By, Shobhit Agarwal, MD & CEO – ANAROCK Capital
Previously, private equity (PE) funds focused on Indian real estate were content with investments at the project-level. Now, investors’ preference is now gradually tilting towards entity-level investments. Data trends from ANAROCK’s recent report Private Equity in Indian Real Estate indicate that the share of entity-level investments is on the rise.
Project Vs Entity-Level – What’s the Difference?
Entity-level investment is an efficient strategy to get a firmer foothold in the real estate market. It allows a private equity investment firm to not only deploy its capital but also gain synergetic skills in the real estate marketplace. PE firms invariably look for high levels of corporate governance in a real estate development company before deciding to invest in it at an entity level.
Project-level investments take shorter-term view of capital deployment as they do not necessarily involve partnering with the developer over the long haul. Rather, a PE firm will invest in a developer’s project, which involves a lower commitment and is, for that reason, a less risky approach to investing in real estate.
Entity-level investments, on the other hand, involve multiple projects and require the forging long-term business alliances. They require a thorough due diligence of the entity’s financials, as opposed to project-level investments where the PE fund will primarily seek to understand the financials of an individual project.
There are well-established benefits to entity-level investments. Once a PE firm and its developer partner have established synergy, more options to deploy further funding open up. In the current cash-crunch scenario of the Indian real estate industry, this is significant as longer-term funding can help the developer address long-term issues rather than merely seek short-term solutions.
While entity-level investments by PE players come at the cost of lower returns and higher due diligence requirements, they are of greater overall value for the real estate market in general and developers and PE players in particular. An increase in entity-level investment alliances implies increasing confidence in developers with high corporate governance scores. As such, they bode well for a market which is making determined strides towards deeper organization.
From an overall 22% share in 2015 and 2016, entity-level investments increased to a share of over 39% during 2017 and 2018. In actual value terms:
During 2015 and 2016, nearly USD 1.1 bn funds were pumped into Indian real estate at the entity-level
In the 2017-2018 period, it was nearly USD 3.3 bn.
Back in 2007, investors were investing all across – largely at the project level – as the picture looked fairly rosy then. However, post the Lehman Brothers crisis in 2008 and up to 2014, they became more selective. They refocused on select developers with good past track records, and with whom they felt ‘comfortable’.
As in any relationship, a comfort level comprises of various dynamics. With private equity players, it primarily hinges on a developer delivering consistently and factoring in their funding partners’ expectations – not just their own requirements.
Despite this new focus on comfort and credibility, PE investments remained limited largely to the individual project-level. This approach was very much in evidence in the 2015 to 2018 period, wherein approx. 2/3rd of PE investments in Indian real estate were at the project level. Of the total USD 14.01 bn PE funds in Indian real estate over the last four years, more than USD 4.4 bn were infused at the entity level.
A deep dive into data reveals that the focus on portfolio or entity-level investments picked up momentum in the latter half of the period between 2017 and 2018. In this period, entity-level private equity inflows almost tripled compared to the previous two years.
For these plays, institutional investors used a combination of ‘vanilla’ and structured equity for investments into projects. That said, they found greater comfort with vanilla equity while investing at the entity level, considering the longer-term focus at the entity level, and also the limited availability of structural options while investing at this level.
The major reason for this change is that institutional investors are now looking at long-term partnerships with fruitful returns over a long period, rather than the earlier focus on short-term gains.