Regulatory framework for FI, financing in Indian property
Current Indian foreign direct investment (FDI) regulations allow investment of up to 100% in the construction sector under the automatic route, with certain conditions. Construction projects include the development of townships, residential/commercial premises, roads or bridges, hotels and resorts, hospitals, educational institutions, recreational facilities, and city and regional level infrastructure.
FDI in India can be made through equity shares, compulsorily convertible debentures or compulsorily convertible preference shares. In addition to FDI, India has witnessed strong inflows of foreign funds in structured debt to real estate companies, those debts being high-yield, coupon-bearing and mortgaged-backed (with real estate assets), and arising through foreign portfolio investors and alternate investment funds.
This article analyses the current regulatory framework for foreign investment, real estate investment trusts (REITs), insolvency, and structured financing in the Indian real estate sector.
FDI
Foreign investors in the construction sector are permitted to exit a project after the development of trunk infrastructure (i.e. roads, water supply, street lighting, drainage or sewerage). While each phase of a construction project is considered a separate project, the investor is also permitted to exit and repatriate its investment before completion of the project, subject to a lock-in period of three years, calculated with reference to each tranche of the FDI. These exit restrictions are not applicable to investments in such infrastructure as hotels, tourist resorts, hospitals and educational institutions.
The transfer of a stake from one non-resident/foreign investor to another non-resident/foreign investor without repatriation of the investment is allowed, and is subject neither to any lock-in period nor to any government approval.
No FDI is permitted in an Indian company engaged in the construction of farmhouses, trading in transferable development rights, or in real estate business.
The term “real estate business” includes the business of dealing in land and immovable property with a view to earning profit, but does not include development of: residential or commercial premises; roads or bridges; REITs; educational institutions; recreational facilities; city and regional level infrastructure; and townships. Earnings from rent or income on the lease of a property, not amounting to a transfer, is exempted from the definition of real estate business.
Further, 100% FDI under the automatic route is also permitted in completed projects for the operation and management of townships, malls/shopping complexes and business centres. However, there would be a lock-in-period of three years, calculated with reference to each tranche of FDI, and the transfer of immovable property or part thereof is not permitted during this period. FDI regulations also allow 100% FDI under the automatic route in real estate broking.
REITs
One notable development has been the introduction of the REIT regulations allowing the constitution and listing of such instruments. Currently, there are four listed REITs in India, three in the commercial office space and one in the retail mall space.
A REIT is constituted as a trust under the Indian Trusts Act 1982, registered with the Securities and Exchange Board of India (SEBI), and generally comprises persons designated as the sponsor, manager, trustee and unit holders.
Such REITs require a minimum asset base of at least INR5 billion (USD60 million) and at least 80% of the value of REIT assets must be invested in completed and rent and/or income-generating properties, while the remaining 20% can be held in the form of stocks, bonds, cash, or under-construction commercial property. At least 90% of rental income earned by a REIT has to be distributed to its unit holders as dividends or interest.
Most recently, the SEBI has notified a regulatory framework for small and medium real estate investment trusts (SM REITs). These are now allowed for smaller or medium-sized projects of at least INR500 million, and not more than INR5 billion. SM REITs can have commercial or residential assets, and require at least 200 investors and at least 95% of the value of the scheme’s assets to be invested in completed and revenue-generating real estate assets/properties, with only up to 5% held in cash, liquid mutual fund schemes and fixed deposits.
SM REIT regulations are likely to be a catalyst for the widespread unlocking of the value of commercial real estate in India, although only one SM REIT has received a licence from the SEBI at the time of writing.
Debt financing
Most debt financing by foreign financial institutions in the real estate sector in India is through either: subscription to secured non-convertible debentures of Indian companies in accordance with SEBI regulations, which may or may not be listed on a stock exchange in India; or loans/debt from alternate investment funds (AIFs) set up in India.
The security interest is created in favour of a debenture trustee, who is responsible for holding the security on behalf of the foreign investor and overseeing compliance by the borrower. The foreign investor subscriber must be registered with the SEBI as a foreign portfolio investor of a SEBI-registered AIF.
Insolvency in real estate
Another key regulation in India is the Insolvency and Bankruptcy Code, 2016 (IBC), which sets out the framework of insolvency and bankruptcy laws, and streamlines the processes for insolvency and liquidation of corporate persons in India.
The IBC enables any financial creditor, operational creditor, or the corporate debtor, to initiate an insolvency resolution process in the event of a default by a corporate debtor, which must be resolved within a fixed period of 180 days from the submission of an application for the initiation of the process.
The IBC has a crucial impact on all stakeholders: homebuyers, lenders and real estate developers. It allows developers with the financial capability and delivery records to salvage an incomplete real estate project where promoters have no financial means to complete the entire works.
Homebuyers have been afforded greater rights through amendments and decisions of the Supreme Court. While initially their role was limited to being recognised as “other creditors”, homebuyers are now recognised as “financial creditors”, and given the right to initiate insolvency processes against defaulting real estate companies, and also take a seat on the committee of creditors. This right to initiate insolvency is subject to a threshold on the minimum number of homebuyers.
Real estate developers in India have also been afforded greater flexibility when seeking and passing the resolution plans of real estate companies. IBC regulations allow a “resolution plan” in respect of one or more projects of the real estate corporate debtor, where no resolution plan was received for such a corporate as a whole.
Enforcement
Apart from the IBC, another prime avenue lenders can use 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, take possession of the secured real estate assets, and monetise the assets without any intervention of the court.
This is a faster process for the recovery of debts in comparison to the ordinary civil court process.
A prior notice in this regard must be sent to the borrower to discharge the liability in full within the stipulated period, on failure of which the enforcement proceedings under the provisions of the SARFAESI Act may commence as per the process set out under its regulations.
In the recent past, the SARFAESI Act has been well used and implemented by lenders in the foreclosure of real estate assets as securities, selling them through public auctions and/or private treaties.
The real estate sector is pivotal to the growth of the Indian economy.
It is one of the biggest contributors to the economy, is its second-largest employment generator, and has more than 275 allied industries (including steel, cement and other construction materials) dependent on it to sustain their businesses.
Happily, the real estate sector in India has been enjoying a notable boom, capturing the attention of investors, homebuyers and corporates, both domestic and foreign, and the surging demand for properties seems likely to continue for some time.
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