Financing Options in Real Estate in India

An Overview

Structure of presentation

Users of Capital and Needs

Sources and Providers of Capital

Financing Instruments – A Snapshot

Definitions

Sources

Features

Financing Instruments

Title Insurance

Regulatory Trends

Users of Capital and Needs

Financing for acquisition, refurbishmentsEnd User

Asset Acquisition, Asset Management, RefurbishmentsAsset Owner

Direct Financing, RefinancingFinancer

Land acquisition, Development/ ConstructionBridge financingDeveloper

NeedsParticipants

Generic Needs

Seed funding to initiate project/ acquisition Working Capital Requirements Realization of future cash flows at current date Lowering the cost of capital Tax Efficiency

Sources and Providers of Capital

Public Offerings , REIT/ REMF, AIM, Pension Funds, Insurance Fund

Public equity

Real Estate Funds, VCF, FII, HNI, End Users (through advances)Private equity

Banks, FI, NBFCs, REIT/REMF, Government bodiesPublic debt

Private trusts, Private syndicates, HNIsPrivate debt

ProvidersSources

Sources and Providers of Capital

Financing Instruments – A Snapshot

Financing Instruments – A Snapshot

Bonds, Term loans, CC limits, Bridge Loans, ECB, Lease Rental Discounting, Asset Backed and Income Backed.

Debt

Private Equity - HNI/ Institutional, Venture Funding, Public listing, REMF/REIT, Preference instruments, End User AdvancesEquity

Mezzanine funding, CTL, convertible instruments, Mortgage Backed Security (RMBS, CMBS, CMO), option linked instruments, Asset Backed Securities, Collateralized Debt Obligation, Covered Bonds, Convertible Bonds, FCCB.

Structured Instruments

Definitions – Debt Instruments

Debt Instruments can be Income Backed or Asset Backed.

They can be fixed rate instruments of adjustable rate instruments.

Bonds : Issued by companies to raise debt for funding their capital requirements. Eg – Infrastructure bonds raised by NHAI which also have a tax exemption status. Some of this might be available to township development projects in the future.

Term Loans : Loans provided by Banks, FIs as project financing with pre determined payback schedules, rates and tenure and against collateral. The loans are usually structured on a case to case specific basis guided by sectoral exposure norms of the Reserve Bank of India.

Cash Credit Limits : This is a facility for funding interim cash requirements subject to a draw down limit. Interest is charged on the amount outstanding and the period outstanding.

Bridge Loans : Also known as "interim financing", "gap financing or a "swing loan“, this loan helps to meet short term cash flow requirements till permanent financing is secured. These are short term loans ( < 1 yr) with higher interest rate and some collateral.

External Commercial Borrowings (ECB) : The current guidelines allow for overseas borrowings for the infrastructure and construction development sector subject certain guiding conditions. This provides access to cheaper source of funds and is subject to currency risks.

Lease Rental Discounting (LRD) : Securitization of future rent receivables.

Structure – Corporate Debt Market in India

Definitions – Equity Instruments

Private Equity HNI/ Institutional : The equity raised is not from the public markets and hence not freely tradable on public exchanges

Venture Capital Fund : Type of private equity capital provided by professional, institutionally backed investors to new or growing businesses

Public listing : These could be initial public offerings or further public offerings. A company can use this route to access the public financial markets for raising capital by divesting equity subject to certain entry norms as guided by SEBI.

REIT : These raise funds from the public markets and invest either in the real estate either directly (through acquisition of properties) or indirectly (through mortgages)

REMF : Also raise funds from the public market and invest in real estate directly in RE properties, MBS, Equity shares/bonds/debentures of listed/unlisted RE companies

End User Advances : Funds received in advance from the ultimate owners of the property

Equity Issuance

Issues

RightsPublic Private Placement

Qualified Institutions Placement (For listed

companies)

Preferential Issue (For

listed companies)

Private Placement (for unlisted companies)

Initial Public Offering(For unlisted companies)

Further Public Offering(For Listed companies)

Fresh Issue Offer for sale Fresh Issue Offer for sale

Definitions – Structured Finance / Hybrid Instruments

Mezzanine funding: Typically unsecured, high yield, subordinated debt or preferred stock which is senior only to company’s shareholders.

Asset Backed Securities: These securities are backed by a pool of financial assets ranging from mortgages to accounts receivables.

Mortgage Backed Securities: Its an ABS where the asset is a pool of Mortgages eg: RMBS, CMBS, CMO

Credit Tenant Lease: Landlord sells property to an SPV and the SPV borrows money against a pledge of the rentals. The right to rentals is further divided into classes of securities each being subordinate with higher promised returns. The landlord typically buys back the first loss piece.

Second Mortgage: A mortgage on real estate which has already been pledged as collateral for an earlier mortgage. The second mortgage carries rights which are subordinate to those of the first.

Collateralized Debt Obligation: typically securitizes a diversified pool of debt assets. These assets, corporate loans for instance, are split into different classes of bonds (known as tranches) that pay investors from the cash flows they generate.

Covered Bonds: similar to ABS but the assets remain on the issuers balance sheet

Convertible Bonds: A convertible bond is type of bond that can be converted into shares of stock in the issuing company, usually at some pre-announced ratio eg: FCCB.

Option linked instruments: Instruments with embedded options like call, put, floor, ceiling, floor, collars, convertibility etc.

Financing Instruments

Past Current Future

Domestic Public Equity (REMF / REIT)

Refinancing Options

Secondary Debt Markets

Access to Overseas Public and Private Debt Markets

Hybrid capital from Banks, FIs

Pension Funds & Insurance Funds

Debt Debt

Asset and Income backed debt

Lease rental discounting

Consumer mortgage

Asset and Income backed debt Lease rental discounting Consumer mortgage ECB

Equity Equity

Individual Private Equity

Public Markets – (limited access)

Venture Funds

Institutional Private Equity – Domestic and Overseas.

Individual Private Equity

Debt Instruments - Features

Past Current Future

Other benchmark linked rates Non Recourse options

Higher Amortization periods – 20 – 30 years

Widespread sources of Debt Flexible exposure norms Bond Placements, Tax Credits

and other Municipal Finance Alternatives

Collateralized Mortgage Pools, Collateralized Debt Obligations and other Credit Derivatives

Debt Debt

PLR linked interest rates High Recourse – often to

promoters Amortization period –

Generally 5-7 years Low availability

PLR linked interest rates High Recourse – often to

promoters Amortization period – upto

10 years max Limited availability Banks more willing now but

stringent norms from RBI

Debt

Equity Instruments - Features

Instrument Features in the past

Current Features Future Possible Features

Guidelines to allow direct access to overseas Public Markets

Equity exposure by Domestic Public Equity sources- life insurance , Pension Funds.

Equity Equity

Limited mainly to High Net worth Individuals and End User Advances

Public Equity not widely available

High risk perception due to absence of institutional participation

Venture Funds both Domestic & Overseas now allowed

FDI allowed Successful Public Equity

raisings in 2006 Successful AIM, LSE

listings in 2006

Equity

Hybrid Instruments - Features

Instrument Features in the past

Current Features Future Possible Features

Senior and Junior Mezzanine Debt

Straight, Convertible and Participating Second Mortgages

Swaps, Options, Caps, Collars, Swaptions, Captions, etc

Hedging Options

Hybrid Hybrid

Mezzanine Funding being explored

Funding with Convertible options being explored

Preferred Equity Structures RMBS

Hybrid

Typical MBS Structure

Source: CMSA

Credit Tenant Lease Structure

Regulatory Trends

RBI has hiked the risk weightage of the commercial real estate exposure to 200% from 150%

Risk weightage on home loans increased to 100% from 75%

General provisioning requirement for banks on standard advances to residential housing loans beyond 20 lakhs and commercial real estate loans increased to 1% from 0.4%

Exposure to SEZ will be treated as exposure to Commercial real estate

Norms for Banks

Regulatory Trends

Two sets of Norms for NBFCs investing in Real Estate proposed for those who avail public deposits and those who dont.

Under the new norms, finance companies which accept public deposits can not invest more than 10% of their net worth in land or property, except for its own use. At the same time, investment in unquoted shares of a company that is not a subsidiary has to be limited to 10% of net worth.

Loan and investment companies are, however, allowed to invest up to 20% of their net worth in unquoted shares.

Current guidelines require asset finance companies to ensure that 60% of their loans go to lease and hire-purchase of machinery, the remaining 40% is used by finance companies to fund the real estate sector. If a finance company acquires land or property or unquoted shares in exchange of its bad loans, these assets have to be disposed off by the NBFC within three years.

Norms for NBFCs

Regulatory Trends

REMF

SEBI approved the guidelines for REMFs in June 2006

Initially REMFs will be Closed ended

Directly in RE properties within India

Will disclose NAV on a daily basis

Mortgage backed securities

Equity shares/bonds/debentures of listed/unlisted companies dealing in properties and development

Other securities

They can invest

Title Insurance

Internationally recognised means of covering the title risk in property transactions.

Protects owners and lenders against any claims against the title guarantees that the mortgage is valid, enforceable and of first priority.

A general insurance policy will usually cover the insured against a future event which may or may not occur.

A title insurance policy covers the insured for past events; that there are, for example, no mortgages registered over the land as at the date of the insurance policy.

Title Insurance

Lenders title insurance, also called a Loan Policy

Owner's title insurance.

The availability of title insurance in India will reduce the risk perception of public debt and equity institutions thereby triggering a greater availability of capital

Type of Title Insurance