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Private equit Investments soar 75% in realty, mutual funds shun sector on rising interest rates

Anuradha Himatsingka & Ravi Teja Sharma, New Delhi, The Economic Times

January 12, 2012

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Private equity investments in India's real estate projects have grown more than 75% over the past year, even as mutual funds and other investors have shunned this sector because of rising interest rates and falling revenues.

Analysts say developers approach private equity players and are more amenable to negotiations during such downturns. That explains why investments in real estate projects by various private equity funds have soared, rising to $1,656 million in 2011, from $944.7 in the previous year, according to accountancy and advisory firm Grant Thornton, while mutual funds reduced their exposure to the sector drastically during this period.

Total investments by mutual funds in real estate stocks declined 63.6% to Rs691.55 crore at the end of September 2011, from Rs1,900.83 crore, according to Delhi-based investment research firm Value Research.

Foreign institutional investors have also reduced their shareholding substantially in real estate firms during this period. At the same time, the private equity arms of HDFC Bank and Kotak Mahindra Bank, among others, have found value in investing in projects of real estate developers.

Analysts say such investments entail much lower risk than investments in stocks. "Project-level investment entails only projectlevel risk while the risk taken by an equities investor is much higher because the company has taken risk in multiple projects," says Harish HV, partner, corporate finance at Grant Thornton.

Much of the private equity money in 2011 came from domestic private equity funds in the form of high-yield debt with fixed returns that carries lower risk, says S Sriniwasan, chief executive officer of Kotak Realty Fund, which achieved an IRR of 32% on $240 million worth of exits that it has made from real estate projects.

The option of carrying out structured equity transactions, after the recent clarity on guidelines from the Department of Industrial Policy and Promotion, has also spurred private equity investments. Most recent deals have been structured transactions with preferred returns built in, which reduce risk.

"HDFC Property Ventures has been investing in more structured instruments and only a small amount as equity kicker," says KG Krishnamurthy, chief executive officer and managing director of HDFC Property Ventures. Kotak Realty Fund and many other private equity players are now busy raising both domestic and foreign money to invest in real estate projects across the country.

A fund, of course, has a lot more control on the project than an equity investor does. "If something goes wrong, the fund still has the opportunity to try and help the developer to fix it. What can an equity investor do?" asks Anckur Srivasttava, chairman of property advisory firm GenReal Property Advisers.

Reliance Mutual Fund reduced its investment in real estate stocks to Rs233.96 crore at the end of September 2009, from Rs680.96 crore a year ago. SBI Mutual Fund scaled down its exposure even more drastically, to Rs18.03 crore, from Rs190.56 crore during this period.

"Mutual funds have to take an aggregate call on the overall project portfolio of a listed real estate company and on the whole there is very less visibility on future profits," says Krishna Sanghvi, head of equities at Kotak Mahindra Mutual Fund.

The company has reduced its exposure to Rs5.89 crore at the end of September 2011, from Rs 169.35 crore a year ago. "We have been wary of the real estate sector and have avoided exposure in view of the highlyleveraged balance sheets and limited earnings visibility," says Sivasubramanian KN, chief investment officer of Franklin Equity-India of Franklin Templeton Investments.

The fund scaled down its exposure to Rs6.32 crore by September-end 2011, from Rs25.46 crore a year ago. Real estate stocks have been hammered also because of the rise in the cost of debt, which has gone up to 15-16%, from about 12%.

In the past year, labour cost has jumped 40-60%, while inputs such as steel and cement have become costlier by about 50% over the past three-six months. Analysts say real estate companies cannot declare quarterly results the way a technology or cement company can.

"Projects have a longer gestation period but the stock market wants to see quick results," says Anurag Mathur, managing director of property consultancy Cushman & Wakefield in India. Besides, there are too many factors beyond control, such as regulatory approvals and policy changes.

The involvement of several real estate firms in scams and legal cases hasn't helped the sector either. "Real estate stocks are untouchable for many investors today. Promoters are not trustworthy. There is lack of transparency. Their numbers are discredited," says Dhirendra Kumar, chief executive officer at Value Research.

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