Indian realty valuations to take a hit

Private equity firms could exit up to 130 real estate projects in India during 2012, but perhaps not at the multiples originally envisaged. Valuations are expected to suffer as investors on the fundraising trail rush to generate returns for their existing vehicles.

Part of the reason for the boom in exits is that many residential projects - which currently represent around half of all PE investments in the sector in India - are scheduled to complete over the coming 12 months. Furthermore, private equity firms are likely to sell off shareholdings in commercial projects, due to the imminent culmination of 2005 vintage funds.

Shobhit Agarwal, managing director of property consultancy Jones Lang LaSalle's capital markets division, estimates that exits in 2012 could reach $3-5 billion, more than the cumulative historical total for India. Such a massive influx of supply would inevitably bring down average asking prices.

"The last 10 years counted 80 exits worth $3 billion, including some very large transactions," says Agarwal. "This time $3 billion would mean close to 120-130 exits, generating less than $100 million per exit in many cases."

The returns achieved will also be impacted, although not so much because of the lower valuations as the lengthy timeframes of many investments, some of which date back as far as 2004. "The multiples are probably not as affected but the IRRs definitely are because of the extended timeframe," points out Archana Hingorani, CEO of IL&FS Investment Managers, whose firm completed partial exits from five of its Indian real estate investments in the fourth quarter of 2011.

Hingorani believes most managers will reap IRRs of less than 20%, and agrees with Agarwal that money multiples will reach a modest 1.8-2x.

Generating returns

How though will PE firms seek to generate these multiples? In the commercial sector, promoter buybacks are expected to be the favored exit route, as in the case of Kotak Realty Fund's sale of its 35% stake in a Noida-based information technology park in early January. In selling to real estate developer 3C, from which it bought the shareholding for $12.3 million in 2007, Kotak reaped an IRR of less than 30%.

Blackstone transacted a buyback exit the same month, offloading a 49% stake in a Crest office building in Gurgaon to developer BPTP for INR1.8 billion. The asset, previously owned by Merrill Lynch, was originally acquired from BPTP for INR1 billion in 2007.

These buybacks are being facilitated by non-banking finance companies (NBFCs). Having clocked on to the PE firms' eagerness to demonstrate returns and cash-strapped developers eagerness to buy, NBFCs offer the debt required to complete deals.

"If you look at the money that's there for Indian real estate right now, it's almost negligible," explains Jones Lang LaSalle's Agarwal. "Most of the real estate funds were for the 2006-07 vintage, and almost all of them have exhausted their capital or their investment period. They all have to go and do fundraising."

However, the only PE firm to have successfully closed a fund during the current vintage is Red Fort Capital, which raised $500 million for its second real estate vehicle, suggesting that the NBFCs could be progressively active over the next 12 months, plugging the gap between exiting investors and the wave of new cash expected to arrive in 2013.

In the residential arena, meanwhile, self-liquidation stands to be the most common way out for private equity firms going forward. The solution is a simple one: A project generating sufficient cashflow returns invested capital plus returns to the PE fund, as the customer pays for the asset once the project is completed. There is no need for a buyback or third-party sale. Although self-liquidation represents just 21% of real estate exits so far, it accounts for nearly half of exits in the residential segment. Many GPs have already started shifting their investment strategies to favor deals in this sphere.

Demand-side drivers

Demand for housing remains buoyant in India, which is why Jones Lang LaSalle predicts the proportion of residential investments will increase from 50% to 70% over the coming years. However, in order for investment to continue, sufficient returns will need to be generated to satisfy the LPs which put their faith in asset class circa 2005.

If taken in isolation, sub-20% IRRs appear muted at best, but these returns must be considered in the correct context. Globally, distributions by real estate PE funds of 2006-2007 vintage have been around 4.5% of the capital called - compared to 23% in India - which suggests that any returns generated locally will be viewed as positive, particularly as so many deals were transacted by first-time funds.

IL&FS' Hingorani maintains a positive stance: "Since there haven't been many exits, any form of exit you can show from the Indian market is good thing. Once you show cashflow and some level of returns from first-time funds, and better visibility on time periods for second funds, it should generate more interest in the market."

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• Topics
• South Asia
• Real estate
• Real estate
• Real estate
• Exits
• India
• Real estate
• Exit
• IL&FS Investment Managers
• Trade sale