American statesman Benjamin Franklin, in the best tradition of timeless aphorists, surely didn’t have private equity (PE) funds or the Indian real estate market in mind when he sagely uttered, “An investment in knowledge pays the best interest”. But he could well have been talking about them as I found out while working on this story: domestic real estate PE funds that invested with knowledge of the local property market made money; the rest are still trying to figure out what went wrong. Look at the line-up: only domestic funds such as Kotak Realty Fund, Indiareit Fund Advisors, ASK Property Investment Advisors and HDFC Property Fund have made good money. Foreign PE funds such as Tishman Speyer, JP Morgan Chase and Lehman Brothers have made very little or no money. Why did some funds then, perform better than the others?
As things played out, foreign funds lost their nerve and took a backseat by the time the real estate market started recovering from the slowdown in 2009. Domestic funds were made of sterner and smarter stuff — that same year, they invested $665 million, for the first time far exceeding the $183 million sunk by American and other overseas funds. Sanjay Dutt, managing director of real estate consultancy Cushman & Wakefield, has an explanation for this. He says that most funds that came to India were new. “Many people who committed to India at that time were opportunistic funds with a short-term view, looking to make a quick return on their investments. As one looks back now, the winners have all been local fund managers,” he adds.
Kotak Realty Fund (KRF), in particular, has been a trailblazer. The fund is one of few that have consistently managed to return money to investors. KRF, which was established in May 2005, is headed by S Sriniwasan, an ex-investment banker. Dutt says that experience has clearly helped. “Srini does not have a real estate background but his more than a decade’s experience in investment banking must have helped him identify the right opportunities.”
Aiding Srini along this very profitable journey has been V Hari Krishna, director, KRF, who has 15 years of experience in real estate, having worked at consultancy firms Jones Lang La Salle and CB Richard Ellis. Krishna says, “Our definition of a worthy investment is something that we can exit easily,” And exit it has. In the last three years, KRF has exited 15 of its 33 investments, with an average return of 27%. The fund has returned a handsome $325 million to its investors. Krishna says prudent investing has saved the fund from losing money, and goes on to add, “We never went by any fads like SEZs or townships, which ruled the market during its peak.” The fund also stayed away from secondary cities, sticking instead to the top metros.
KRF has $765 million funds under management and is now looking to raise another $200-300 million from domestic investors in what would be its fifth round of fund raising. It plans on parking the bulk of these moneys in residential projects, following a narrow investment strategy that offers easy exits. “Exits in residential projects self-liquidate when sales happen,” points out Krishna. “Commercial property is more difficult to exit. It has to be first leased and then sold to either third-party investors or buyers. Moreover, there is no REIT market in India to list the property.” A REIT (Real Estate Investment Trust) is an entity that raises money from investors to own and manage property. Its shares are traded and the bulk of its revenue comes from property rent. It helps that a good chunk of Kotak’s 28-member team has a real estate or construction sector background. “We have had the same team of experienced people for the last five or six years,” says Sriniwasan. “In a business where you have to stay married to an investment for a couple of years, continuity of management matters.”
KRF’s secret sauce, clearly, is its ability to rein in developers. “The real estate sector is an undisciplined industry,” Krishna says. “It needs people like us to bring in discipline.” Kotak has local people on the ground breathing down the necks of developers to make sure its projects are on schedule. “We keep a close eye as the focus is on getting the developer to deliver.”
Same to same
Being in sync with market realities has also helped Indiareit Fund Advisors and ASK Property Investment Advisors. Quiz the funds on the reasons for their success and their answers sound uncannily similar to KRF’s, which maintains that “it is all about finding the right partner in the right location at the right time.”
ASK is a rare fund — in March 2012, the IRR on its investment in ATS Infrastructure’s Noida project stood at an impressive 56%, and it gave a fantastic return of 2.45 times (Rs 121 crore on an investment of Rs 50 crore) in less than two-and-a-half years. This was one of the seven projects in which ASK invested from its initial fund of Rs 326 crore. It raised a second fund of Rs 1,000 crore, most of it domestically (and many of them repeat investors) in June 2012.
“You need local knowledge,” agrees Indiareit CEO Khushru Jijina, who lays the blame for the failure of other funds to the lack of it. Indiareit has regional offices in Delhi, Bengaluru and Hyderabad to have local people on the ground. “In India you have land issues, title issues…it is not easy getting money out of this country unless you understand the system well,” he adds.
More local gospel
Shobit Agarwal, managing director, Jones Lang La Salle, agrees that a deeper understanding of the local market sets apart the winners from the losers. “Domestic fund managers operating in India understand the challenges of doing business in India; they understand that chief ministers change, approvals take longer than expected and that, therefore, they need to budget for it,” says Agarwal. “Domestic funds have very robust underwriting models and the right acumen. Sriniwasan, for instance, is a very old hand. Jijina has been in business for 20 years. You can’t sell a pipe-dream to these people.”
Indiareit, too, keeps a tight leash on its partner, to make sure the invested money is used well. Not only does the fund never give cash out to its partner, it makes sure its partners have invested some amount of ‘hurt money’ in the project, so that the developer hurts, too, if something goes wrong. “If I like a project, I would still like to have some ring fencing so that money doesn’t get transferred to another project,” says Jijina. “We may even demand escrowing of cash flows from a project. We have clauses that say that if a developer doesn’t perform in a particular manner, we can take over the project.” While Indiareit has not taken over any project as of now, Jijina says the fund will not stop short of doing so if the need arises. “You will see some action happening soon,” he said. “We could take over some project.”
Arun Natarajan, founder, Venture Intelligence, a firm that tracks private equity investment in India, says the real estate private equity landscape in India is now completely dominated by domestic funds. “This has more to do with the FY09 global recession, when foreign funds went away and never came back. A few funds were asked to withdraw from private equity investment by the US regulatory authorities,” says Natarajan. “In their absence, domestic funds consolidated their position.”
Domestic funds have a clear edge now because of their rapport with developers and lessons learnt from earlier investments. But Natarajan says this could change. “Foreign funds such as Blackstone have become more aggressive, so we could see more foreign funds returning to the Indian market.” And when this does happen, it will be interesting to see whether domestic funds hold their fort. Kotak’s Sriniwasan believes his fund will continue its good run. “At various points in time there will be new opportunities and challenges. Given our skill sets, we will always be able to provide customised financing solutions. The way we run our business and our speed of decision making will give us the edge.”
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