Investors come up with alternative funding plans for crisis-hit realtors

With developers hit by weak sales, investors offer innovative options to replace plain equity and debt lending

Private equity funds and non-banking financial companies are offering various modes of lending and repayment to real estate developers struggling with weak sales for the third consecutive year.

Innovative forms of investments are replacing plain equity and debt lending, with investors lining up special situation funds, uniquely-themed funds and construction finance.

ASK Property Investment Advisors, which made high risk-high return equity investments in the last seven years, is preparing to raise a special situation fund this year, which will invest equity-type (but not pure equity) money in residential projects for completion of development, or to replace existing high-cost debt and stay invested for 3-5 years.

Along with Rs.1,500 crore of pure equity dry powder, ASK believes there is need for a separate pool of capital for projects at an advanced stage.

“Real estate is passing through a difficult time, with project delays and repayment pressures. The need of the hour is to have different kinds of capital and funds are tweaking their offerings to fill in those funding gaps for developers,” said Sunil Rohokale, chief executive and managing director of ASK Group.

From the pure equity funds of 2005-06, structured debt and mezzanine debt instruments took over in the last few years, with PE funds and NBFCs demanding higher collateral and fixed repayments on a quarterly basis.

However, this put pressure on developers to service debt, as cash flows continued to remain tepid—it was not sustainable. Following this, PE funds and NBFCs started tweaking lending norms, offering more refinancing and repayment flexibility.

With a lot of liquidity chasing a few good projects, this also led to intense competition. PE funds moved towards debt-like structures.

According to Rajeev Bairathi, executive director and head of capital markets at Knight Frank India, NBFCs have evolved too. “From lending based on existing cash flows of a project, NBFCs are now offering acquisition financing to buy land parcels, construction finance as well funding for commercial office projects, different from simple lending to residential projects,” Bairathi said.

Altico Capital India Pvt. Ltd, an NBFC from Asia-focused investor Clearwater Capital Partners LLC, plans to offer construction finance and lend to commercial office projects.

Banks offer construction finance at 11-12%, while NBFCs charge a bit more, but the latter offer more flexible capital and an extended repayment periods.

“NBFCs are now well-capitalized and can compete with banks, by giving construction finance. We are also looking to offer construction finance but with established developers and also lend to office projects because there is a lot of potential in the office sector. We will do early-stage financing in residential and office projects to buy land and in pre-leasing stage respectively, and lend to projects in an advanced stage by facilitating transactions, in which we collect the last payments from customers,” said Altico Capital’s chief executive Sanjay Grewal.

Piramal Fund Management Pvt. Ltd, which introduced innovative financial products such as an apartment buying fund, Mumbai Redevelopment Fund and began construction financing early on, plans to focus on equity investments once again.

This year, it will execute a new strategy for equity investments in land opportunities for investors, to generate superior returns by investing in plotted land development. The firm is in the last leg of signing a $300 million offshore platform with a large Canadian pension fund and will also raise a second redevelopment fund. It also started deploying Rs.5,000 crore to fund commercial office projects this year, and introduced a Rs.15,000 crore line of credit to some of the top developers.

“When we started lending at 18-20% a few years back, it was opportunistic but not sustainable. We realized that developers need to be given time to repay, till the market revives. It is also important to have multiple pools of capital to service different kinds of financing needs but equity remains the need of the hour in the current scenario,” said Khushru Jijina, managing director, Piramal Fund Management, which has Rs.32,000 crore of assets under management, including equity investments and commitments made but not yet disbursed.

Customization is key while structuring transactions and each transaction is adapted to the needs of developers.

“Both equity and debt are offered through different customized products, but we think we will see more equity products coming in. With RERA (Real Estate Regulation & Development Bill) being implemented, investors will have more confidence in developers because there will be delivery timelines for projects, repayments,” said Chintan Patel, partner, deal advisory, real estate and hospitality, KPMG India.

Century Real Estate Holdings Pvt. Ltd, which raised Rs.720 crore from Piramal and Altico last year and an additional Rs.520 crore from Piramal in 2016, got an opportunity to refinance high-cost debt, use some of it as construction finance and to make land payments as well.

“These transactions offered much more flexibility in the usage of capital, which banks don’t offer even if it is cheaper. Because there are different kinds of capital involved, the blended cost of funding automatically comes down,” said Century managing director Ravindra Pai.

“They are under a little pressure in terms of margins, but if they want more margins, they have to take more risks,” he said.

Not only different capital structures, but repayment structures are also customized based on the risk-return perspective.

Repayment issues have cropped up, but funds and NBFCs have either refinanced their own loans to projects or given developers more time to service debt.

Balaji Raghavan, chief investment officer, real estate, IIFL AMC Ltd, said repayment structures are also being customized for each transactions, and instead of fixed repayment schedules, they are being matched with cash flows anticipated from a project.

“We are optimistic about investments in real estate over the next 24 months and are looking at substantial growth in India across investment platforms we have built and capitalized over the last 11 years,” said Rohan Sikri, senior partner, Xander Group Inc.

In the last two years or so, Xander has invested about $250 million mostly in residential assets through the preferred equity route. Separately, Xander Finance, which does senior secured debt transactions, has executed almost 50 transactions adding up to Rs.1,800 crore.

The question is, if the health of the sector doesn’t improve anytime soon, how long will the cycle of financing and refinancing help developers sail through this crisis?

S. Sriniwasan, chief executive of Kotak Realty Fund, is cautious and “hasn’t deployed any money in the last 18 months or so and is in wait-and-watch mode”.

Kotak Realty Fund raised $250 million from offshore institutional investors this year, to make equity investments in residential projects, at a time fund managers wary of equity risks extend only debt finance.

Turn of the screw

Ultra-low interest rates are slowly squeezing Germany’s banks

BANKS the world over are groaning under the burden of low, even negative, interest rates. The gripes from Germany are among the loudest. In March, when the European Central Bank cut its main lending rate to zero and its deposit rate to -0.4%, the head of the savings banks’ association called the policy “dangerous”. At the co-operative banks’ annual conference this month, a Bundesbank official earned loud applause just for not being from the ECB.

Germany’s banking system comprises three “pillars”. In the private-sector column, Deutsche Bank, the country’s biggest, expects no profit this year. That is mainly because of its investment-banking woes, but low interest rates have also weighed it down: it wants to sell Postbank, a retail operation it took over in 2010. Commerzbank, ranked second, specialises in serving the Mittelstand, Germany’s battalion of family-owned firms. It has felt the interest-rate squeeze even more. Analysts at Morgan Stanley place it among the worst-hit of Europe’s listed lenders.

Most Germans, however, entrust their savings to the other two pillars. One includes 409 savings banks (Sparkassen), mostly municipally owned; the other, 1,021 co-operatives. These conservative, mainly small, local banks are the most vocal complainers—even though at first blush they have little to moan about. Savings banks’ combined earnings declined only slightly last year, to €4.6 billion ($5.1 billion) from €4.8 billion in 2014. Deposits and loans grew; mortgages soared by 23.3%. Capital cushions are reassuringly plump: their tier-1 ratio rose from 14.5% in 2014 to 14.8%. Co-ops had a similar story to tell. But trouble is brewing.

The ECB has flattened long-term rates as well as short ones, by buying public-sector bonds and, starting this month, corporate debt. Ten-year German government-bond yields are near zero—and recently dipped below, thanks in part to markets’ fears about this week’s Brexit referendum. For banks, this means ever thinner margins from taking in short-term deposits and making longer-term loans—from which, says McKinsey, a consulting firm, German banks earn 70% of their revenue.

Lenders have been well insulated so far, because most loans on their books were made when interest rates were higher: 80% of loans last longer than five years. Rising bond prices (the corollary of falling rates) have provided further padding as banks’ portfolios gain in value: that effect alone has brought the savings banks €19.4 billion over the past five years. But as old loans mature, they are being replaced by new ones at today’s ultra-low rates. The mortgage boom is thus a mixed blessing: rates are typically fixed for ten years or more.

With no increase in ECB rates in sight, the screw is tightening. Half of the 1,500 banks surveyed by the Bundesbank last year—before the latest rate cuts—expected net interest income to fall by at least 20% by 2019. Although banks would prefer higher rates, too sudden an increase would also be awkward, pressuring them to pay more for deposits while locked into loans at rock-bottom rates.

Banks are seeking ways to alleviate the pain. Commerzbank is charging big companies for deposits, above thresholds negotiated case by case. (It is also reported to be pondering stashing cash in vaults rather than be charged by the ECB.) Bankers warn of an end to free personal current accounts. But with so many banks to choose from, scope for raising fees is limited.

Selling investment products and advice seems more promising; and commission income has risen, as some savers seek out higher returns. Yet low rates have made many Germans, already a cautious lot, even less adventurous. They are stuffing more, not less, into the bank—but into instant-access accounts: with rates so low they may as well keep cash on hand.

Low rates are not banks’ only worry. Both bankers and politicians vehemently oppose a proposed deposit-insurance scheme for the euro zone: the savings banks and co-ops have always looked out for each other, and don’t see why they should insure Greeks and Italians, too. Smaller institutions complain about an increase in regulation since the financial crisis—even though they weathered the storm far better than many larger ones. The savings banks’ association claims that red tape costs its members 10% of earnings—and some as much as 20%.

Another concern is the march of technology. Germans have been slow to take up digital banking, but their banks—reliant on simple deposits and loans, and still carrying the costs of dense branch networks—are vulnerable to digital competition nonetheless. Number26, a Berlin startup, has signed up over 200,000 customers across Europe for its smartphone-based current account within months. The savings banks plan to hit back this year with Yomo, a smartphone app aimed at young adults.

McKinsey reckons that low rates, regulation and digitisation together could cut German banks’ return on equity from an already wretched 4% in 2013 to -2% within a few years if they do nothing in response. The pressure is starting to tell. This month the Sparkasse Köln-Bonn, one of the biggest savings banks, said it would close 22 of its 106 branches. Some rural banks have replaced branches with buses.

All this is likely to thin the crowded ranks of Germany’s lenders. Consolidation has been under way for decades: since 1999 the number of co-ops has fallen by half; on August 1st their two remaining “central” banks, DZ Bank and WGZ Bank, which provide co-ops with wholesale and investment-banking services, are to join forces. The pace of mergers has steadied in recent years. Negative rates may speed it up again.