008/2009. Orbit has historically focussed on redevelopment and sees an opportunity in cluster redevelopment where it acquires a number of buildings and redevelops them together. The interview is surprisingly upbeat given the negative news around Mumbai real estate.

A few days ago DNA had an article about Kotak Realty Fund calling off a deal to buy Orbit's Hafeez Contractor House, a 0.25 million sq. ft. commercial property in Lower Parel. While the company is looking to pre-sell the property by 2Q08, given the fact that the space will only be available after 2 years and an estimated 5 million sq. ft. of office space is expected to hit the market in that time period, chances are that it will be a buyer's market and Orbit may be forced to lower expectations on the sale price.

Lehman invests in Unitech project in Mumbai

Lehman Brothers Real Estate Partners (the real estate private equity fund of Lehman) has announced a $175 million stake in a Unitech project on the Western Expressway. Since this news has been extensively covered in the media, I will just provide a few links

Business Standard: Lehman real estate arm to invest Rs740cr in Mumbai
Bloomberg: Lehman to Invest $175 Million in Unitech's Project
NDTV Profit: Lehman to invest $175 mn in Unitech's project

Articles mention that the project will be on the lines of Canary Wharf, London and Battery Park City, New York. One hopes that the project does not go through the boom-bust cycle that plagued Canary Wharf.

On a side note, Deutsche Bank is supposed to have evinced interest in the deal initially and passed on it subsequently.

Mapletree Investments - New Kid on The Block

Mapletree Investments (a Temasek subsidiary) has launched a new fund called Mapletree India-China Fund (MIC). Asian Investor has an article about the fund and its tie-up with HSBC Private Bank for distribution. Salient points are below

• MIC is a dual-country, total return fund that aims to capitalise on the growth potential within India and China by developing office, retail and residential real estate within these two markets. Its assets now stand at $1 billion and it has a targeted maximum fund size of about $2 billion. After leverage at the project level, the size of the fund will be $4 billion.The target annual returns for the fund are 20%. Drawdown and investment period is expected to be completed within three years and with a typical lifespan of around five years per investment. There is no liquidity for the fund, and the tenor is approximately eight years
• HSBC Private Bank has been given the exclusive distribution rights for high-net-worth investors via a feeder fund named the HSBC Emerging Growth Real Estate Fund. Ordinarily, tickets of $50 million have to be written in order to invest in this Mapletree fund, but for HSBC private clients, they can come in for $250,000.
• The fund has already made three investments - all of which are in China. Investments have been in a mixed-use development (retail + service apartments), an office block and an integrated retail & residential development

The logistics segment in India is ripe for institutional investing and we have seen some signs of it already (Eg. Old Lane's investment in Sical Infra Assets). With real estate majors looking at logistics in a big way, it is a matter of time before more investors put their money in this space. Given Mapletree's history and investments outside of the MIC fund, as also the real estate investment landscape in India, I would expect them to focus their investments towards industrial/logistics facilities and away from the traditional retail/residential segment.

Affordable Housing - The New Buzzword

With home prices in the large cities showing signs of softness and affordability of houses being cited as a key barrier to increased offtake, affordable housing seems to be the new buzzword for developers (Wonder if this is an acknowledgement that the current crops of houses are not affordable!).

Business Standard has an article on this trend and mentions a host of private equity firms that have committed capital for this space. Firms mentioned include Red Fort Capital, Warburg Pincus and Fire Capital. While the article does not have any great insights into how this segment of the industry is evolving, one datapoint cited makes me wonder if anybody in the editing room is doing a sanity check on what is written.

Recognising the potential growth in affordable housing segment, Delhi-based Omaxe Ltd has formed a company, National Affordable Housing Infrastructure Ltd, which will invest Rs 80,000 crore to develop 100,000 affordable homes across the country.

Sure hope this is a typo and the journalist meant Rs 8,000 crores. After all, Rs. 80 lakh per house is not my idea of affordable housing!!

Global Credit Crunch Hits Indian Real Estate

The Economic Times has a timely article on the cash crunch facing Indian developers. Excerpts below:

The recent bloodbath in the real estate sector has started taking a toll. Almost all large developers are now facing a severe cash crunch and finding it difficult to complete their ongoing projects. In fact, the situation is so bad that most of them have reported a 50-70% cash shortfall. Industry sources told SundayET that the liquidity crunch has forced many developers to pick up cash from the unorganised market at interest rates as high as 35% to 50% annually. The lending rate of banks is between 18% and 20%.

As a result of the crash crunch many developers have started going slow or even stopped construction of projects which are either in their initial stages of development or which would not affect their bottomline in the near future. While most developers that SundayET spoke to, agreed with the problem at hand, none of them were ready to be quoted on how it had affected them.

What’s more, bankers say they may now get more cautious towards lending to real estate developers. “Real estate companies have many projects at hand and the sales have been constantly dwindling. Analysing these sentiments, any financial institution will be cautious. Remember, during monsoons, housing sales come down and banks may have to consider increasing interest rates further in future,” says HDFC Bank chairman Deepak Parekh. State Bank of India (SBI) is no different. It is also contemplating similar measures. “We are not sure for how long the current volatility will exist in the realty market. Also, banks need to maintain their reach among their clients. However, it is possible that all banks may sanction loans to only those developers with whom they have had a long relationship,” says a top SBI official.

Industry experts feel the only avenue available for raising capital in the current situation is at the project SPV level and by way of private equity or similar sources, which is generally the most expensive method of raising capital and has limitations on the over all extent of financing that is required. “Concerns about liquidity will continue to plague the market since debt will not be easily available. Real estate players had traditionally raised money from debt funds via corporate deposits and commercial paper. However, debt funds are currently not eager for more exposure in real estate and are continuously rolling over the debt advanced to these players. The primary source for institutional funding will, therefore, now be private equity,” says JLLM chairman & country head Anuj Puri.

It was only a matter of time before the worldwide squeeze in liquidity affected Indian real estate and this news should not come as a surprise to anybody. While the implications of a liquidity squeeze are no doubt bad for developers, private equity investors who have already taken stakes at an SPV level are also likely to be hit badly. High cost of leverage & delayed cash flows have a severe impact on IRRs. Consider the scenarios below

Even without accounting for any escalation in costs/drop in prices due to softness in the market, returns to the private equity investor drop by more than half due to an increase in the cost of leverage and a 6-month delay. Of course, if even if you add a very conservative input cost escalation (we have seen higher numbers), there is a further drop in realized returns. Not a very pretty sight for anybody who went in thinking this was easy money. The developers are in a slightly better position because a) Their investment in the SPV was likely in the form of land bought at a lower price b) They get paid a variety of fees (construction, project management etc.) and are able to recoup a part of their investment regardless of how little the private equity investor makes.

If the conclusion drawn up in the ET (of private equity being the primary source of institutional funding) needs to hold, expect to see private equity investors demand a very high return on investments going forward. In turn, this does not bode well for Indian developers who not too long ago were in the driver's seat and could choose between investors. The altered landscape is already weighing on the equity markets, though it is not clear to what extent it has been priced in.

Singapore REIT Market And The Indiabulls Listing

Mint has an article on how DLF and Unitech have put off their Singapore listing plan.

Unnerved by withering global equity markets, India’s two leading real estate developers, DLF Ltd and Unitech Ltd, have indefinitely postponed plans to list their real estate investment trusts (Reits) on the Singapore Stock Exchange until market conditions improve, in turn increasing pressure on them to find alternative means to fund projects.

DLF, which was looking to revive the initial public offer (IPO) of its promoter-owned company, DLF Assets Ltd, confirmed that it has postponed the IPO. It had initially planned to update the IPO documents in Singapore by May end or this month.

“We are not going to look at a Reit listing till market conditions improve,” said Ramesh Sanka, group chief financial officer, DLF. He didn’t say what kind of funding the firm would now look at.

Unitech is also not looking at a Reit listing in the immediate future. The company had planned to raise around $700 million (Rs3,000 crore) from the IPO in Singapore.

“At this point, Unitech Corporate Parks is not planning to float a Reit,” said Sanjay Chandra, managing director, Unitech. “We are not talking to any banks.”
Unitech Corporate Parks, the London-listed investment company of Unitech, hopes to sell three commercial assets to the Unitech Office Trust, the proposed Reit of Unitech.

The underperformance of recently listed property trusts is discouraging developers from raising money through this route, which, until six months ago, was considered the most promising way to raise funds.

Indiabulls Real Estate Ltd, the fourth-largest listed Indian developer raised only S$262 million from its Reit offering, less than the S$286 million it had initially sought. And Indiabulls Properties Investment Trust, which made its debut on the Singapore stock exchange on 11 June, has traded for three straight days below its offer price of S$1. Key bankers to the deal said it was a “tough’’ offer to pull off because of the weak sentiment in the equity markets.

While the article does a good job of highlighting the weakness in the Singapore REIT market, it has gone easy on the performance of the Indiabulls Property Investment Trust (IPIT). During the first three days of trading, Deutsche Bank, in their capacity as stabilization manager for the transaction, has purchased about S$20 million worth of units of IPIT (8% of outstanding units). Peering at the trading volumes, one finds that over 90% of the shares traded over Thursday and Friday were purchased by Deutsche Bank - a reflection of the absolute lack of investor demand at that price point. So, the clearing price for IPIT is probably lower.

With this insight in mind, it is fair to say that another avenue for moving assets around to boost valuation (DLF Assets to proposed Singapore REIT, Unitech Corporate Parks to Unitech Office Trust) is not viable in the near term.

IPIT Analysis
At this juncture, it is important to highlight that IPIT has the same assets viz. One Indiabulls Center and Elphinstone Mills, that were partly owned by Dev Property Development Fund (Dev), an Indiabulls Real Estate (IBREL) affiliate that was listed in AIM. (Dev, IBREL and Farallon owned 13%,40% and 47% respectively). Dev was merged into IBREL earlier this year. IPIT purchased these assets and about 85% of the consideration was to paid in the form of IPIT units.

Reading the IPIT prospectus, it is clear that through all these listings (Dev, IPIT) and mergers (Dev & IBREL), the extent of beneficial interest in these properties that has changed hands is not much. Farallon and IBREL owned 87% of these properties when the IPO of Dev took place in 2007. After this listing, they still own 85% of the two properties. One should also note that the IPIT units owned by IBREL and Farallon are subordinated (and locked in) and would be worth slightly less than what IPIT is quoting on the Singapore Exchange.

The IPIT propectus (available on the SGX website) is a recommended read for anybody who is looking to understand the structure of REITs, compensation for property managers/brokers and a list of tenants for the properties in One Indiabulls Center. The prospectus also has good background information on the Indian real estate market, the Mumbai market and the Parel micromarket.