Hot money: PE investors are getting burnt by realty

PE firms that invested in Indian realty in the 2006-08 boom years are looking to exit, but are unable to so with profitable returns. Sources say heads are rolling at the top levels of these firms as a fallout of the negative returns from the investments made under them.

While most PEs had expected 20-25% returns post tax, the harsh reality is they are being forced to exit with zero returns, and this is the outcome of too much hot money chasing the same commodity without a proper due diligence.

Soaring land prices and price-resistance from buyers began to narrow investors’ margins slowly, but significantly. While many PE funds have postponed their plans to exit investments due to lower returns a few cash-rich ones are treading cautiously and avoiding investing anywhere as valuations have dropped.

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[caption id=“attachment_479317” align=“alignleft” width=“380”]  While most PEs had expected 20-25% returns post tax, the harsh reality is they are being forced to exit with zero returns[/caption]

The fact that real estate in India has seen $3.2 billion of private equity investor exits in the last four years makes it amply clear that developers and investors have been simply playing the Indian real estate market, using opportune moments to buy in or sell out, behaving more like hot money stalwarts than the long-term FDI investors, as the government touted them to be.

According to property consulting firm Cushman & Wakefield, private equity investments in Indian real estate have seen a drop of 15 percent in the first three quarters of calendar year 2012, compared with a year ago due to concerns over government policy coupled with an uncertain investment scenario as the amount of capital available is limited.

But in realty, India’s private equity story, which gathered stream in the last decade, has been attacked for poor return on investments and sticky exit environment. Between 2007 and 2008, PE firms raised $20 billion to invest in India as developers built optimistic business plans that predicted returns as high as over 30%. PE fund managers provided developers with large amounts of capital at ridiculous valuations, with no tangible downside protection.

Over-optimism about India sent valuations soaring, which was best mirrored in Indian realty. By focusing only on Tier I cities; the developer-investor nexus bought scarce land parcels at exorbitant rates and consequently priced homes in a manner that pushed affordability off the charts.

Soon enough speculators followed, creating artificial demand and consequently higher prices. The land sharks repeated the model in Tier II cities too as property prices peaked in metros. With dirt of demand, many projects were left unfinished and now the finance ministry is forcing banks to expose themselves to these projects to bail out realty players.

Refusing to acknowledge the slowdown, the PE guys are now in a catch 22 situation as demand taperes off for high-valued property and inventory levels shoot up. Says Pankaj Kapoor, MD at real estate firm Liasas Foras, “The investor can only make returns if there is an end-user to finally purchase that property. With no genuine buyers, PE investors have three choices: Either salvage their capital and exit, stick to the project and wait for the tide to turn or hope that black money will continue pouring in.”