The real estate economy is growing right now. What do you think is the role of AIF in this growth? What is the impact of AIF on the future of real estate?
The Indian economy thrives to move from being the world’s fifth-largest economy to the third-largest by 2028, with a business size ranging between $4 trillion and $8 trillion. India’s population growth is also making it the most populous country. With both the economy and population expanding, there is a significant demand for more real estate, particularly following the pandemic.
To sustain this growth, developers need to acquire new land and initiate new projects. However, as per RBI amendments, Banks and NBFCs are prohibited from directly/indirectly financing land purchases. Consequently, Alternative Investment Funds (AIFs), especially those in Category II, are assuming a crucial role. They offer the necessary funding for land acquisition and for initial approvals, which is vital for real estate development. While some major developers may obtain bank loans at corporate level, the majority rely on AIFs for the capital required to buy land and finance their projects.
Looking ahead, unless the RBI amends the regulations to permit banks and NBFCs to once again finance land purchases, AIFs will continue to play a pivotal role. In the past decade, leading NBFCs provided over ₹1.5 lakh crore for land funding, but they are currently unable to do so. The total sum of large real estate funds (via AIF route) in India is not more than ₹10,000 crore. This creates a substantial gap between demand and the available funds. Consequently, AIFs have a significant opportunity to expand and continue providing the necessary funding to assist developers in creating superior real estate projects.
As an investment fund manager, what are the key challenges?
Managing an Alternative Investment Fund (AIF) presents several major challenges for the fund managers. First, raising enough capital is difficult and obtaining prompt funding approvals can be a recurring issue. Moreover, the high entry threshold of 1 crore INR for AIF investments acts as a barrier, limiting the participation of potential investors who cannot meet this requirement.
Secondly, the fees charged by distributors and wealth managers diminish the fund’s returns and affect upfront cash flows situation. Although SEBI has made adjustments to allow the spreading of these fees over time, initial cash flow problems and competition from mutual funds remain major obstacles.
At present, both equity and real estate markets are performing well, a rare situation from their usual inverse relationship. Equity markets offer high returns with lower taxes (12.5% on capital gains), whereas real estate funds are subject to higher taxes (linked to Investor’s applicable tax bracket), making them less attractive compared to equity investments on post-tax returns basis assuming gross returns at par.
Furthermore, RBI regulations restrict large institutions like LICs and banks from investing in AIFs, which constrains potential funding sources. Consequently, a substantial amount of capital is being directed towards IPOs. If SEBI mandates specific licenses for brokers to raise funds for AIFs, the pool of potential fundraisers is further restricted, intensifying the challenge of raising funds.
SEBI’s new liquidation rules also pose challenges, as they necessitate the quick sale of projects at the end of their term, potentially leading to losses if properties are sold for less than their value, thereby adversely affecting investors. In conclusion, while raising funds is the primary challenge, fund managers need to navigate these issues prudently and make the necessary adjustments to safeguard investors and ensure favourable returns.
In the past, AIF has not seen any significant success in real estate. What are the contributing factors?
Indeed, most real estate Alternative Investment Funds (AIFs) in India have not performed well overall. While there have been some exceptions and bright spots, the track record from 2006-07 till now has been quite uneven. It’s important to understand and address the key issues that contributed to this situation and how these have been rectified. The outlook seems more promising compared to the past.
Firstly, from 2005-2010, many large international funds and AIFs focused on equity rather than debt and invested in major projects, often in tier-two and tier-three cities, before completing prime tier-one locations. During this time, regulations like RERA (Real Estate Regulation and Development Act) were not in place, allowing developers to undertake multiple projects simultaneously due to readily available funds and valuations for land acquisition. However, with the introduction of RERA, the developers have also become more responsible and focused, shifting from handling numerous projects to concentrating on a smaller number, improving quality and timelines significantly.
Another contributing factor is the high competition in funding sources. From 2006 and 2020, many Non-Banking Financial Companies (NBFCs) and other funding sources competed to provide money to developers. This intense competition forced AIFs to offer high returns from 18% to 23% due to acquisition and management costs, while banks offered money at a lower interest rate of 10% to 12%. Post-2020-22, banks and NBFCs have reduced their exposure to real estate, creating a different funding scenario. This has allowed equity and AIFs to fund higher quality, less risky deals with better returns.
It is evident that real estate AIFs with operations post-COVID, especially after 2020-2021, have shown significantly improved track records, often surpassing expectations. The underperforming assets or AIFs are primarily from before the pandemic, from 2006 and 2020. With the current RBI norms and the quality of managers entering the AIF market, real estate AIFs are expected to thrive in a more mature and targeted manner.
This is a game of confidence. What do you as a fund manager do differently to maintain confidence and manage returns?
I believe it’s not just about confidence; it’s more about detailed analysis, active asset management, and using your experience to know what to control and what to leave to others. As an AIF fund manager, your primary role is as a financier. Delving too deeply into the operations of the business can do more harm than good, and this is a mistake many AIFs make.
When investing in a developer, it’s important to trust their track record in repayment, development, and corporate governance. They understand their business, including branding, planning, selling, and obtaining approvals. Your role should be to monitor and oversee, not to interfere excessively, as this could demotivate and disrupt their operations.
Trust is important, but caution is even better. While trusting the developer to manage their projects, setting up appropriate checkpoints and technology systems to monitor their progress is crucial. This involves tracking project delays, and approvals, and ensuring that funds are used as committed.
In traditional financing, banks often react only after a default has occurred, which is too late. Just like a car needs regular maintenance to avoid problems, projects require ongoing monitoring. You should have a robust system to ensure that funds are being allocated correctly, identify any leaks, and predict cash flow issues before they arise.
Confidence comes from knowing that your development partner has the right intentions and capabilities and from having effective asset management and technology in place. With proactive asset management, issues can be addressed before they become problems, and this approach builds the confidence you need, supported by good technology, active management, and reliable partners.
How is the AIF offered by Altern Capital different from the existing one and what are the reasons for the specific thesis?
Every Alternative Investment Fund (AIF) has its strategy and will do well based on its plans. What sets my AIF apart is primarily the product we offer. Most domestic real estate AIFs are based in Mumbai, with some in Delhi, and they have a good grasp of vertical development and commercial yields. With my 20 years of experience in real estate investment, I spent the last 10 years in Bangalore, where we did around 15,000 crore of business. This experience introduced me to a new asset class called residential plotted development. We invested about 2,500 crore in this sector and saw good returns, which led me to focus on this niche.
We are among the first few to create a fund focused exclusively on plotted development. Our fund is different from most, which usually have a fund life of six to eight years. We have designed ours to last just four years. The goal of this first fund is to demonstrate that AIFs in India can be viable and return money to investors. To achieve this, we chose an asset class with low approval and execution risks, allowing us to complete projects within 9 to 15 months. Completed assets sell well even in tough markets, making this approach effective.
With our fund, investors can expect to start receiving returns (by way of interest) from first or second quarter from deployment with target exit with expected returns within three to three and a half years. In contrast, other funds might only start returning money after three to three and a half years. This provides clear visibility and quicker returns compared to other funds, making it a major differentiator
Why do you think plotted developments are better investment opportunities?
Investing in plotted development has been a popular choice for a long time. For example, DLF, one of India’s largest developers, started as “Delhi Land Federation” and was known for dealing in plots. In South India, land and gold are traditional investments because land is valuable and its price increases as the population grows and the demand for real estate rises.
The value of an apartment often increases because the underlying land appreciates. However, buying a plot in an established location in any city could be a good investment. A 1200-square-foot plot in Bangalore may cost around 36 to 42 lakh rupees, and you can get a home loan for most of this amount. With a little help, you can manage the down payment and repay the loan within three to four years. Over time, the plot can appreciate and become a valuable property.
On the other hand, buying an apartment today is more expensive. A 1000 to 1200 square feet apartment could cost 70 to 80 lakh rupees. With a 25% down payment, you would need to invest around 20-25 lakh rupees, which is more stretched compared to buying land. Additionally, the EMI on a larger loan for an apartment can be higher, and you’ll also have to pay significant property taxes and maintenance charges.
The cost of plots on the outskirts of growing cities like Bangalore is increasing due to urbanization and rapid population growth. Buying smaller plots on these fringes could be an attractive option for investors, offering significant potential for appreciation.
Why not launch your maiden fund across Pan India?
Our current focus is on the local real estate market in Bangalore and South India. We have a small fund of 250-350 crores, which fits well in this region. The demand for real estate in Bangalore, Mysore, and Chennai is strong, so there’s no immediate need to take on additional risk by expanding Pan India. We have a good understanding of the local developers, market behaviour, and socio-economic culture, which allows us to handle any challenges effectively.
At present, we believe that there are plenty of opportunities within our current focus and prefer not to spread our investments to other cities or tier two and tier three locations. It’s important to us not to experiment with investors’ money in less familiar markets.