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Will Piramal Realty prove to be lucky for Warburg Pincus and Goldman Sachs?

The PE investors' bet is a mix of proprietary insights and ambitious assumptions

Photographs by Soumik Kar

It is half past noon as the sun beats down on the promenade in the upmarket locale of Hiranandani Estate in Thane, a satellite city abutting Mumbai district. Working out of a 400-sq ft office in one of the bylanes nearby is 50-year-old Mahesh Ahuja, who sorely misses the intermittent buzzing of his phone between sporadic visits from customers, all of whom are looking for a reasonably-priced dwelling in a locality that has fast emerged as one of the most sought-after residential hotspots.

“Did you hear the phone even ring once? It’s that bad,” laments Ahuja, even as he gives a lowdown on how business has gone cold for real estate agents like him over the past year. “My business has dropped by at least 75%. It is a clear case of oversupply in Thane, with no demand,” says Ahuja, who is one of the 300 registered agents among a crop of 2,000 largely unorganised ones who have mushroomed over the past five years in Thane. 

Till last year, business was brisk for Ahuja and his ilk, as not just the Hiranandani group but a whole lot of developers — from the likes of Lodha Developers to Dosti Realty, Kalpataru, and Rustomjee — had set their sights on this part of the district to hit pay dirt by either constructing residential townships or standalone multi-storey premium towers. Soon, the number of developers with an interest in Thane shot up to over 80.

Fancy project names promising the moon to buyers started papering every single hoarding across the satellite city. But with prices hitting the roof and buyers suddenly turning away, desperation has crept in across the rank and file of developers. Niranjan Hiranandani, co-founder and managing director of Hiranandani Constructions, which holds over 200 acre in Thane and around 150 buildings, however, sounds rather optimistic. “While there may be a situation of demand being slow to take off, there is nothing to worry about. We have seen even tougher times in the business,” says Hiranandani rather dismissively.

Niranjan Hiranandani, Hiranandani ConstructionsThough Hiranandani does not buy the gloom-and-doom observation, his actions seem to suggest the contrary. After 15 years of building apartments of various sizes, with a significant presence in premium housing (3BHK and above), the group has built a 25-storeyed residential tower named Lavinia in Thane, which houses only 1BHK units.

What’s more, the standard practise of charging a premium for every floor rise of 1%, too, has been scrapped. With prices hovering around ₹12,500 per sq ft, over 30% of the flats still remain unsold, reveal agents in the area. In fact, they believe a lot of the flats have been booked by investors and not end users.

“Today, there are smaller builders in the area who have the land and the permissions but not the guts to develop the property,” says Ahuja candidly. The same scenario is playing out in different parts of Mumbai as well.

The boom in housing demand was accompanied by an unreal hike in the cost of housing. In Thane, prices increased almost four times between 2006 and 2008, by two times between 2009 and 2013 and in the past two years, developers have managed to stretch prices by around 5-7%. 

While rates have not been dropped officially, incentives and freebies are being doled out by the hour. None of that has impressed buyers, who are taking their own sweet time to decide. According to Nishant Singhal, promoter of realty services firm Investors Clinic, there is no obvious drop in headline prices but many an incentive is on offer. He cites the case of Omkar 1973, a luxury housing project in south Mumbai, where a buyer needs to pay only 20% of the total price of ₹25 crore, with the rest at the time of possession.

“Today, subvention schemes (where the developer pays interest for a fixed period instead of the borrower) are a reality. Over the past 18 months, prices in Mumbai have crashed by at least 20-25%, whether developers admit it or not,” adds Singhal. Putting things in perspective, Pankaj Kapoor, managing director, Liases Foras, a realty research firm, points out that in 2009, when 65,000 units were sold in Mumbai, the inventory was at 69,000 units.

“If inventory was at 12 months then, it is at 46 months today,” he explains. Developers, for now, are sticking to their guns and maintain that there is no question of a price reduction, though that is not always true. In the process, absorption rates, or just the number of apartments bought, have fallen.

Though a majority of developers — who have put on a brave front for several quarters — refuse to admit that anything is amiss, those like Rohit Poddar, managing director, Poddar Developers, a company in the affordable housing segment with projects at locations such as Badlapur and Kalyan, are willing to delve into a discussion on the extent of the crisis.

“We are extremely worried about low absorption rates, that too at a time when prices of cement, steel and oil have dropped significantly. There is a lot of stress in the system and the boom that everyone spoke of has just not happened,” he tells Outlook Business. A report put out as recently as July by brokerage firm Ambit Capital predicts a 50% drop in Mumbai’s real estate prices. 

Against such a backdrop, Piramal Realty, owned by pharma bigwig Ajay Piramal and thus far synonymous with its commercial property in central Mumbai and a commercial JV in Kurla, is making grand plans of entering the already overcrowded residential housing market. On 34 acre in Thane, where the group had a drug manufacturing unit, the company is launching a residential project featuring high-rise townhouses.

Besides Thane, it has plans to expand into Mulund and Byculla as well. Prod Ahuja on what the entry of a biggie such as Piramal, in addition to the big boys who are already around, in the market will mean — he sounds indifferent. “Builders have to get it right on pricing today. That looks really difficult as buyers are not willing to pay high rates,” he says.

But what makes Piramal’s foray interesting is that it has the two biggest names in the private equity business, Warburg Pincus and Goldman Sachs, backing its venture. The US-based funds have chosen to invest a substantial ₹2,700 crore in the unlisted Piramal Realty. For marquee PE investors, this could well be the acid test, as a lot of high-profile names have yet to make a killing in India’s much-trumpeted real estate story.

Familiar terrain

It was in September 1997 that, in a significant deal for the time and one that marked the entry of Warburg Pincus in India, the PE fund invested $36 million in Nicholas Piramal. At that point, Nicholas, as the entity was known then, was a ₹525-crore entity and it had been less than a decade since the Piramal Group acquired it from its UK parent. When Pincus sold its 9.9% holding in Nicholas Piramal in 2007, the company was renamed Piramal Healthcare, the investment giving it a return of 3X and forming a critical part of its exit story, which was already looking very enviable.

Almost eighteen years later, Warburg Pincus has now picked up a significant minority stake (said to be 26%) in the unlisted Piramal Realty, the real estate arm of Piramal Enterprises, for $284 million (₹1,805 crore), valuing the company at around ₹7,000 crore. It is an entity that had a modest revenue of ₹81 crore in FY14, with a net worth of ₹416 crore, according to the annual report filed with the Registrar of Companies. 

Following the transaction, Piramal Realty said it has over 10 million sq ft under development across Mumbai and that money would be raised to expand its portfolio and acquire marquee land parcels in and around the city. In that sense, the deal has confounded industry trackers, who think a revival is a long way from now.

For Warburg Pincus, this is the first big-ticket investment in India’s real estate story after having missed out on at least three large transactions over the past decade. Similarly, after a not-so-eventful debut in the real estate space, global investment bank Goldman Sachs, too, invested $150 million (₹900 crore) in Piramal Realty, just days after the deal with Warburg Pincus was announced in early August. Obviously, Warburg Pincus remains smitten about the sector, while Goldman Sachs is desperately looking to make some money, although many a question remains unanswered. Much of that revolves around Piramal’s portfolio, which is completely Mumbai-centric and is yet to take a concrete shape.

If the grapevine is to be believed, the entire transaction with Warburg Pincus was pretty much struck between Charles Kaye, the fund’s co-CEO and Ajay Piramal, chairman, Piramal Enterprises. However, Anand Piramal, executive director, Piramal Group, and also in charge of its real estate business, maintains that Warburg Pincus came to the Piramals through veteran banker and HDFC chairman Deepak Parekh, who is also on the board of the company.

“Warburg Pincus was keen that we build the company together and that was really the logic of investing at the entity level,” he says. A senior private equity professional confirms that there was no other fund that was interested in the deal, given that it was rather expensive. “It has taken Warburg Pincus a decade to close a big-ticket real estate transaction,” he says. What is probably not commonly known is that the private equity major was in the fray to acquire a stake in Oberoi Realty and the Bengaluru-based Mantri Developers.

Both went in favour of Morgan Stanley Real Estate. This was during 2006-07 and it was around this time that Warburg Pincus inked a deal to pump in $150 million into Unitech Corporate Parks, a commercial real estate company with a focus on the IT and ITeS sectors. But Unitech changed its mind after the term sheet was signed and instead decided to take the listing route, leaving Warburg Pincus in the lurch. 

In 2006, Warburg Pincus made a ₹280-crore investment for a 27% stake in hospitality player Lemon Tree Hotels to help it set up a chain of 25 hotels across the country. Five years later, Lemon Tree entered into talks with Warburg Pincus for a foray into real estate, with plans to invest over ₹1,400 crore to launch housing projects. The two formed a 51:49 joint venture — Oceanus Real Estate — and each put in an equal contribution.

Back then, Lemon Tree founder Patu Keswani said the residential apartments would be sold under the Lemon Tree brand in the range of ₹20 lakh to ₹1 crore per unit and that the JV had identified a couple of sites in Gurgaon. Niten Malhan, MD of Warburg Pincus India, had said back then, “The reason we got talking to Patu is that we know there is a need for housing, especially mid-market — something very similar to his hotel product. And if someone can deliver that with a manufacturing sort of a mindset — for instance, when you buy a car you get treated in a certain way as a customer. I don’t think you get treated the same way when you buy a house. Most of us feel pretty sad about the whole experience, especially when we buy property in Mumbai. We’d like to do more in that sector, the way we have in China.”

But since then, there has been no news of further developments and though both partners are mum about it, sources say the JV has been called off.  Lemon Tree declined to comment on this when contacted by Outlook Business. Four years after this debacle, the deal with Piramal has now got the industry talking.

Bharat Khanna, managing director, Union Square Capital Management, who was earlier country head for Morgan Stanley Real Investing in India, says, “There is no doubt that Warburg Pincus and Goldman Sachs have paid top dollar for Piramal Realty. The valuation is definitely a question mark and for Piramal, execution and scalability will be key.” Khanna expects more large players to come in in a big way over the next five years, with some of the older names making an exit. “We will see the likes of Godrej Properties and Tata Housing taking greater interest in the sector. In the case of this deal, it is obvious that it is based on trust and the ability to scale up.”

The case of Goldman Sachs is even more intriguing, given that its record in the sector has been nothing to write home about. In October last year, it sold its 73% stake in City View Bangalore Properties to private equity major Blackstone and Bengaluru-based realty firm Embassy Property Development.

Goldman Sachs had acquired this stake through Whitehall, its real estate fund, for ₹500 crore in 2009 ($100 million at that point). For a long time, all was not well between Goldman Sachs and the other shareholder, Century Real Estate, which continues to hold a 27% stake.

The plan was to develop a 6.5-acre land parcel to eventually house a Four Seasons Hotel and luxury residences. None of that worked out and starting 2012, Goldman Sachs was looking to exit its holding. Media reports state that the deal to sell the stake to Blackstone and Embassy was inked for ₹630 crore ($104 million), resulting in a sale at par for Goldman Sachs, although industry sources say the fund exited at a loss.

Another deal that went awry for the fund was an investment made at the peak of the real estate cycle in November 2007. Goldman Sachs invested ₹600 crore in the Delhi-based Vatika Group, a real estate company, with another ₹400 crore coming from Wachovia Bank and Baer Capital Partners. A public issue was planned in 2009, which never materialised. In May 2013, Goldman Sachs sold its investment to the Vatika promoters at par. Last December, Goldman Sachs invested ₹255 crore in Vatika Hotels, which owns two properties under the Westin brand. This investment was followed up by another ₹100 crore in Ashiana Housing, a Delhi-based company, through the qualified institutional placement route, with an equal amount coming from Creador Advisors. Ashiana is looking to develop housing projects in Haryana and Rajasthan in addition to a focus on senior living.

Prior to the investment in Piramal Realty, Goldman Sachs and Nitesh Estates, a Bengaluru-based developer, signed an agreement to jointly invest $250 million in commercial assets. This was a day after Nitesh bought over the troubled Koregaon Park Plaza, a 1-million sq ft mall in Pune from Israel’s Elbit Imaging for ₹250 crore. The mall has run into many a problem, like a fire accident in mid-2012, anchor tenants moving out and rising vacancy rates. This, at a time when Pune, along with most other cities in India, is facing an oversupply of malls. 

Ankur Sahu, co-head of private equity, Goldman Sachs (Asia), in a release announcing the deal with Piramal Realty stated that  the investment is consistent with his fund’s strategy of partnering with India’s leading entrepreneurs to invest in sectors critical to the country’s development. “The government’s focus on simplifying regulation and boosting economic growth will kick-start investment and consumption. Under such a cyclical recovery, the demand for high-quality, modern housing and office spaces from a trusted, proven brand and standard-setting developer will serve to create a significant leader in Indian real estate.”

Risks in sight

The big concern is that Piramal’s entire land bank is in Mumbai, with the company having paid large sums of money for each parcel. This, at a time when the residential market is going through its worst phase (see: Realty check). The first half of 2015, according to a report put out by global property consultancy Knight Frank, has seen Mumbai registering a 36% drop in new launches — from 28,000 in the second half of 2014 to 19,000 for the first half of 2015 — even as unsold homes in the city piled up to 2 lakh units.

Realty check

Piramal Realty's land bank in Mumbai has all been bought at a premium

“July has been nothing to write home about. If there is no serious demand during the festive season later this year, we will face an extremely grave situation,” says a worried Shishir Baijal, chairman and managing director, Knight Frank. The bigger worry is that the premium market (homes that cost over ₹5 crore) has had no launches in the past six months. Historically, most of these have been in south and central Mumbai, which is where Piramal has acquired its land.

Take the case of Byculla, where Piramal bought 7.25 acres, which is approximately 3.25 lakh sq ft (1 acre assumed as 45,000 sq ft). On a FSI of 1.33 or a little more, there is a good chance that Piramal can develop 5 lakh sq ft. If the acquisition cost of ₹600 crore is divided by 5 lakh sq ft, the land price works to around ₹12,000 per sq ft. Assuming that the construction cost will be another ₹3,000 per sq ft, an additional ₹1,000 per sq ft being interest cost and another ₹500 per sq ft being architect’s fee, etc., the total would work out to ₹17,000 per sq ft.

That figure excludes a profit margin, which could be 30% if Piramal manages to command that kind of a price. Now, compare this with a redevelopment project in Byculla, where Godrej is charging ₹21,500 per sq ft. Commenting on the math, the head of a leading real estate consultancy says, “The question for Piramal will be, “Should I trade-off at ₹18,000 per sq ft or wait to make more money at ₹21,500 per sq ft? It will also depend on the apartment size. If Godrej or a rival builder has 1BHK or 2BHK, Piramal’s project will be under stress. If he is the only one selling luxury, then the equation could change.” 

According to Sunil Rohokale, CEO and managing director, ASK Group, a financial services entity with a presence in real estate, the island city, on an average, has had just 800 registrations each month over the past five years. “The audience that buys luxury property accounts for no more than 0.5% of the population and it is never their first home. This segment is growing very slowly and there is a lot of pressure when it comes to generating return,” he explains.

Piramal’s premium housing project Signature Island, which is a joint venture with Sunteck Realty, at Mumbai’s Bandra Kurla Complex is scheduled to be handed over this Diwali. It is learnt that of the 64 apartments, each with an area of 11,000 sq ft and a price tag of ₹35 crore, only 40 units have been sold to date. The two other projects, Signia Isles and Signia Pearl, too, have witnessed just 60% of their apartments being sold.

Anand Piramal is forthright when he says that real estate in Mumbai is going through “challenging times”. By his own estimate, this phase will hold out for a while, at the very least. “The stress will be there for two-three years, though we are banking on India growing at 8-9% and people being willing to pay for good housing,” he thinks.

Piramal makes it clear that the deal will be restricted to the company’s land parcels at Byculla, Kurla, Mulund and Thane. “The rationale was to look at projects that are currently under development. We expect those in Thane, Mulund and Byculla to begin soon,” he says.

Interestingly, very little has moved at each of these projects. Take the case of the one in Byculla, where there is nothing to show after 7.25 acre of land was bought for ₹605.8 crore in 2011 from the Mafatlal Group. For that matter, the one-acre plot bought from Hindustan Unilever in Worli in 2012 for ₹452 crore is yet to get environmental clearance and the buzz is that it will be utilised by the Piramal family for their personal use. Shashank Jain, partner, transactions group, PricewaterhouseCoopers, says Piramal Realty will have its hands full for at least five years, even as he terms the investors’ decision “a bold bet”. 

The unsold stock in each of the areas where Piramal projects are proposed to come up has steadily increased. According to data from PropEquity, Mulund had unsold stock of 5,797 units in FY15. Thane, too, was no better, and the number moved from 90,927 units to 1.18 lakh in FY14 and 1.03 lakh the following year. Byculla had 149 unsold units in FY15 in the backdrop of nil launches for three years and 310 units as of Q1FY16. Piramal concedes that approvals for areas like Byculla have been very slow.

“Every developer is struggling and it is not easy when a real estate project in the city needs 199 approvals. From the time we acquired the land, prices have moved upwards,” he insists. He expects the other projects to get off the ground “very soon”, though he declines to share specific timelines. To his mind, there is still a dearth of high-quality housing, with very few good buildings. “This is a really high-beta business, where things can get really good when the going is good and vice-versa. We are confident of the Indian economy doubling every nine years and that is where the opportunity is,” he says. In the context of the slowdown, he also does not discount the possibility of acquiring good land parcels at competitive rates.

Project vs entity

Both Warburg Pincus and Goldman Sachs have chosen to invest in Piramal at the entity level. In most cases in India, especially after the 2008 crisis, most PE funds began acquiring stakes in project-level entitites. Jain admits to being surprised by this strategy. “The only way to understand it is the investor’s higher risk-taking ability or someone like Warburg Pincus just having a level of comfort with the Piramal Group after its earlier experience. There is also a chance that the investor is adopting a special purpose vehicle approach and is not restricting itself to just five to six projects,” he says.

Some of the bigger domestic real estate funds like ASK Real Estate Special Opportunities Fund are not comfortable with investing at the entity level. Rohokale insists that there is no history of healthy return in India when this strategy is adopted. His firm — with five funds and structured debt — has deployed over ₹3,100 crore across 23 investments to date. “The exit depends on the listing and that is greatly driven by the sentiment in the industry at that point,” he says.

According to Rohokale, the advantage of a project-specific approach is that there is more control and clarity over how the money is being spent. That approach certainly seems to have paid off, given that all his funds have never delivered an internal rate of return (IRR) of less than 25% on any project. “That is the thumb rule we adopt, along with overall return being at least 2X,” he adds.

Rohokale is not entirely wrong. In the past, global private equity funds have burnt their fingers betting on this sector. Investments like those of DE Shaw in DLF, Morgan Stanley in Oberoi Realty and Mantri or TPG-Axon Capital in DivyaSree are just a few examples (see: Uneventful stay). Piramal defends the decision to invest at the entity level, saying that both the investors bring in capital and allow Piramal Realty to build a war chest.

Uneventful stay

None of the exits by private equity funds were anything to write home about

“It gives us the firepower to look at new projects, apart from capitalising on the expertise that they have in this business,” he says. Piramal talks about Goldman Sachs having helped develop buildings in tony locations like New York’s Central Park and Collyer Quay in Singapore. “A firm like Goldman Sachs has property management divisions, which will help us in improving quality parameters. Warburg Pincus, too, has invested in projects in China and Vietnam,” he adds.

According to Khanna, investing at the asset level is a lot more difficult. “To a large PE investor, size is critical and that means you are restricting yourself to just a couple of developers. Typically, funds spend a lot of time with developers in understanding the business, and that often results in being comfortable investing at the entity level,” he says. In that sense, it is not about the compulsion to break out a big cheque all the time.

“This approach gives the fund the liberty to offer things like structured credit. All this is possible when you work very closely with the developer.” Though Warburg Pincus and Goldman Sachs refused to participate in this story, Malhan of Warburg Pincus, in a release announcing the deal was quoted as saying, “Warburg Pincus invests in companies with high growth potential and believes that Piramal Realty is best positioned to achieve leadership in one of the world’s most attractive real estate markets.”

Talking about the reasons behind choosing to invest in Piramal Realty, he outlined factors such as the group’s strong values, track record of creating long-term value for stakeholders, brand value, emphasis on customer centricity and its reputation as strong deal-makers.

Multi-storeyed hopes

Given the sizeable amount of unsold housing stock, Khanna insists that prices will come down. “That is a reality and the only question is when it will happen,” he says. But Khanna believes that the key in the real estate business is execution, where the land is quickly converted into a project that brings in money. He refers to the case of the Bengaluru-based Mantri Developers, where Morgan Stanley Real Estate invested $68 million (then ₹300 crore) in early 2006.

“The mistake there was that the developer believed in land banks and not execution,” he says. In fact, in September last year, construction major Shapoorji Pallonji threatened to take legal action against Goldman Sachs and Century on grounds of abandoning its Bengaluru project site, for which it claimed dues of ₹82 crore.

According to Rohokale, private equity investors in real estate have to adopt an active asset management approach and not behave like people who just infuse funds. “There has to be a very high level of involvement, like contractors not being changed without my consent,” he explains. For every 100 investment proposals coming his way, barely three make the cut. “In that sense, my universe comes down to just 50 developers across five cities in India. That’s where I make my money,” he says, matter-of-factly.

But that doesn’t seem to be the case across the board, as a report by consultancy firm McKinsey shows that of the $9.8 billion worth of PE investments made in real estate between 2002 and 2008, only 14% managed to exit their investments by 2013, that too generating a measly dollar return of 2%. In fact, since the Warburg Pincus and Goldman Sachs deal was announced, the rupee has depreciated by over 4% to 66.4 levels. 

Though Khanna believes Piramal Realty will not hesitate to drop prices if there is a need, he expects the new entrant to bide its time as its priority would be to recover the cost of land. This is especially true in a case like Byculla, where the land was acquired at the peak. “Developers look to double their investment over four years but today, they are not in a position to command pricing. Piramal Realty could well find itself in the same boat,” says an industry observer. 

Piramal is, however, not perturbed and believes that most developers in the city have overpromised and under-delivered. “Yes, there is pressure in Mumbai and if the market continues to remain saturated, we will definitely look at other cities.” The company has also announced a buyback guarantee, Piramal Assurance, where the property will be bought back at a 5% discount to the market value until possession if the buyer is not satisfied. Though Piramal refuses to elaborate on the details of the scheme, he doesn’t sound pessimistic and cites the instances of China and Vietnam, where real estate, he says, has been the biggest wealth creator. “We think there is space for a big player in India and that’s what makes me comfortable. Real estate is a fragmented sector today and there is a serious opportunity to consolidate,” he says. 

The question is what kind of return will Warburg Pincus and Goldman Sachs make on this transaction? Piramal says that there is no commitment to either list the company or offer assured return to either of the investors. With prices having stagnated at high levels and a reversal long overdue, it is not clear what strategy Piramal Realty will finally adopt. Perhaps the two marquee private equity funds can only pray that the worst is over for the Indian real estate market. But as the adage goes: “History may not repeat itself, but it sure does rhyme.” 

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