PE for the mid income housing segment in Tier II and Tier III cities

VIJAY LAXMI ASANGI reveals how developers and investors have turned their gaze to the tier-II and III cities, in order to tap into the rising demand in the mid-income housing segment 

Tier-I cities in India have seen tremendous growth over the past several years and are now close to saturation in terms of their ability to offer sustainably lucrative investment opportunities in various industries. Tier-II and III cities, on the other hand, still boast of relatively untapped demand in various industries, which is only going to get accentuated over time, as these cities witness progressively higher growth enabled by concerted attention from a range of players.

When it comes to property investment, definitely metros are no longer the only investment options; tier-II and III cities are growing exponentially. Also, as observed in a Jones Lang LaSalle India study, the market in these cities is more suitable for local builders than external developers, as the local builders understand regional geographies, culture and consumers’ tastes better. However, most of the regional realty developer firms are small in size and need external funding support. With stringent lending norms followed by the banks, these small developers face problems in capital generation. Therefore, these developers are increasingly looking at private equity (PE) as a preferred funding option.

Sanjay Deshpande, director, Pune-based Sanjeevani Developers, says that “PE brings in clean money and as PE companies are professional financial organisations, they do not expect unrealistic profits.” According to him, more and more PE funding is required in the residential real estate segment, specifically for mid-income housing in tier-II and III cities. The burgeoning middle-class with rising salaries, is looking at acquiring an abode at an affordable price.

As for the PE investors, investing in a real estate fund offers the advantage of portfolio diversification and hedge against economic uncertainties. Dina A Mehta, CEO, Asit C Mehta Investment Intermediates Ltd (ACMIIL), says that “The housing sector needs to be encouraged by all means. Encouraging private investment is the need of the hour, especially from domestic investors. The current risks demand a high degree of skills and returns. A great deal can, should and will have to be done in the interest of all the participants in this sector and for general social good,” she adds.

PE FUNDS MOVE IN TIER-II AND III CITIES

According to a Cushman & Wakefield study, PE investments had come down by 15 per cent, as there was inertia within the government where policy initiatives were concerned, apart from the slow growth in the economy. Besides, several PE funds were looking for exits from their real estate investments. However, PE fund houses are now looking at residential real estate, specifically in mid-income housing across tier-II and III cities and have found good valuations in these cities such as Pune, apart from the fact that exits are quick and provide good returns.

Morgan Stanley’s PE arm has invested USD 65 million in Alpha G Corp, active in tier-II and III cities. The US-based Trammell Crow in a joint venture with the UK-based Meghraj Properties is looking to invest in tier-II and III cities such as Pune, Kochi, Coimbatore, etc. One of the most important factors of investing in real estate in these cities is also the fact that land parcels in metros have become extremely expensive and are in short supply. This significantly brings down the cost of houses and consequently, brings them within the reach of the burgeoning middle class of India.

PROXIMITY TO MUMBAI ATTRACTS PE INVESTORS TO PUNE

Pune is a three hour drive from Mumbai and therefore, has always been a favourite with the real estate investors. Also, since real estate prices in Mumbai have gone through the roof and profitable deals are tougher to be found in the city, both domestic and international PE funds are increasingly investing in Pune property. The proximity to Mumbai is also a great advantage, as monitoring the real estate market in Pune becomes easy.

According to Jones Lang LaSalle India, Pune saw close to USD 800 million of PE deals (domestic and foreign) till December 2011 and a large part of this money went into residential segment. Some of the international PE fund houses that have invested in Pune real estate are Mauritius-based Paracor Capital Advisors, US-based hedge fund Och-Ziff Capital Management Group LLC, India-based HDFC Realty Fund and Peninsula Land Limited. In December 2011, ArthVeda Fund Management Company launched a Rs 200 crores real estate fund to invest in mid-income housing in tier-II and III cities and in emerging metros such as Pune.

MID-INCOME HOUSING IN GREAT DEMAND ACROSS TIER-II AND III CITIES

This ongoing growth has opened up a number of investment opportunities in real estate for PE investors. Apart from the likely increase in demand for commercial real estate with the advent of corporates, residential real estate market will see a strong demand. While the existing mid-income households would continue to drive replacement demand, an additional boost will come from households crossing over the mid-income segment and aspire for a better living condition. Besides the rising exposure level, cultural changes and the younger generation’s desire for independence will create further demand on account of increase in nuclear families.

As housing demand picks up, there will be a significant potential demand for construction materials by developers and housing appliances by the residents. This has increased demand for consumer goods and a healthy growth is seen in other related sectors as well. This definitely presents a scalable investment opportunity for PE investors in mid-income housing.