A regional comparison of real estate markets: India

NAVIGATING INDIA INVESTMENT

India allows automatic foreign direct investment (FDI) of up to 100% in the construction development sector, which includes projects such as townships, residential/commercial premises and hospitals, accounting for a significant nine per cent of recent total FDI in the second quarter of 2023.

This article analyses the current regulatory framework for this vibrant sector, including FDI, real estate investment trusts (REITs), insolvency and structured financing.

FDI IN CONSTRUCTION

With 100% FDI allowed, investors can exit on completion of the project or after development of trunk infrastructure, namely roads, water supply, street lighting, drainage and sewerage.

Each phase is considered a separate project. This means investors can exit and repatriate their foreign investment before completion of the entire project, subject to a lock-in period of three years, calculated with reference to each tranche of the FDI. But these exit restrictions are not applicable to investments in hotels, tourist resorts, hospitals and educational institutions.

Transfer of a stake by one non-resident Indian to another without repatriation of the investment is also allowed, without lock-in period or government approval.

But it is pertinent to note that FDI is not permitted in an Indian company engaged in construction of farmhouses, trading in transferable development rights or real estate business, defined as dealing in land and immovable property to earn profit.

Although the so-called real estate business does not include development of townships, residential or commercial premises, roads or bridges, REITs, educational institutions, recreational facilities, city and regional level infrastructure, and earnings from rent or income on lease of a property not amounting to a transfer.

Foreign companies with a branch office or other place of business in India wishing to acquire immovable property for carrying on business operations are governed by the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019.

This requires them to file certain declarations with the Reserve Bank of India (RBI). Payment for this with funds received in India may be made through normal banking channels by inward remittance from anywhere outside India, or debit to an NRE/FCNR (B)/NRO account.

INVESTMENT TRUSTS

Another recent development for the real estate sector is adoption of the REIT model by both retail and institutional investors. There are presently five registered REITs, including three together owning 11% of grade A office space, a sector projected to soar by up to 68% in coming years.

REITs are principally governed by the Securities and Exchange Board of India (SEBI) REIT Regulations because they are constituted as a trust under the Indian Trusts Act 1982, generally comprising a designated sponsor, manager, trustee and unit holders.

The REIT regulations prescribe that at least 80% of the value of REIT assets must be invested in completed and rent and/or income-generating properties. The remaining 20% must be invested in properties under construction or completed, but not rent-generating properties.

To safeguard investor interests – enabling them to make well-informed decisions for their REIT investments – the regulations prescribe certain periodic valuations, including full valuation of all REIT assets on an annual basis, through a registered valuer. On receipt, such valuation reports are required to be submitted to the designated stock exchange and unit holders within 15 days.

INSOLVENCY AND BANKRUPTCY

The Insolvency and Bankruptcy Code, 2016 (IBC) codifies the existing framework of insolvency and bankruptcy laws, streamlining processes for insolvency and liquidation.

The IBC enables any financial creditor, operational creditor, or the corporate debtor to initiate an insolvency resolution process upon the event of default by the corporate debtor. This must be resolved within 180 days from submission of application for initiation of the insolvency resolution process.

The IBC has had a crucial impact on real estate insolvency for Indian real estate companies involving interests of both homebuyers and real estate developers as stakeholders. Homebuyers are also afforded greater rights through recent amendments and decisions of the Supreme Court.

Previously their role was limited to being recognised as “other creditors”. But since amendments in 2018, homebuyers are now recognised as financial creditors, with the right to initiate the insolvency process against defaulting real estate companies. This right is subject to a minimum threshold on the required number of homebuyers to initiate the process.

Real estate developers are also afforded greater flexibility by the Insolvency and Bankruptcy Board of India in seeking and passing resolution plans of real estate companies. The Insolvency Resolution Process for Corporate Persons Regulations, updated in 2022, enable the committee of creditors to seek a fresh resolution plan in respect of one or more assets of the corporate debtor, where no resolution plan was received for the corporate debtor as a whole.

A resolution professional can also allocate a budget towards a marketing strategy directed at maximising valuation of the corporate debtor’s assets. This amendment allows resolutions designed specifically for individual real estate projects of a corporate debtor, which can also vary based on factors including project size, development type, stage of completion and location.

PROTECTION OF INTERESTS

Apart from the IBC, another prime avenue for lenders to recover their debts is governed by the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act).

If a borrower fails to repay a secured debt, the secured creditor may classify the borrower’s account as a non-performing asset and initiate proceedings to enforce its security interest and take possession of the secured assets; a faster process for debt recovery compared to the civil court process.

A prior notice must be sent to the borrower to discharge the liability in full within the stipulated period, upon failure of which enforcement proceedings may commence under SARFAESI Act provisions.

While the SARFAESI Act controls and facilitates enforcement of financial agreements between real estate developers, homebuyers and banks, the Real Estate (Regulation and Development Act), 2016 (RERA) is the principal legislation balancing the interests of allottees and promoters in construction, development and marketing of real estate projects.

Under the RERA, certain liabilities are imposed on promoters and allottees of the real estate projects. Promoters are required to disclose pertinent information such as sanctioned plans and schedules for completion of the real estate project to allottees.

On the other hand, allottees are primarily liable for making payments in accordance with the sales agreement with the project promoter, along with any financing agreement with a secured creditor, and paying interest in the event of default.

In Union Bank of India v Rajasthan Real Estate Regulatory Authority and Ors, the Supreme Court upheld the decision of Rajasthan High Court, reiterating the principle that the RERA is a special legislation that prevails over provisions of the SARFAESI Act in the event of conflict.

Critically, it further held that RERA authorities had jurisdiction to entertain complaints from homebuyers against banks as secured creditors if the bank takes recourse to any provisions in section 13(4) of the SARFAESI Act.

DEBT FINANCING

Lenders from foreign jurisdictions are also subject to the Master Direction on External Commercial Borrowings, Trade Credits and Structured Obligations (ECB Framework), updated from time to time by the RBI. This framework provides for certain conditions that must be satisfied by borrowers and lenders in cases where the loan falls under the automatic or approval route.

Alternatively, another route that foreign lenders and investors use is through subscription to secured non-convertible debentures of Indian companies, listed or not, in accordance with the SEBI (Issue and Listing of Debt Securities) Regulations, 2008.

The security interest is created in favour of a debenture trustee responsible for holding the security on behalf of the non-resident Indian (NRI) and overseeing compliance by the borrower. The NRI subscriber must be registered with SEBI as a foreign portfolio investor.

Pursuant to amendments in 2021, the RBI amended the Foreign Exchange Management (Debt Instrument) Regulations, 2019 to allow foreign portfolio investors (FPIs) to invest in debt securities issued by REITs and infrastructure investment trusts under the Medium-Term Framework or Voluntary Retention Route. The maximum unit holding of an FPI in a single REIT has, however, been capped at 10%.

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