Hectic lobbying is on to bring about a small change in the way a rule on foreign investment in property is interpreted—a change that could backfire on overseas investors but rescue several Indian realtors.
It will not require a Cabinet decision or a new Press Note issuance by the government. All it calls for is a simple government clarification—one that could make or break many players in the local property market that has attracted around $20 billion in the last five years.
According to the foreign direct investment (FDI) regulations, a foreign investor has to bring in a minimum $5 million to participate in a JV with an Indian developer while the rest of the money can be brought in at a later stage, may be in tranches.
Incidentally, the March ‘05 Press Note 2, which spells out the FDI rules, says: “Original investment cannot be repatriated before a period of three years from completion of minimum capitalisation.”
Till date, the interpretation has been that the 3-year lock-in applies only to ‘original’ or ‘minimum’ investment of $5 million and not the entire money that the foreign investor puts in.
For instance, if a foreign fund invests $100 million, the interpretation has been that it can recover and repatriate up to $95 million before 3 years while the balance $5 million can be repatriated only after 3 years.
But not any more, something the government would soon specify.
“We are expecting a change....There have been representations to the government to clarify that the repatriation rule and the lockin should apply to the entire investment and not just the initial capitalisation of $5 million,” said a large shareholder of a top property firm.
The change could mean a boom to at least 30 Indian real estate groups, large and small, which had sold put options to foreign investors to bring in FDI through fancy deals.
But grappling with a cash crunch, slow demand and soft property prices, these developers are today not in a position to honour these options. And even if they can cough up the amount, they want to avert a large payout.
Under the circumstances, if the government spells out that the entire investment of the foreign investor is locked in for 3 years, the foreign investor will not be able to exercise the option immediately. This will give several cash-strapped property developers the time to organise money.
PRESENT SCENE
The 3-year lockin clause is being extended only to the ‘original’ or ‘minimum’ investment of $ 5 million in a realty JV, and not the entire amount a foreign investor brings in
THE DEMAND
Indian realty cos now want the govt to clarify that the repatriation and lock-in rule should apply to the foreign entity’s entire investment
THE IMPACT
At least 30 Indian realty groups stand to gain. If total investment is locked, a foreign investor will be unable to exercise the put option sold to it. Also, Indian cos will get time to raise funds & avoid distress sales
FUTURE LOCK
Many experts think the new interpretation must not be applied retrospectively Distress sales can be avoided
AND, more importantly, they can avoid distress sales and hang on to higher property prices.
But some say the new interpretation, informally being spoken about by government officials, should not apply to deals that were signed before. “It (the new clarification) can have a significant impact on FDI in real estate sector. At best, it should apply prospectively,” said Pricewaterhouse Coopers financial service practice tax leader Punit Shah. “The existing FDI,” said Mr Shah, “was done on the basis of earlier interpretation.”
In the original investment documents, signed at the peak of the property boom, the builders had agreed to pay back bulk of the money after one or two years. Local builders and global property funds resorted to new financial structures that helped them side-step FDI restrictions; and more importantly bring in money that was essentially debt but could masquerade as equity.
Indian property firms and special purpose vehicles floated by them issued a new security called compulsory convertible debentures (CCDs) to foreign funds while promoters signed a simultaneous agreement in which they agreed to buy back the CCDs after one or two years at a pre-agreed price.
Starved of institutional finance, it was a desperate, expensive and risky mechanism to bring in money. But few cared as property prices rose, real estate emerged as a new asset class and everybody thought that the boom would last forever.
Today, real estate stocks have dropped, property buyers who were pure investors have left the market and deals are few and far between. “Since the chips are down, builders are pushing for a new interpretation of the FDI norms. In the last few years, no one objected to the rules,” said the country head of private equity firm which is looking for an exit.
While a clarification on the lock-in may not go down well among foreign funds, who would be stuck for a few more years, the government may give in to a formidable lobby.
