Realtors turn to AIFs for solving funding woes

lending to real estate developers via category II AIFs has become popular because banks and even housing finance companies lend only for construction activities and not necessarily for purchasing a land.

At a time when banks and other financial institutions have become cautious in lending to the real estate sector, alternative investment funds (AIFs) have emerged as a popular vehicle for financing real estate projects.

According to industry players, Category II AIFs are taking a lead in making funds available for realtors by subscribing to NCDs or non-convertible debentures issued by developers.

The recent past has seen a jump in such real estate focused AIF funds being launched as there is a huge demand from both, developers and the investor community, they say. Even though banks offer a lower rate of interest on loans as compared to AIFs, complexities are lower in AIFs as compared to banks.

"Real estate developers are increasingly reaching out to us for growth capital as well as re-capitalization," said Amit Bhagat, chief executive officer and managing director at ASK Property Fund.

He further said that lending to real estate developers via category II AIFs has become popular because banks and even housing finance companies lend only for construction activities and not necessarily for purchasing a land, which a fund can do. Further, banks don't lend for increase in working capital requirements, he said.

Incidentally, RBI rules bar banks from lending for land acquisition, or fees for land approvals, among few other things which an AIF fund can provide, said a person on the condition of anonymity.

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“Not only that the banks are hesitant to lend to real estate but even if they agree to lend, the commercials turn out to be very difficult (for realtors),” said Siddharth Mody, Partner at JSA Advocates and Solicitors.

He further banks they will not typically change the terms of loan although the same is possible in AIF as private parties have an ability to negotiate the terms.

Another part is that banks generally are not too enthusiastic in lending to construction projects, said an advisor to a real estate fund. Also, after the 2009-2015 real estate slowdown, banks are wary of lending to real estate and they prefer to lend only to completed larger developers.

This is how the funding is done through AIFs.

It all starts with a meeting between the realtors and the AIF investment manager where the projects and the funding requirements are deliberated in detail to understand the requirements and the size of the fund that needs to be raised.

This is important also from a regulatory perspective as the rules laid down by the Securities and Exchange Board of India (SEBI) state that an AIF cannot have an exposure of more than 25 percent towards a single company or entity.

The investment manager then initiates the process of raising funds from his clientele and once the funds are in place, the real estate entity issues NCDs that the AIF subscribes to.

While there are other ways through which an AIF can fund a real estate developer, industry players say that the most common way in which it is happening is through NCDs, which are used by companies to raise long-term funds and they cannot be converted into equity.

“This is essentially like an AIF lending to the company. And it cannot be converted into equity so it has to be redeemed at one point of time. This is more like repaying the loan,” said Joseph.

Indeed, as the real estate company will have to pay a certain coupon on the borrowed funds – the rates are typically in the range of 14-15 percent, however, it can go as high as 22 percent also.

“How often the coupon has to be paid will depend on the kind of cash flows the company is generating,” said a person on the condition of anonymity.