ACAE Chartered Accountants Study Circle - EIRC Kolkata Funding Avenues for Real Estate Sector Real Estate Conclave - Kolkata Presented by: Jayesh Kariya Partner - International Tax and Regulatory 5 September 2015

The journey ahead… 1 Overview 2 Funding Avenues – An Overview 3 Foreign Funding Avenues – FDI/FPI/ECB 4 Domestic Funding Avenues 5 Summing Up

Overview

Staggering growth in foreign Investments witnessed in 2014-15 Total FDI inflow was US$ 380.21 Bn (April 2000 – June 2015) FDI inflow was US$ 19.39 Bn (Jan, 2015 - June, 2015) against US$ 14.97 Bn in the corresponding previous year (30% growth) In the PE sphere 350 transactions valued at US$ 12.7 Bn were announced in first half of FY 2015 The Real Estate space witnessed US$ 34 Mn of FDI investment (April, 2015 – June, 2015) PE funds have pumped in US$ 1.68 Bn in the commercial and residential real estate in six months ended June 2015, compared to US$ 0.6 Bn a year earlier FII’s pumped in an astounding INR 105.92 Bn (Jan 2015 – June 2015) Estimated that foreign investment into real estate in India will increase to US$ 25 billion over the next 10 years Source: DIPP, NSDL , Cushman and Wakefield Research, VCC Edge Venture Intelligence and Bloomberg

Recent funding transactions in news … Real estate among top favoured sectors for PE and VC investments Realty major DLF on Monday raised Rs 375 crore through non-convertible debentures (NCDs) as part of its strategy to boost internal cash flows. The company is also planning to launch two real estate investment trusts (REITs) this fiscal year to monetize its rent-generating commercial assets DLF Raises Rs 375 Cr Through NCDs SEBI has allowed 158 entities to set up AIFs newly created class of pooled-in investment vehicles for real estate, private equity and hedge funds in about three years Among the newly registered AIFs are HDFC Capital Affordable Real Estate Fund, Unicorn India Ventures Trust, Arthveda Affordable Housing Trust and Blume Ventures India Fund SEBI permits 158 AIF’s to operate in India Warburg Pincus will be investing Rs 1,800 crore in Piramal Realty for a minority stake at entity level The capital raised through equity transaction will be used to expand Piramal Realty’s portfolio and acquire land parcels in and around Mumbai Warburg Pincus to invest Rs 1,800 crore in Piramal Realty IREF is targeting to raise a total of Rs 1,000 crore under the first scheme of Indiabulls' Alternative Investment Fund (AIF) The commitment of around Rs 300 crore includes funds raised from high net worth individuals, institutional investors and family offices. Indiabulls Real Estate Fund raises Rs 300 crore from investors

Recent funding transactions in news … Parsvnath Developers has allotted unlisted, secured, redeemable, non-convertible debentures having face value of Rs 5 lakh each aggregating to Rs 355 crore on private placement basis The fund has been raised from Edelweiss and it will be used to prepay debt of the company Delhi-based builder, Parsvnath Developers raised Rs. 355 crore from Edelweiss Piramal Realty, the real estate development arm of the Piramal Group has said that US investment bank Goldman Sachs has agreed to invest $150 million (Rs 900 crore) for a minority stake in the company The funds will be used to expand the company’s real estate portfolio and acquire prime properties in and around Mumbai Goldman Sachs to pick stake in Piramal Realty Raised Rs.255 crore through a NCD issue from NBFC Indostar Capital Finance Ltd NBFCs still remain a fairly active lot of investors in the real estate industry and are competing with a number of PE funds who have been doing more debt or debt- equity structured transactions, as they chase developers who are in need for capital Total Environment Building Systems raised Rs 255 crore from Indostar Capital Finance Lodha raised Rs.542 crore through a non-convertible debenture sale to Kotak Realty Fund for a portion of the Palava project. Lodha raised Rs.542 crore through a NCD sale to Kotak Realty Fund

Key funding challenges in Real Estate Sector 1 Weak financial markets Weak financial markets limiting developers and institutional lenders to raise equity and debt capital 2 Weak global and local economy Weak global and local economy restricting flow of equity capital 3 Lack of institutional funding Lack of institutional funding (the maximum tenure of any capital is about 4 to 5 years leading to multiple rounds of fund raising by developers) 4 Lack of lending sources at initialization and land acquisition stage Lack of lending sources available to real estate developers to acquire land which accounts for about 20-40 per cent of a real estate project 5 Lack of organized functioning of industry restricting raising of finance Unorganized nature of the industry 6 Perception of high risk industry Perception of high risk industry leads to higher borrowing costs

Funding Avenues – An Overview

Bank / Construction Finance Funding Avenues Close-group Investor funding LRD for leased commercial properties PMS – Real estate a preferred asset class Use of innovative JDAs FDI NBFC Funding Listed NCDs REIT AIF ECB Bank / Construction Finance Crowdfunding* Funding Avenues *SEBI had issued a Consultation paper on Crowd-funding in July 2014. As per the Consultation paper, the crowdfunding is not allowed for real estate business

Funding mechanism in RE sector has gained depth and maturity over last decade Major Channels of Financing in Real Estate Development in India Funding options keep re-inventing supported by ever changing external (local & global economy; country risk; political scenario etc.) and internal (developer credibility; demand supply equation etc.) dynamics of the RE sector Recently introduced REIT regulations may provide an alternate channel for raising funds offering a structured and perpetual source of capital Offshore Listing QIP IPO PE Fund QIP PE Fund PE Fund PE Fund NBFC Lending PE Fund Bank Lending Bank Lending Bank Lending Bank Lending Bank Lending NBFC Lending NBFC Lending NBFC Lending Private Lending Private Lending Private Lending Private Lending Private Lending Private Lending Pre-2005 2005-2007 2008-2009 2010-2011 2012 2013-2014 Offshore Listing ECB Offshore Listing Offshore Listing Offshore Listing Offshore Listing IPO NBFC Lending IPO IPO IPO IPO NBFC Lending ECB ECB ECB ECB Bank Lending QIP QIP Levels of Activity High / Medium Low Extrinsic and intrinsic factors determine the cost of funding Extrinsic factors — INR-USD depreciation/appreciation; Country risk; GDP growth; Domestic interest rates etc. Intrinsic factors — Developer risk; stage of funding; project risk; background of developer etc. Cost under various funding options Rapid Increase due to global liquidity crisis Cost of funds have declined in recent years suggesting improving fundamentals

Established / preferred sources of funding in Indian real estate market Funding options available at Value Chain Level Preferred Financing Options by Developers Stage 3 (construction) Private equity Mezzanine debt Bank funding (12-15% for 4-5 years) Stage 4 (exit) REITs LRD/CMBS (for leverage buyout) Foreign listing Stage 2 (approvals) Private equity (24-25% for 4-5 years) Mezzanine debt (18-24% for 2-4 years) Stage 1 (Obtaining land) Joint Venture (till the end of project) Private debt (24-30% for 2-3 year) Outright purchase Project initiation and land acquisition (0-2 year) Approvals (2-3 years) Project development (4-10 years) Handover and operation Specialized Real Estate Investment Options Real Estate Mutual Funds (REMFs) Established in form of trust which invest directly/indirectly in real estate assets Real Estate Investment Trust (REITs) Corporate structure that buys, sell and manage real estate assets and are publicly traded

Foreign Investments in India – FDI/FPI/ECB

Foreign Investments in India – An Overview Foreign Investment in Real Estate 1. FDI Route 2. FPI Route 3. ECB Route 4. NRI Route Construction Development - PN 10 of 2014 Hotels and Hospitals Industrial Parks – PN 3 of 2008 Educational Institute/ Old age home Investment in SEZ (SEZ Developer) Listed shares of corporate developers Listed corporate debt: Overall USD 51 billion investment limit available Hospitals Hotels Units in SEZ Affordable Housing* SEZ Developers* Unlisted securities on repatriation and non- repatriation basis Direct purchase immovable property other than agricultural property, plantation or a farm house *Permissible under Approval Route

1st 2nd Key Conditions prescribed in PN 10 of 2014 C O N D I T S Exit FDI not allowed in Real Estate Business; or Construction of Farm House; or Trading in Transferable Development Rights 1st Investment-related guidelines Minimum foreign investment – USD 5 million Funds to be brought into India within 6 months. Subsequent tranches can be brought till the period of 10 years Issue of shares within 180 days of receipt of inward remittance C O N D I T S 2nd Project-related guidelines Minimum area requirements: no minimum area requirement for serviced plots and 20,000 sq. meters for construction development projects The Indian Investee company will be permitted to sell only developed plots PN 10 of 2014 does not apply on investment by NRI’s Project to comply with norms laid down by state, municipal, etc* Exit Exit permissible on completion of project or on development of trunk infrastructure (i.e. roads, water supply, street lighting, drainage and sewerage). Any repatriation of FDI or NR to NR transfer prior to completion of project will require FIPB approval 1st and 2nd condition (except condition to obtain approvals from local bodies) is not applicable where investment is made in JV/WOS which has committed at least 30% of project cost for low cost affordable housing

Key Impact Areas of PN 10 0f 2014 on FDI Route Existing Investments/Projects Eligibility under new FDI Policy Applicability of new exit restrictions? Applicability of minimum capitalization norms - project wise, bringing additional funds, etc.? New Investments/Projects Reduced minimum capitalization Single Company structure vs. SPV structure Entry and Exit point Relaxation for Affordable Housing Projects Key Impact Areas Exit through NR to NR Transfer Approval for NR to NR transfer before completion of trunk infrastructure or project Unused/ Idle Parcel of Land Disposal of unused / idle parcel of land permissible through FIPB approval Completed Projects Exit from completed projects through FDI route for operation and maintenance

Funding instruments for Real Estate sector How does one Finance Business and Operations? Funding instruments for Real Estate sector EQUITY CCPs CCDs Optionally Convertibles Redeemables DEBT ECB MEZZ Capital Auto Route ECB, conditions and restrictions apply Currently, Mezz FDI is permissible only in form of CCPS and CCD Equity/ADR/GDR CCPS CCD Optionally Convertibles Debt Capital structure for the Indian entity needs to be appropriately structured to ensure smooth business operations and also repatriation in a tax and regulatory efficient manner. Appropriate capital structure also helps in addressing control issues

FPI Route – Listed NCD No minimum amount criterion Pricing guidelines not applicable on investment as well as redemption No end use restriction Ability to distribute higher coupon (as compared to CCDs) Redemption of listed NCDs at premium to achieve commercially agreed IRR Creation of security possible - RBI approval required on case of enforcement of security and repatriation Tax efficient from developers perspective – can be structured as per project cash flows Lower withholding tax of 5.41% on interest for FPIs for loan funding between 1 June 2013 and 31 May 2017 (as against tax rate of 21.01% / 21.63%) on the maximum coupon rate not exceeding 500 basis points over the base rate of SBI Offshore Investor Project SPV Overseas India Subscription of Listed NCDs Registered as FPI Simplified structure for investment in debt instruments – tried and tested structure

ECB allowed for Affordable Housing Projects ECB Route ECB sectoral conditions Infrastructure Hospitals (capital stock and includes medical colleges and para medical training institutes) Hotel Sector Hotels with fixed capital investment of atleast Rs. 200 crore; Convention centres with fixed capital investment of atleast Rs. 300 crore; and Three star or higher category classified hotels located outside cities with population of more than 1 million Automatic route - USD 750 mn Beyond USD 750 mn - under approval route Services Hotels (other than those covered above), Hospitals (stock-in-trade) Automatic route - USD 200 mn Beyond USD 200 mn - under approval route ECBs cannot be used for the purchase of land SEZ Developers Infrastructure facilities Approval route Includes ‘Industrial Park’ within SEZ ECBs may also be raised by companies in infrastructure and service sector from foreign equity holders for general corporate purposes (including working capital) with minimum maturity of 7 years provided atleast 25% of paid-up capital is held by lender Security of immovable property / securities permissible subject to conditions Coupon at a higher than all-in cost ceiling – under approval route Other conditions – Eligible lender, minimum maturity, end-use restrictions, etc to be complied with Lower withholding tax rate of 5% applicable on interest payable on ECB ECB allowed for Affordable Housing Projects

ECB Allowed for Affordable Housing Projects Eligible Borrowers – Developers/ Builders Registered Companies Min 5 years of experience in residential projects No financial commitment defaults No litigation in project Conformity with master plan Obtain all clearances Definition of Eligible Project Atleast 60% of FSI would be for units having max. Carpet area of 60 sq. meters (equivalent to 646 sq. ft.) SRA projects Whether eligibility criteria to be satisfied either at Group Level or SPV level Whether SRA projects needs to satisfy the criteria of 60 sq. meter Eligible Borrowers – HFC’s Registered with NHB NOF for last 3 FY >= 300 Cr ECB within HFC’s overall limit of 16 times of NOF NPA =< 2.5 % of the net advances Max. Loan – Individual buyer – 25 Lakh (Subject to individual housing unit =< 30 lakh) ECB Guidelines No borrowing limit specified for individual developers/ builders Issues Merger of two units –satisfy the criteria of 60 sq. meter End-use Restriction Proceeds should be utilised only for low cost affordable housing units and shall not be utilised for land acquisition General guidelines NHB to act as Nodal agency –will approve the project and forward to RBI Not permitted to raise FCCB’s under this scheme All other conditions of ECB applicable Aggregate limit of USD 1 billion fixed – subject to annual review Whether terraces, common area, balconies, etc. would be included in 60 sq. meter Total ECB availed is USD 265.7 million from Jan 15 till July 15 as per RBI website

Domestic Funding Avenues

AIF Structure Domestic Investors Trustee Investment Manager Settlor / Sponsor Investment Management Agreement Sponsor contribution AIF Investment Committee Management fees and carry Investment in securities of unlisted companies or interest in LLP Investee Co 1 Investee Co 2 Investee Co 3

.. SEBI AIF Regulations – Categories of AIF.. CATEGORY I AIFs with positive spillover effects on economy Incentives given by SEBI, GOI, or other regulators in India Includes - VCF SME Funds Social Venture funds Infrastructure funds Others – as may be specified Close ended funds – minimum tenure of 3 years Not to invest more than 25% of corpus of AIF in one investee co CATEGORY II No incentives given by SEBI, GOI, or other regulators in India Private Equity funds Debt funds Other funds (not falling under Category I or III) Close ended – minimum tenure of 3 years Not to invest more than 25% of corpus of the AIF in one investee co. Limited asset-side restrictions CATEGORY III AIFs which trade for making short term returns, includes hedge funds / PIPE funds, etc. Employs diverse or complex trading strategies Open ended / close ended Directions to be issued by SEBI for regulation of this category of AIF Not to invest more than 10% of corpus in one investee co. Generally real estate fund are registered as Category II – Out of total 158 AIFs registered with SEBI, more than 28 AIFs are real estate fund

AIF Tax considerations (Trust structure) Category I and II AIF (Pass through status - Income exempt under Section 10(23FBB) of the Act) Category III AIF (Income not exempt under Section 10(23FBB) of the Act) AIF Income distributed taxable in hands of investors on accrual basis Other provisions of Act to apply No Contributions made to trust revocable? No Settlement made to trust revocable? Is it a discretionary or a determinate Trust? Yes Yes Income taxable in hands of contributors Income may be taxable in hands of Settlor Discretionary Determinate Income of the Trust would be charged to tax in hands of Trustee at MMR i.e. 30% Income of Trust would be taxed in hands of Trustee as representative assessee in like manner and to same extent as taxable in hands of beneficiaries Arguable that capital gains rate over-ride MMR provisions in case of discretionary trust In case of business income earned by the Trust, whole of income would be liable to tax at MMR

NBFC Route Key Benefits Lending possible without any sectoral restrictions No restriction on rate of interest Security possible Easy repatriation of capital Possible to diversify into other financial services business with domestic clients NBFC – “QIB” status under SARFAESI No lock-in for real estate (if NBFC Indian owned and controlled) Listing possible Key Concerns Costlier funding avenue Not very tax efficient as compared to FDI Regular filing and other compliances with RBI to be monitored FDI Entity Tax efficient jurisdiction RBI Registered India NBFC Investee company Loan / OCDs / OCPRs / RPS Tax efficiency and concentration norms to be evaluated based on commercials

REIT - Structure Mechanics: Sponsor to set-up a trust and appoint an independent trustee Trust to be registered as REIT with SEBI Trustee to appoint Manager Manager to appoint Valuer REIT to hold / propose to hold commercial real estates assets worth Rs.500 crores Manager to obtain in-principle approval from stock exchanges for raising funds through initial offer REIT to raise funds through initial offer from the public, within 3 years of registration with SEBI REIT to make investment in real estate assets REIT to generate and distribute 90% of net cash flows to its unit holders Unit holders can trade in units of REIT on the stock exchange Investors Sponsor Contribution Sponsor units Investment Management agreement REIT Trustee Investment Manager Investment Management fees SPV Valuer Full valuation Real estate assets

REIT– Challenges Tax inefficiency – Not a complete pass-through status Stamp duty cost on transfer of immoveable property to REIT i.e. 5 to 12 percent depending upon the state in which property is located Better interest yield on other fixed income products remain deterrent to the retail investors Soft real estate market conditions (i.e. enhanced transparency and good governance) and asset quality affect the potential for a REIT market

Summing Up

Summarizing Funding Avenues Higher funding cost No easy exit mechanism Open only for commercial real estate projects and large developers Tax inefficient and high stamp duty cost FDI REIT Available to high net worth developers Regulated Market Not available for Real estate business Globally accepted FPI Route Crowdfunding Most popular construction finance Relatively higher cost End use restrictions Stringent conditions Low interest rate ECB Bank/ Construction Finance Less regulated than banks Security Mortgage Higher interest rate Tax inefficiency Regulated Market High administrative and compliance cost AIF NBFC

Developers Due Diligence Investor’s Expectations …. Project Due Diligence Developers Due Diligence Real Estate Experience Portfolio of Project Asset Creditability IRR of Project and Security Track Record Marketability Management Team Project Life Cycle Good Governance Ease of Exit/Repatriation

Selection Parameters Understanding the funding requirement i.e. size of project, project life cycle, etc. Nature of the asset class, risk and other factors associated with the Project Cost of funding and return expectation i.e. IRR, interest coupon rates, YTM, etc. Evaluating macro and micro economic factors including regulatory policies – Domestic vs International leverage Tax and cost efficiency for raising finance Easy exit mechanism to investors Security enforcement – Principal and interest protection Regulatory compliances i.e. Obtaining approvals and routine compliances

Future Outlook Significant Demand for Affordable Housing More Transparency and Good Governance China and Europe Slowdown 100 Smart Cities REIT and Other Innovative Products Vision - Housing for All by 2022 Interest Rate Cut Improving perception as High Risk Industry Improved Tax and Regulatory Environment

Q&A

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