Emaar-MGF's Gupta: The joint venture has placed the biggest realty bet in the form of the largest FDI in the country

Globally, capital for real estate has never been as plentiful as it has been in the last year or so. Real estate firms are raising record amounts from institutional investors such as pension funds that are seeking higher returns than stocks and bonds. And the party is likely to continue. According to a study by PricewaterhouseCoopers, the fund flow is likely to strengthen in 2007.

But it is not just an India-specific phenomenon. Funds have been flowing into the Asia-Pacific region in the property sector by the planeloads. Some of the factors dictating these fund flows are purely global dynamics-the high realty prices in the US and Europe and correspondingly lower yields. Moreover, as all asset class prices have risen, international property funds over the last few years have found it useful to increase the real estate weightage in their portfolios.

In India specifically, the investment market received quite a fillip in early 2005 when the rules for foreign investment in Indian real estate were partly relaxed. There are significant clamps though that make speculation on land difficult. Foreign funds cannot invest directly in land and neither can they invest in existing properties. But market fundamentals make Indian real estate hot property for many cross-border investors and developers (see It's Raining Funds).

Though the number of actual deals may be fewer, the results have been immediately apparent. Foreign direct investment in the sector increased from 2.7 per cent of the total FDI flowing into the country in 2003-04 to 16 per cent in 2005-06. It is expected to rise to a quarter of the total flows in current year, according to assocham. "There is a lot of money waiting to be invested in the Indian market. Last when I spoke to overseas investors, this amount was pegged at $15 billion," says Ravi Ramu, Director, Puravankara Projects.

These fund flows come at an opportune time for the Indian developers. Rising interest rates coupled with RBI restrictions on funding land acquisition are creating a huge demand for raising funds through equity route (see Turning Dust to Gold on page 168). This is likely to continue. As India's economic growth sustains at over 8 per cent, the growth plans of the Indian developers are also becoming bigger. "Banks are insisting on lower debt-equity ratio while funding projects, and that will also create need for raising capital through the equity route," says Harsh Neotia, Managing Director, Ambuja Realty.

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In line with the Asia Pacific trends, most of the funds aimed at Indian real estate are coming from both multinational developers and financial institutions or venture capitalists. Pure play financial investors (largely us and European) are investing as strategic investors in projects or companies via private equity or real estate funds. Consider Morgan Stanley, which invested $68 million in Bangalore-based Mantri Developers and another $65 million in Delhi-based Alpha G:Corp Development. Multinational developers (largely from South East and Central Asia), on the other hand, are finding it convenient to invest through joint ventures or joint development agreements with Indian developers. For instance, there is Singapore Realty, a JV between Singapore-based Lee Kim Tah Enterprises and an Indian partner, BP Ventures. Occasionally there are investors such as Vancouver-based Royal Raj International Corp., which is said to be mulling a massive township in Bangalore at a cost of $8.9 billion, as a wholly-owned subsidiary.

Giving the foreign funds stiff competition are local players. "They can offer heavyweight competition to foreign funds in any number of ways: their experience in getting deals done in cultures that are quite alien to the newly-arrived westerners, their ability to assess and defray risk in their own markets, their political and commercial connections..." says the PwC report. For these reasons, perhaps, foreign investors are much more comfortable sharing risks with Indian partners, according to E&Y's Ganesh Raj. Availability of land, viable pricing, and clarity of land title are some of the key constraints for foreign funds. And these are areas where local funds have an edge. "Partner selection is very important in an emerging market like India, since we like to do projects in multiple locations with the same developer," says Rak Chugh of Trikona Capital

However, this abundance of riches has made deals difficult, especially in prime locations. "Quite often there may be a valuation mismatch, with the present valuations not matching the kind of returns that foreign funds are seeking," says Vivek Mehra, Executive Director, PwC. Although, as ICICI Ventures' Kishore Gotety assures, "The deals that we are able to pursue, we are able to close despite competition. In another two-three years, the market will become more sensible."

Given the attractiveness of the sector, both foreign and domestic investors are looking at project internal rate of returns (IRRs) between 20 and 30 per cent. Are they being ambitious? "Not at all," assures Kurt Roeloffs, Head, RREEF Asia Pacific-the real estate arm of Deutsche Bank. "Escalating land prices do mean that future speculation is more risky. We hope some of the hot money will recognise that and step away from the market. Nevertheless, we think the current prices permit acceptable return on equity for those participants who have good execution skills." Shishir Baijal of Kshitij Investment Advisory Co., which is targeting 30 per cent-plus IRRs, also believes that the returns "look quite achievable at this point".

While money is surely a reason why Indian builders are shaking hands with foreign investors, it is not the only thing. As PwC's Mehra points out, the foreign funds also bring development experience to the table. That may well be one of the most critical assets in the next few years as India gets built up.