The real estate sector is very capital-intensive and developers have to manage large cash flow mismatches. The long development cycle — starting from acquiring land, planning, getting approvals to start construction to final sale and hand-over — takes three to five years or more, based on the locality.
The cash-strapped developers, who are typically saddled with a large debt burden, are usually on the look-out for new funding sources.
FUND SOURCES
The cheapest source of funds is from banks and institutions such as HDFC and ICICI which offer construction financing at around 15 per cent. NBFC funding ranges anywhere between 18 and 21 per cent, according to Shreekant P Shastry, VP, Strategy and Business Development, Ozone Group. Developers also take private funding with an average interest rate of around 24 per cent.
NEED FOR PE
While the bank rates are lower, they only lend at the construction stage, after all the approvals are obtained.
However, there is a delay of one to two years between purchasing land and getting all the approvals necessary to start building.
This is where PE funds come in, to take care of initial cost of project development, says Bharat Dhuppar, CMO, Omkar Realtors and Developers.
The typical time it takes to close a deal is around three to six months and the typical cost is around 20 per cent. PE funds have lately been expecting 18 to 21 per cent internal rate of return (IRR) and most are in the form of structured debt.
Funds also offer debt funding for project completion to builders in distress. These have a return expectation of 25 to 30 per cent, depending on the risk perceived.
OTHER BENEFITS
The PE funding may also help the builders in other ways. “They bring a sense of financial discipline which is useful,” says Ravindra Pai, MD, Century Real Estate, which raised close to Rs 450 crore equity and Rs 380 crore debt finance from PE funds in the last three years.
Buyers too are comforted to know that the project they are buying is funded by a PE firm, although many do not typically ask about the sources of funding.
Funds provide credibility due to their in-depth due diligence process prior to investment. “PE partnership developments, bring in transparency in terms of licenses, marketability of titles, legal compliance norms, strict adherence to the local, municipal rules, and that in turn, ensures timely completion of the project,” says Shrinivas Rao, CEO-Asia Pacific, Vestian Global.
Some of the PE funds have access to buyers from additional geographies or target group that the builder does not have access to. For instance, Ozone group, which has received entity level and SPV level investments from UIREF (Urban Infrastructure Real Estate fund) and HIREF (HDFC fund) stated that funds provided leads for corporate sales.
“We have been also active in providing management support where needed to improve governance and disclosure levels as well as project monitoring and reporting standards,” says Nitin Goel, Partner, Real Estate Investments at Milestone Capital.
For the PE fund, successful real estate projects generally provide over 20 per cent IRR over a 5-to-7 year period. To achieve this, PE funds and developers work together right from project inception till final exit.
