Corona Virus Effect Will Most Likely See The Funding For The Real Estate Sector Go Up As The Risk Increases

The cost of institutional funding for real estate projects during and post COVID-19 is likely to become expensive with financial institutions having to factor in risks of completion, construction timelines, supply chain disruption, zero absorption, not to mention the high cost of forex hedging, say transaction experts.

Despite the government having reduced lending rates by 75 bps points, banks will continue to be cautious while lending to the real estate sector and NBFCs and HFCs too post the IL&FS crisis, may not be forthcoming either unless some steps are taken to encourage them to lend to the sector.

The only recourse left to developers post the three-month moratorium will then perhaps be the domestic and foreign institutional funds who have all along been lending at 15-17 percent earlier and may decide to lend at 19-20 percent post COVID depending on the risks associated with the projects.

The RBI moratorium for three months, say experts may resolve the cash flow issue but what will not get addressed is the issue of liquidity in the real estate sector. For those who do not know, the sector receives funding from four categories of investors – banks that includes PSU and private sector; NBFCs and HFCs or shadow bankers for real estate; domestic funds and international funds (the likes of HDFC Capital, Kotak and Goldman Sachs and KKR).

“Today, deals are not happening and the overall risk has gone up on account of coronavirus. Due to COVID-19, these funds may ascribe anything between 150 bps to 200 bps premium to the price point that they were seeking earlier. If they were looking at 17-18 percent returns earlier, they would not want to look at returns of 20 percent,” says Anckur Srivasttava of GenReal Advisers.

“Structured debt- pricing of capital is likely to increase going forward,” he says.

The last deal to go through in these COVID-19 times was in March this year when Delhi-headquartered financier, DMI Group had raised $200 million from overseas investors by selling rupee-denominated non-convertible debentures (NCD’s) to them despite tight liquidity conditions in global and local credit markets. The company operates in the consumer lending and affordable housing segments.

“Overall, institutional funds may increase lending rates by 200 bps despite the three-month RBI moratorium. That is going to be a major pain. If that happens, projects may no longer be viable. The projects may not be able to sustain the cost of debt which is over 17-18 percent. Anything above that will be unsustainable at a point when sales are not happening at all, collections are zero and revival of constructions seems uncertain,” he says.

Fund managers agree that at this point in time there are no new transactions that are taking place. “At this point no one is evaluating fresh transactions. This is because real estate is a touch and feel business and in a lockdown situation, it is impossible to make site visits. This hinders a deal from taking place,” a transaction expert told Moneycontrol.

Funds may invest in ‘safe’ and completed projects

The way forward, say some experts, is that funds would prefer investing in projects that are ‘safe’, command the least risk and are at the ‘completion’ stage.

“In light of increased risks during and after the COVID-19 phase, funds would prefer to invest in assets with the lowest risk, especially completed assets that have an occupation certificate and low debt. For projects meeting these benchmarks, the rate of interest could be close to what it was earlier – around 14-15 percent but for others, the rate could be as high as 20 percent. Going forward, there would be a race towards ‘safe projects’,” says another transaction expert.

Demand for funding to emanate from NBFCs and HFCs. “The RBI moratorium for three months is for banks. NBFCs and HFCs still have to make all bank and MF payments on time. This would lead to the cash flows of the more leveraged institutions getting strained and they may not be in a position to deploy significant funds even if the lockdown is lifted and there is room for fresh transactions to take place,” says Amar Merani, managing director and CEO of Xander Finance.

Will the cost of funding go up?

Finance providers would prefer to invest in assets with the lowest risk, especially completed assets that have an occupation certificate and low group level debt. For projects meeting these benchmarks, the rate of interest could be close to what it was earlier – but for others, the rate could be higher. Going forward, there would be a race towards ‘safe deals’, he says.

A real estate developer Moneycontrol spoke to said that the current scenario is extremely ‘dismal and scary.’ Tenants in malls and even office occupiers are asking for rent reduction and even complete waiver. “If we write off their rents, how will we service our debts,” he asks.

“New lending may now be almost impossible now. The scenario going forward will be scary. If institutional funds start lending upwards of 20 percent, how will the projects be viable. In some cases, even sanctioned loans are not coming through,” he says.

“The industry is expected to face acute problems going forward. The problem is aggravating by the hour. Coronavirus is the nail in the coffin,” he said.

Another real estate developer is of the view that funding could in fact become easier to come by because PSU banks may start funding the real estate sector going forward. Having said that, the government should mandate that and create an enabling environment for the PSU banks to start funding the sector.

“It can designate home loans upto Rs 70 lakh as priority sector lending and segregate the risk weightage associated with the sector. The entire sector is funded under commercial real estate. The risk associated with residential should be lowered,” he says.

Having said that, the biggest tragedy that developers may face in the next six months would be that while banks would be ready to fund projects, there may not be workers at construction sites. “If I don’t get back workers in the next six months, what am I supposed to do with capital,” says the realtor.

A six month delay will have an impact on the construction cycle upwards of two years, he says.

In the case of the commercial segment, too, investors are analysing the risks associated with tenants moving out or for that matter multinationals wanting to renegotiate their existing contracts or decide to shrink their business in India.

Current estimates of the COVID-19 impact on Indian commercial real estate indicate net office space absorption across the top seven cities will plummet by 13-30 percent in 2020 against 2019, “ says Shobhit Agarwal, MD & CEO – ANAROCK Capital.

“This is because most multinationals and domestic businesses will re-strategize their expansion plans and optimize operational costs in the wake of the COVID-19 pandemic. All these factors will inevitably impact the Indian investment plans of US private equity majors as well.”

“Investors are studying this impact. In the residential space too, with salary cuts and uncertainty associated with jobs, the propensity to consume will go down drastically, especially with regard to long term commitments,” explains another expert.

Going forward, it is imperative that the government announces certain measures to relax lending norms to the sector such as reducing the risk rate for the sector or for that matter allow for refinancing in an existing project that may be stuck, says a banking expert.

“There should be a temporary relaxation of these norms and restructuring of loans should be allowed,” he says.

What will happen going forward?

Foreign funds and for that matter even domestic funds will play an opportunistic game going forward and some experts believe that there may actually be more lenders in the market offering loans at competitive rates. Banks will be loaded with liquidity and offer low interest rates. This may propel funds to reduce their expectations.

“If PSU banks do start lending at 10-11 percent for construction finance, the borrower who is borrowing at 14 percent for construction finance will get access to 10 percent. In such a scenario, funds would have to recalibrate their expectations as per the market,” says a capital markets specialist, adding they may offer funds at 13 percent in case banks offer at 11 percent and may decide to reduce their expectations.

A 14 percent return for an international investor is also a ‘healthy’ return considering the rates being given in emerging and mature markets during COVID times, he says, adding the returns would definitely be better than in their home country despite the increased risks.

One thing is clear though, the stress on funding is definitely going to increase, not decrease anytime sooner, at least until COVID-19 is under control.

(Source: Moneycontrol)