Last year the Indian real estate market saw one of its worst plunges in recent history. The sector is now rebounding, with postponed and cancelled projects back on track

One sure sign of a property revival is the re-appearance of knots of small children playing in puddles and on sandhills amid big-city building sites. It usually means that India’s labour-intensive construction industry has returned to work. What might be bad for education – the migrant children have little access to schools and other resources – could be good for India’s bubbling property sector.

“The market, after last year’s meltdown and shakeups, has shown tremendous recovery in both commercial and residential space,” says Himanshu Chahar, a partner at LexCounsel in Delhi. “Real estate projects that had all of a sudden lost substantial net worth and value, creating severe liquidity problems, are back on track.”

Himanshu Chahar Partner LexCounsel

The sector’s recovering health has prompted at least 10 large and medium-sized property companies to re-examine plans for public offerings totalling about US$4 billion in 2010-11. Delhi-based Emaar MGF Land hopes to raise Rs38.5 billion (US$870 million) in the third quarter of 2010, while Delhi’s Ambience Co, Mumbai-based Lodha Developers, Lucknow developer Sahara Prime City and Bangalore-based Nitesh Estates are also planning to tap capital markets.

Private equity (PE) is also weighing in: Red Fort Capital plans to invest US$1 billion in property over the next five years, partnering with Delhi-based Parsvnath Developers and the Prestige Group of Bangalore. Several other developers have raised capital through PE funds, including Ireo and Spire Edge, for several projects across the nation, as well as Maharashtra-based Ackruti City, Sunteck Realty and Orbit Corporation for projects in Mumbai, Pune and Thane.

Law firms say they see increased client confidence in their real estate practices. “Clients are eager to find plots of land for large developments such as townships, and multiple-building complexes,” says Poorvi Chothani, founder and owner of LawQuest in Mumbai. “These can be around large cities or in small cities as property developers are building a national presence even if they are relatively new or small players in the market.”

Poorvi Chothani Founder and Owner LawQuest

It’s all a far cry from September 2008, when India’s most recent real estate slump began in earnest. Rentals and valuations suffered severe corrections during 2009, with prices falling 20-40% and transaction numbers cut in half. Major cities from Kolkata to Chennai were strewn with unsold and unfinished office towers and residential complexes.

Only Mumbai, with its severe geographical space restrictions, has remained relatively unscathed. In April, Royal Bank of Scotland sold an apartment it had owned in the Worli area for Rs370 million, one of the highest prices recorded to date for a residential property in the city. Such one-off deals – it was part of an asset disposal – probably should not be construed as signs of a bubble. “Mumbai is a city that generally has an immense appetite for real estate and the supply is limited,” says Chothani.

To be sure, commercial rentals and prices across the nation remain under pressure. A study by Jones Lang LaSalle Meghraj – a unit of the Chicago-based global real estate consultancy – noted that office rentals in major cities fell up to 40%, returning to 2005-06 levels. “There was an oversupply of commercial space,” a report by the Mumbai office of London-based DTZ International noted bluntly. DTZ expects office space vacancies to increase in the first half of 2010, and then stabilize or fall later.

Higher costs, charges

Property prices are also likely to be affected by rising costs of building materials, especially steel and cement, according to the Confederation of Real Estate Developers Association of India. Developers say an expected 12% increase in building costs during 2010 is likely to be passed on to buyers directly.

Consumers will also be hit by a 10% service tax on the purchase of apartments imposed under the most recent Union budget. “The levy of service tax is expected to have a negative impact on the off-take and demand levels, especially at a lower to middle level,” says Anshuman Magazine, chairman and managing director of CB Richard Ellis South Asia, the Mumbai arm of the international real estate consulting firm.

Foreign investors – who put about US$12 billion into India’s hotels, hospitals and townships in 2008-09 (the few commercial sectors in which they can invest) – have fled real estate investment trusts (REITs), the principal model for foreign investment in Indian property. Most of the REITs are based in Singapore and have lost up to 80% of their value since the slump hit. (See REIT or retreat on page 41 for an update on India’s progress in developing a domestic REIT market).

International interest in the long-term potential of Indian real estate remains high despite such setbacks. Vasant Prabhu, the Indian-born vice-chairman and chief financial officer of Starwood Hotels & Resorts Worldwide, which has no direct investments in India, said recently that he sees India becoming the global hospitality company’s number one market if it can find the right local partner.

Some lawyers urge caution as to the sustainability of the recovery. “The strength of the trend cannot be ascertained at this stage since the upturn is at its infancy,” says Kishore Vussonji, a partner at Kanga & Co in Mumbai. “Judgments at this stage would be too early to make.”

India’s residential property market remains closed to individual purchase by foreigners, with experts seeing little hope of a change in policy. “There is greater need for relaxation of acquisition of immovable property by non-residents and repatriation norms,” says Chahar. “While proposals have been doing the rounds for quite some time now, it is difficult to expect any amendments in the imminent future.”

Property consultants would also like to see a change of heart. “This is quite frustrating for us, as we receive a lot of interest from British nationals and others who are not allowed to invest in Indian property,” says Parikshat Chawla, business development manager at MacDonald Sarin, a London brokerage specializing in Indian real estate for non-resident Indians and persons of Indian origin.

Overhaul opposed

The government has attempted to formalize and regulate India’s fragmented and disparate property sector by proposing the Model Real Estate (Regulation of Development) Bill, which was published in draft form by the Ministry of Housing and Urban Poverty Alleviation in 2009. “This, if enacted, will have a huge impact on the real estate sector in India,” says Sunil Tyagi, senior partner at Zeus Law Associates in Delhi.

Building or destroying: Real estate developments threaten to wipe out fertile agricultural land and displace farmers.
Building or destroying: Real estate developments threaten to wipe out fertile agricultural land and displace farmers.

The linchpin of the proposed law is a single-point regulatory body for property on the lines of Securities and Exchange Board of India or Telecom Regulatory Authority of India. The bill seeks to provide for compulsory registration of developers and the regulator would have to issue a certificate before a development could proceed. Developers would also have to lodge a bank guarantee with the regulator representing 5% of the total cost of the project.

While consumer groups welcomed the ideas, industry associations were less receptive. “Many of its provisions are harsh and inimical to industry and concerned stakeholders,” the Associated Chambers of Commerce and Industry of India responded, adding that the bill shows “callous disregard for [the] freedom to conduct business … It will do nothing to address the inevitable delays … [that] make timelines impossible to adhere to.”

Huzefa Nasikwala, a partner at Juris Corp in Mumbai, sees the attractions of a single-window regulation process for the property sector and greater accountability in the entire process. “Clear title to the property, its marketability and creating encumbrances and charges on the property to secure the investment remains top priority in a transaction,” he says.

Other lawyers are more cautious. “The intention of the government to introduce a system of real estate regulation is noble but a lot of factors need to be taken into consideration before formulating the role of a regulatory body, otherwise the effect can be counter-productive,” says Tyagi. “The bill is likely to create more procedural compliances and added burden on developers, and thereby create more stumbling blocks to the growth of real estate.”

Sunil Tyagi Senior Partner Zeus Law Associates

Indian real estate’s Waterloo was the Nandigram controversy in West Bengal during 2007, when residents, mostly poor farmers, objected to the state government’s expropriation of 4,000 hectares of land for a special economic zone to be developed by Indonesia’s Salim Group. At least 14 people died in the ensuing violence.

This was followed by the Tata Group’s abortive 2008 plan to build a car factory in Singur, West Bengal, where the state opposition mobilized support for displaced farmers.

“The basic question is whether industrialization should happen at the cost of agriculture and those who depend on it,” says Diljeet Titus, managing partner of Titus & Co in Delhi. “Despite the controversial Nandigram project the future for acquisitions of rural greenfield sites is bright, providing certain issues are kept in mind.” Titus says the government should compensate farmers adequately, keep environmental issues in mind and allocate fertile agricultural land optimally.

Diljeet Titus Managing Partner Titus & Co

Dispute dynamics

Some advances are being made on the legislative front to streamline property development while avoiding or at least minimizing the infringement of rights of existing owners and tenants. Two key developments under consideration by parliament are the Land Acquisition (Amendment) Bill, 2007, and the Rehabilitation and Resettlement (R&R) Bill, 2007.

The bills would mandate a detailed social impact assessment (SIA) for projects involving displacement of families and bar the jurisdiction of civil courts in land-acquisition disputes by proposing alternative mechanisms. The acquisition amendment bill proposes the establishment of a Land Acquisition Compensation Disputes Settlement Authority to decide on acquisitions of land by state governments and a separate authority for acquisitions by the central government.

Under the R&R bill, the proposed SIA would consider the impact that the project would have on public and community properties, assets and infrastructure. Also, the government (whether state or central) must specify that ameliorative measures for addressing the impact would not be less than what is provided under any central or state scheme or programme in operation in the affected area.

Some legal experts are concerned that the bill is too rigid. “The bill needs to be more fluid in nature and be able to fill in the possibilities that different cities offer,” says Manish Desai, who heads Vidhii Partners in Mumbai. “We cannot expect the Mumbai success of slum redevelopment in a Bhopal, simply because the construction cost in any city would be by and large the same, but the buying potential, demand of property and the land cost would be drastically different.”

Zain Azra'i Abd Samad Partner Abdul Raman Saad & Associates

The industry opposition to both bills is such that many real estate lawyers expect they will face a tough road through the Lok Sabha, India’s lower house of parliament. “Until there is adequate protection and a fair deal carved out for the land owners, the bills – whether enacted with or without modification – will be subject to judicial review,” says Vussonji.

Another major issue is a lack of transparency, such as incomplete, incorrect and out-of-date title records. Under the model bill, no development could proceed without evidence of clear title. Kaviraj Singh, founder and managing partner of the Trustman & Co in Delhi, would like to see improvements in the registration and maintenance of title records. “Policy must be clear and consistent and all the records must be available for inspection to all,” says Singh.

Under another proposal, a real estate regulator would establish an ombudsman’s office to settle disputes. Ravi Bishnoi, a founding partner of SRGR Law Offices in Delhi, has seen a number of disputes between buyers of residential properties and developers, either due to construction delays or disagreements over the actual saleable area of properties. “These problems should be minimized with a dedicated forum like the proposed regulators,” Bishnoi says.

In addition, the Reserve Bank of India (RBI) commissioned a report on asset price monitoring which recommended that the RBI launch indices covering residential and commercial property rates. The indices are intended chiefly to monitor property price dynamics and guide the bank’s monetary policy, but could also prove useful to investors and consumers.

REIT or retreat?

The introduction of REITs in India promises to boost transparency in the real estate sector, but only if legal, tax, pricing and disclosure issues are carefully addressed

The modern real estate investment trust, or REIT, turned 50 years old in 2010. The REIT, which has its roots in 19th century investment trusts, was launched in the US with the passage of the Real Estate Investment Trust Act of 1960 and soared in popularity there during the boom years of the 1980s.

However, India is taking only baby steps towards a domestic REIT market. It wasn’t until December 2007 that the Securities and Exchange Board of India (SEBI) issued its first draft REIT regulations, which envisaged, for the first time, “a registered trust whose object is to organize, operate and manage real estate collective investment”.

In April 2008 SEBI issued its Mutual Funds Amendment Regulations, widening the scope of mutual funds to include real estate mutual funds, or REMFs. To this day, it isn’t clear if the REMF, which includes a substantial number of the features of a REIT, is a replacement or an alternative. “There has been no official intimation from SEBI whether the REMF regulations are intended to replace a separate REIT regime,” notes Daksha Baxi, executive director of Khaitan & Co in Mumbai.

REMFs envisage investment in real estate assets, mortgage-backed securities, equity shares or debentures in listed or unlisted companies involved in real estate development projects or engaged in dealing in real estate assets. “This is quite different from the investments intended to be made by REITs which typically invest only in real properties, which offer steady rental or lease income and capital gains on sale of such properties,” says Baxi.

Indian lawyers are largely in favour of a domestic REIT regime. “Implementation would surely help bring transparency in the real estate sector, help standardize stamp duty costs across the country and would give organized players and small investors a kick-start in the commercial real estate investment sphere,” says Asha Nayar Basu, a partner at S Jalan & Co in Delhi.

Backers say the REIT has proved to be a resilient investment model. A report by the global consultancy Ernst & Young released in March concluded that REITs have led other property investments out of the downturn. “Throughout 2008 and into early 2009, REITs reeled from a combination of debt exposure, an illiquid asset base in a falling market and an increasing cost of funding,” the report acknowledges.

The report adds that “just as they led the market into the downturn, global REITs are leading the way out. REITs have raised billions in capital through secondary offerings, and they are using it mainly to reduce their debt, recapitalize their balance sheets and position themselves for growth.” It notes that REIT markets in South Korea, Malaysia and Hong Kong were particularly resilient and ended in positive territory at the end of three years.

Experts warn that the establishment of an Indian REIT market faces a number of challenges. “Parts of India’s legal and tax framework will require amendment and the property industry’s transparency and disclosure levels would also need to be improved significantly,” says Sachin Sandhir, managing director and country head for India at the London-based Royal Institution of Chartered Surveyors, an industry body.

Others warn that REITs can have their downside. “One of the biggest problems with REITs is that real estate becomes a financial vehicle,” says Yoji Otani, managing director and senior analyst at Deutsche Securities in Tokyo. “After approval in the Indian market, real estate prices would be skyrocketing,” he adds. “Global money will go to India aggressively, creating asset inflation.”

In the meantime, Singapore remains the de facto home of the Indian REIT market. Singapore is the third-largest REIT market in the Asia-Pacific region, with total capitalization of about US$20 billion, much of which is investment in India. Two of the largest Indian developers, DLF and Unitech, could launch REITs totalling US$2 billion in Singapore this year.

The international REIT community would welcome a domestic regime in India. “India’s draft REIT regulations were welcomed by the global institutional investor industry, although the draft regulations themselves had many flaws,” says Peter Mitchell, chief executive officer of the Asian Public Real Estate Association in Singapore, a lobbying group. “Nothing has happened since then, which is very disappointing.”

International lawyers agree. “It would definitely be a boost to the Asian REIT market,” says Zain Azra’i Abd Samad, a partner with Abdul Raman Saad & Associates in Kuala Lumpur. “The addition of India, Indonesia or China, with their huge domestic appetite, could do much to propel the REIT industry in terms of growth ahead of the mature European and US markets.”