Indian Real Estate Sector

A Perspective
March 2010
 Contents

 Indian Real Estate – The Story So Far...

 Asset Classes – Trends & Opportunities

pp

 Key Concepts

 Exchange Control Restrictions

 Transaction Parameters

 Indian tax laws

Indian Real Estate
...The Story For Far
 Indian Real Estate – The Story So Far…
 Traditionally;
- has been un-organized, non-transparent and run as family business
- financing options were restricted to construction finance and private debt
f
from local
l l HNIs
HNI

 Sector Opened up in 2005 for Foreign Direct Investment (FDI), triggering:

- transparency
p y and institutionalization
- News avenues of Capital Raise - Overseas and Domestic Private Equity,
Overseas Developers, Mezz Funds, Public Markets (domestic and
overseas) and Construction Debt

 FDI till December 2009 - $7.8 billion

 Private Equity Deals in 1H09 - $ 355.20 million ($ 2.3 billion in 1H08)

 Qualified Institutional Placements - $ 2.6 billion (another $2.4 billion in the pipe
line)

 As on March 09 , Credit to Real Estate Sector by Indian banks stood at $ 19.7

billion
 …Indian Real Estate – The Story So Far

 Size of Indian Real Estate market is currently USD 48 bn

The sector contributed ~ 5% to the country’s GDP

 As of Sept 09, Investment Grade Real Estate in India is valued at $ 768.23

billion – 63% of India’s total equity market capitalisation during 3Q09. CAGR of
27% from 2007 - 2008

 Second largest employer, only after agriculture

 Regulations for Domestic Real Estate Mutual Funds and REITs introduced

 Key Asset Classes

 Residential
 Commercial
 Retail
 Hospitality
 …Indian Real Estate – The Story So Far

Challenges Issues
Title • High percentage of lands do not have clear titles
• Complex and numerous land regulations make title clearance
more difficult
• Land transaction have high component of off balance sheet
consideration making it difficult to capture the correct cost in the
financials

Legislations • Has numerous legislations governing the sector

• Tenancy laws are archaic in most of the States and favor tenants

Lack of Corporatization • Land are typically held in individual hands

• Largely family run business

T
Transaction
ti Cost
C t • High
Hi h stamp
t d
duties
ti on reall estate
t t ttransactions
ti

Liquidity • RBI has negative view to real estate financing ; has stringent
conditions for bank finance to the sector
• External debt permitted only in integrated townships
• Capital restricted to high cost private equity and mezz finance

Miscellaneous • Accounting of revenues in real estate projects

• Exits options
• Lack of institutional market for sale of incoming yielding assets
Asset
sset C
Classes
asses
- Trends & Opportunity
 Asset Classes – Trends and Opportunity

Asset Class Comments

• Has huge demand for housing due to demographic profile of India
- 300 million middle class, high earning high spending population
- 23 million urban families do not own homes (aspire for one)
- Average age of Indian home buyer is 28 years down 10 years since the last
decade
Residential • Affordable housing is the next big thing; estimated to be worth $110 billion by 2013
- could be almost 80% of India’s total housing demand.
- Indian Planning Commission estimated 80 to 90 million units for lower income
group
- incentives for lower budget houses are being implemented

• Prices have stabilized in major cities. Some cities like Mumbai are seeing price over
the 2008 levels.
• Has taken a sever beating since the Credit Crisis
• Total absorption in major cities stood at 26.3 million sq ft in 2009 as compared to
37 million
illi sq ft in
i 2008.
2008 The
Th supply l was approx 5151.8
8 million
illi sq ft 2009
Commercial • 60% of the space is accounted for by IT/ ITES Companies
• Most micro markets in India have seen a correction of 15%-20% of rentals in 2009
over last year. However, rentals have started stabilizing
• Exit yield continue to be in the range of 11% to 13% range
• Demand for office space likely to increase in the second half of 2010
2010.
 Asset Classes – Trends and Opportunity
Asset Class Comments
• There are about 120 malls totaling 3.9 million sq ft as on March 2009.
• Presently the country is seeing a state of oversupply; due to retailers cutting back on
their expansion plans due to the Credit Crisis, with keyy retailers renegotiating
g g rents
• However, there is still latent demand
Retail - Indian retail 5th largest retail destination in the world.
- Overall retail sector is expected to rise to $ 813 billion by 2013 & $ 1.3 trillion by
2018. Organized retail only forms 5% of the total retail sector and is expected to
witness a maximum number of large retail formal malls in South India, followed by
N th , W
North Westt and d East.
E t ( Source
S : AT Kearney
K Research)
R h)
• According to a research by RNCOS number of shopping malls is expected to
increase at CAGR of 18.9 % from 2007 to 2015.
• However, liquidity/ construction finance is a biggest challenge for mall developments,
as banks are reluctant to lend to this asset class.

• Indian is world ‘s 5th most popular tourist destination. Occupancy rates of hotels in
India are among the highest in the world. However, since the credit crisis the hotel
have been seeing low occupancy. Signs of stability and recovery are visible in large
metros
Hotels • ARR for Delhi and Mumbai are comparable to that of global cities of New
New-York,
York
Singapore, and Hong Kong
• Between 24000-25000 new upscale hotel rooms are expected in major Indian cities
by 2011, as compared to 18000 in mid-scale and budget segment
• Total stock of hotel rooms are likely to continue to lag behind demand by 2011.
• Debt financing g to hotel is no longer
g classified as commercial asset funding,
g, and
hence cost of borrowing is significantly come down.
• Tax incentives have been announced for 2 Star Category and above Hotels
Key Indian Concepts
 Residential- Key Indian Concepts
 Land is either acquired by the developer on ownership basis or joint
development agreement (JDAs); wherein there is either revenue share or built-up
share with the landowner – JDAs are becoming more popular and prevalent

 Apartment are general sold to end-users/ investors. The concept of residential

rentals buildings does not exist.

 Sales are largely

g y pre-sales.
p No specific
p guidelines
g that pre-sales
p deposits
p should
be used for construction only

 Apart from base price, generally a separate price is charged for parking and
amenities space - Collections are either time period based or construction linked

 Generally, apartments sold on salable area basis – i.e. Carpet plus loading (for
common area) – Loading can range from 25% to 40%

 The transaction between the buyers and the developers largely governed by the
State level Flat Apartment Ownership Acts (most of the Indian States have it)
 Commercial lease – Key Indian Concepts

 IT/ ITES are the largest drivers of commercial lease

 Typical leases are not triple net – property taxes, and insurance is on the
l d
landowner – Though
Th h th
there iis iincreasing
i visibility
i ibilit off lessor
l pushing
hi for
f any
increase in property taxes to be borne by the lessee

 Typical the lease agreements are either leave and licence/ lease deed, with a
minimum lock in period

 Long leases are rare – typical lease period 6, 9 and 15 years, with a minimum 3 to
5 year lock-in

 Rent escalation are typically 15%/ 12% every three years, with 3 to 6 months
security deposit. A separate fee is charged for common area maintenance

 The lessor typically holds on to the lease agreement and do lease discounting
from a cash flow perspective,
perspective however recent liquidity has forced lessors to sell
properties to investors at a pre-determined yield

 Lack of institutional market for sale of leased properties

 Retail – Key Indian Concepts

 Mall are still concentrated in metros and tier – II cities

 A retail space from even 200,000

200 000 sq ft to 500,000
500 000 sq ft is considered as
a Mall in India

 Typical lease structures:

 Minimum Guarantee and/ or Revenue Share (% of sales of the retailer)

 Increasingly the anchor tenants are pushing for fit-outs to be done by the
developer
 Increasing trend of Anchor tenants requesting for long tenure lease – 15 to
20 years, against the conventional 9 years.
 Property tax and insurance is to the landlord

 Lack of visibility of Mall exits by developers

Exchange Control
Restrictions
 Real Estate — FDI guidelines: Press Note 2 (2005)

Investment-related guidelines

Foreign • Minimum foreign investment in Wholly Owned

investor Subsidiary (WOS)—USD 10 million; for a joint venture
(JV) with an Indian partner—USD 5 million
• Funds to be brought into India within 6 months
• Lock in period of 3 years from completion of minimum
capitalization. Early exit possible with prior government
Indian JV Indian approval
partner company
(Optional) (JV / WOS) Project-related
j guidelines
g
• Minimum area requirements: 10 hectares for serviced
housing plots and 50,000 sq. meters for construction
development projects
Project
oject • 50 percent of project to be developed within 5 years from
date of obtaining all statutory clearances

Press Note 2 (2005) does not apply to

• Investor cannot sell undeveloped plots or TDRs
Industrial Parks (including Information • Project to conform to norms and standards laid down by
Technolog (IT) parks),
Technology parks) Hospitals
Hospitals, respective state authorities
Hotels, and Special Economic Zones
(SEZs)
 Asset class - FDI framework (Non NRIs)

mpt from PN2

% Automatic

Falls under PN 2
Exem

Direct ownership of Real

100%

Estate
not permitted. Investment
possible
only in shares and
In
nvestment in G

SEZs convertible instruments

of the Company owning / Offices

Investment in Greenfield projects

developing
Real Estate
Hotels &
Greenfield pro

Hospitals Malls
assets

Service Foreign Currency debt

Residential
ojects and exis

Apts. itt d only

permitted l for
f
integrated townships

Industrial
Townships
p
P k
Parks
sting
 Real Estate FDI Guidelines – Non Resident Indians

 NRI / PIO are permitted to directly acquire immovable properties in India – No

restriction of the number of properties that can be acquired – Acquisition of
agricultural land not permitted

 Property can be rented, and rent can be remitted overseas net of taxes

 The property so acquired can be mortgaged to Indian banks

 NRI/ PIO can sell his immovable property to an NRI/ PIO or Person resident in
India
 If property is acquired out of foreign exchange, amount that can be repatriated back
cannot exceed the original investment, and maximum restricted to two residential
properties; capital gains if any need to be credited to NRO account from where
repatriation up to $ 1 million is permitted per financial year
 If property acquired through rupee source, the proceeds need to be credited to NRO
account,, where remittance up p to $ 1 million is permitted
p every
y financial year
y

 NRIs direct equity investment in Indian real estate company does not attract
restrictions imposed under Press Note 2
Transaction
a sact o
Parameters
 Key Transaction Parameters
 Deal Structuring
 Commercials
 Structuring
 Partner diligence
 Transaction tax

 Type of instruments
 Equity/
q y Preference shares/ Convertibles
 FDI issues
 Tax optimization

 Exit Options
 Sale of shares / Assets
 ROFR/ ROFO/ Put Option
 Mechanics of profits distribution
 Overseas taxes
 Lack of developed capital markets

 Corporate Governance
 Board representation
 Affirmative Votes
 General day-to-day governance structure
 Exit Mechanisms and Strategies
Exit Options

Enterprise Level Asset Sale SPV Level

Exit through
transfer of
Exit through Exit through an SPV shares
stake sale to domestic Initial Public to domestic
Investor / JV Partner Offer listing Investor / JV Partner

Exit through
Sale to a Exit through
Strategic Investor Sale to a REMF / REIT *

* Exit through Real Estate Mutual Fund (Amendment) Regulations,

Regulations 2008
Draft Real Estate Investment Trust Regulations issued – Pending implementation
Indian Tax laws
 Indian Taxes – Indian Tax Year 2009-2010

Rate %
Corporate Income Tax
Income Tax 33.99%/30.90%
Direct
L
Long Term
T Capital
C it l Gains
G i tax
t 22 66%/20 60%
22.66%/20.60%
Taxes
Short term capital gain tax 33.99%/ 20.60%
Minimum Alternate Tax (MAT) 16.99%/ 15.45%
Dividend Distribution Tax (DDT) 16.99%

Central Government General Rate

Customs duty Imports 24.42%
Indirect CENVAT/Excise Manufacturing 8.24%
T
Taxes
Central Sales Tax Inter-state sale 2% / 12.50%
Service Tax Notified services 10.30%
R & D Cess Import of technology 5.00%

St t G
State Governmentt
State-VAT* Intra-state sale 1%
Entry Tax Goods entering state 0% - 12.50%
Local Municipality
y
Octroi Goods entering municipal limits 0% - 12.50%

Note: Lower rate applies where total income is less than or equal to INR 10 million
* Sales tax is also applicable on lease transactions
22
 Indian Taxes – Indian Tax Year 2010 -11 (Proposed)

Rate %
Corporate Income Tax
Income Tax 33.21%30.90%
Direct Long Term Capital Gains tax 22 14%/ 20
22.14%/ 20.60%
60%
Taxes
Short term capital gain tax 33.21%/ 20.90%
Minimum Alternate Tax (MAT) 19.93%/ 18.54%
Dividend Distribution Tax (DDT) 16.61%

Central Government General Rate

Customs duty Imports 24.42%
Indirect CENVAT/Excise Manufacturing 10%
T
Taxes
Central Sales Tax Inter-state sale 2% / 12.50%
Service Tax Notified services 10.30%
R & D Cess Import of technology 5.00%

St t G
State Governmentt
State-VAT* Intra-state sale 1%
Entry Tax Goods entering state 0% - 12.50%
Local Municipality
Octroi Goods entering municipal limits 0% - 12.50%

Note: Lower rate applies where total income is less than or equal to INR 10 million
* Sales tax is also applicable on lease transactions
23
 Key Tax Incentives

 Tax incentives available for development of housing project on less than 1 acre
land, subject to fulfillment of prescribed conditions

 SEZ Developers are entitled to Tax incentives subject to fulfillment of prescribed

conditions

 Developer of Industrial Parks are entitled to Tax incentives subject to fulfillment

of prescribed conditions

 2 Star and above Hotels set-up after 1st April 2010 entitled to 100% deduction of
Capital Expenditure incurred on hotel (excluding land and goodwill cost), subject
to fulfillment of prescribed conditions.
 Tax Triggers

 Sale of Apartments to Buyers  Acquisition of land/ property

 Stamp duty
 Stamp duty
 VAT  Engaging of Contractors
 Service Tax
 VAT
 Income tax
 Service Tax

 Lease of property  Procurement of Construction

Material
 Stamp duty
 Central excise
 Service tax  Customs duty in case of
 Income-tax imported material
 VAT
 Sale of shares of SPV  Octroi

 Stamp duty
 Income-tax
For Further Information Please Contact

Mustafa Hussain
Director
Urban Link Consulting Ltd
mustafa@ulc.co.in

Visit us at www.ulc.co.in