Real Estate Financing

AREAS OF REAL ESTATE

MARKET
Development Project Typical Sources of Investment Capital

Angel Investor or VC

3
 OPTIONS FOR FINANCE
 Investment/Equity
 Debt
◦ Deciding the appropriate balance of equity and debt will
be an important decision when deciding the appropriate
funding or capital structure for our business.
◦ Overall aim is to find the mix of finance that minimises
overall capital structure, thereby increasing the net
present value of future cash inflows.
◦ Credit Score requirement, debt to equity and interest
coverage. Could be Liability to Asset Ratio. Ideally 1 to
1.5. Real Estate may go upto 3 to 3.5.
◦ The criteria and implications of each source require
critical analysis before proceeding, and it is essential to
weigh the cost versus benefits of each source before
making a decision.
FINANCING SOURCES
 BANK CREDITS:
 Cash Credit/Overdraft / PROJECT LOAN
 FACTORING
 LC/BG(Non fund Based)
 Lease Rental Discounting ( LRD )
 Loan Against Property
 EXTERNAL COMMERCIAL BORROWING (ECB), not
permitted for Real Estate Business by RBI.
 PRIVATE EQUITY- DOMESTIC FUNDS
 FOREIGN DIRECT INVESTMENTS CCD/
 CCP/EQUITY
 FCCB/ADR/GDR/QIP(For Listed Co.’s)
 IPO in International markets such as ( Alternate Investment
Market- London )AIM
BANK CREDIT – CC/OD/ PROJECT
LOAN
 Purpose: To meet working capital requirements
 Amount of facility: Based on the Bank's
assessment of working capital requirement
(WIP & book debts)
 Security:
 Charge on Current assets
 Collateral(s) on case to case (External rating
etc)
 Interest Rates: 12% -16%
 Tenure : 1 -5 years
 BANK CREDIT – LC/BG
 Letter of credit(LC) is a written undertaking by a
bank(issuing bank) given to the seller (beneficiary) at
the request and in accordance with the instructions
of buyer (applicant) to effect payment of a stated
amount within a prescribed time limit and against
stipulated documents provided all the terms and
conditions of the credit are complied with.
 Bank guarantee is a type of guarantee in which a
bank promises to repay the liabilities of a debtor in
the event of default.
 The contract of guarantee has three parties
Principal Debtor, Principal Creditor, Guarantor i.e.
Bank
BANK CREDIT – FACTORING
 Factoring is a service that covers the financing &
collection of account receivables of series of trade
transactions between a seller & a buyer in the
domestic market as well as international market.
 Advantages:
◦ • It is among the quickest & easy way to get advance cash
◦ • Cost effective with elimination of demand & collection
activities
◦ • Getting cash with factoring helps in eliminating the risks
of bad debts
 • It helps the company in developing more projects
 • It gives an opportunity to offer credit to customers
 • It helps in building credit history and no long-term
obligation
BANK CREDIT - LEASE RENTAL
DISCOUNTING
 Lease Rental Discounting (LRD) is a type of Term Loan
offered against rental receipts derived from lease
contracts with corporate tenants.
 Quantum:
◦ Based on the discounted value of the rentals
◦ 60% to 80% of underlying property value.
 Tenure: 5-15 yrs( Linked with lease period, lock in ,
quality of tenant etc.)
 ROI :@10.50 – 13%
 Repayment Mode: Generally Rentals are payable by the
tenant directly to an escrow account with lending bank.
 Security: The underlying leased property will be taken as
prime security.
BANK CREDIT -LOAN AGAINST
PROPERTY
 Loan against property is similar to other
loans like term loan, Equipment Loan etc.
 Quantum of Loan:
◦ Depends on type of property
◦ Income of the borrower
◦ LTVs are at 60 - 70% of PMV
 Tenure: Flexible for 1 – 15 years
 Interest Rates: @11%-14%
 Security: Charge on Property
 EXTERNAL COMMERCIAL
BORROWINGS ( ECB)
 ECB allow corporate to access the foreign currency loans through
commercial bank in the form of loans, suppliers’ credit, fixed rate bonds,
nonconvertible, optionally convertible or partially convertible preference
shares availed of from non-resident lenders.
 Was opened in January 2009, ECB route was opened for the development
of Hotel projects, integrated townships, Low cost affordable housing &
Industrial Parks.
 For Industrial Parks ECB is allowed under automatic route while for SEZ &
 Integrated township development ECBs is allowed under approval route.
 Real Estate companies like Jai Prakash Associates, Unitech, HDIL and AMR
 Construction, etc. have used ECB to raise funds.
 Maximum Loan Amount:
◦ Corporate engaged in hotel, hospital & software sectors: Up to USD 200 Million
◦ Real sector ( Industrial & Infra): up to USD 750 Million. Now stopped.
 Factors to be Considered
 Risks
 Costs incl Total cost of capital
 Control. Requirement of investor and
lender.
 Long Term Vs Short Term Borrowing
 Repayment Terms
 Risks
 Capital risk
 Market risk
 Liquidity risk
 Interest rate risk
 Currency risk
 Option risk
 Investment timing risk
 Credit risk
 Legal regulation
 Systemic risk

The higher the level of risk, higher the return required.

 Costs
 The cost of finance and its effect on income will
play a fundamental role in our financing decision.
 Investors may consider that the additional borrowing
increases the risk of bankruptcy then they may
require an additional return as compensation for this
risk. Therefore, this compensation will represent an
increase in the cost of equity.
 We also need to consider the other costs of
borrowing which include interest rates, origination
fees, and brokers’ fees.
 Lenders often require additional security to safeguard
against defaulting on a loan
 Cost of IPOs and Listing.
 Control
 Issuing additional shares (equity) will result in a
dilution of control among existing
shareholders/owners.
 Investors will require input into the operations such as
sitting on the board of directors and receiving
performance and operation reports. Provide them with
information that you may have wished to keep hidden
from your competition, as well as detailed explanations
for your business decisions.
 Owners who do not want to lose control of their
business, will only consider equity financing up to a
certain level or may prefer loan capital.
 Once the loan is paid back, your relationship with the
lender ceases, whereas investors continue to have a say
in the company until they are bought out, the company
is sold, or goes public.
 Long Term Versus Short Term Borrowing
 Long Term Funding. If we are obtaining a noncurrent asset, for
example, Real Estate, a piece of machinery that will form a
permanent part of our operating base, then we would consider
using a long term source of finance to fund this asset.
 Long term finance will be repaid over a longer period and include
institutional loans, bank loans, hire purchase, debentures
and retained profits

 Short Term. This kind of finance is intended to be paid back in a

matter of months rather than years. As a result, there is less risk
involved for the lender.
◦ Overdrafts and supplier credit would be an example of short term
finance. Short-term financing can often appeal more as they often
come with no additional penalty for early payment, which is not
the case with some sources of long-term finance.
◦ Flexibility will also have an important bearing when choosing an
appropriate source of funding. If interest rates are high but are
forecasted to lower in the future, we may choose a short-term source
of funding to delay a commitment to long-term sources until a future
debt.
 Equity
 Financing through issuing new shares can
lead to a change in management and a
shifting in strategic focus. In addition, the
costs associated with issuing new shares can
be substantial and there is also uncertainty
with regards to the success of the issue.
 Furthermore, shareholders will expect
appreciation for their investment in the form
of a dividend or increased share value.
 The payment of dividends is not tax
deductible whereas interest payments on
borrowing are tax deductible.
 Grants, Venture Capital or Angel Investors

 Receiving a grant may mean that we won’t

incur additional debt.
 Grants often come with certain criteria that
must be met such as employing a certain
number of people over a period of time or
using the funds for research and
development or say low cost housing etc.
 Money from venture capitalists, for example,
may not require repayment for years, at
which time the investor may expect to be
repaid at a steep premium all at once.
 Providing direction and control
 REITs and InvITs
 The REITs providing a platform to pool money for
investment in properties, especially commercial ones.
 These are first required to be registered via an initial
public offering.
 Just like stocks, investors can buy REITs as securities
from both the primary and secondary markets.
 REITs are registered with stock exchanges and are
structured like trusts with their objective being able
to provide investors with dividends acquired from the
sale money of assets such as offices, residential units,
hotels, shopping centres and warehouses etc.
 Real Estate Investment Trusts
A REIT is an investment vehicle that owns and operates real estate-related
assets, and allows individual investors to earn income produced through
ownership of commercial real estate without actually having to buy any
assets. Typically, the income-producing real estate assets owned by a REIT
include office buildings, shopping malls, apartments, warehouses and
mortgaged property.

REITs were first introduced in the US in the early 1960s and

have since then been adopted as a preferred investment mode
across the world. Over the years, they have constructively
changed the way in which the real estate market operates,
benefitting investors as well as real estate developers
 STAKE HOLDERS AND BENEFITS
Developers
❖ Liquidity REITS and InvITs facilitate the following:

• An increase in entry and exit opportunities for developers, asset owners

and financial investors, enabling them to monetise their assets (real estate or
projects)
• Availability of last-mile funding for stalled projects

❖ Business

• Transformation of business from an asset-heavy to asset-light model

• Focus on core competencies, and segregation of operations and

infrastructure

• Capital-raising avenues for developers of small companies

 BENEFITS
 Retail Investor
◦ Facilitation of easy entry and exit in the real estate sector
◦ Small retail investors able to participate in asset classes that are normally
unaffordable for them
◦ Additional income generating and stable investment avenues offered for
retirement planning
◦ Diversification of investment holdings enabled to help financial and strategic
investors
◦ manage risk. Risk management strengthened by allowing holding of multiple
assets to reduce concentrated asset risk
◦ Fragmentation of real estate asset holdings with multiple owners avoided,
leading to focussed high-quality asset maintenance
◦ Forced strata sale of assets at discounted valuation discouraged

 Industry
◦ Facilitation of easy entry and exit for existing financial investors
◦ Alternative financing offered
◦ Low-risk investments offered to attract long-term investors such as insurance
and pension fun
 SEBI has devised detailed guidelines governing the markets
for
 investments, covering the following:
 • Eligibility of the sponsor (the person who sets up the REIT
 or InvIT), the manager of the trust and the trustee
 • Investment conditions such as the ratio of the value of
 income-generating assets as well as other assets
 • Policies and requirements with respect to distribution of
 dividends, minimum capital required for an initial public
 offer (IPO), listing requirements, key responsibilities of the
 parties to the trust, etc.
 Pre-requisites for Bank Loans
 A Builder/Promoter is required to make a project report before approaching
Banks or any other financial institutions for finance purposes.
◦ Details of the project cost and means of finance.
◦ Profitability statement.
◦ Annual Cash Budget for the duration of the loan showing monthly/quarterly cash inflows of
the specific project along with repayment schedule.
◦ Audited financial statements for the last 3 years, the current year’s estimate and projections
for next 3 years or till the completion of the project.
◦ Original Title Deed of the land, detailed estimate of the proposed construction from a
Chartered Engineer/Architect and permission from the competent authority of the property
in case it is falling under Urban Land Ceiling Act.
◦ Documents like non-encumbrance certificate, certified copy of renew/Municipal receipts,
Lawyer’s opinion on ownership and marketable title and sanctioned plan.
◦ The Bank should enter in to a legally vetted tripartite agreement with promoter and buyer
that should ensure among other covenants adherence to National Building Code (NBC).
SECURITY FOR REAL ESTATE
 Primary: The primary security will be the
building which is being constructed and also the
land on which it is constructed. The amount of
Bank finance should be adequately covered by the
value of primary security.
 Collateral: Collateral in the form of
equitable/registered mortgage of other land and
building of adequate value of promoter/ guarantor
may be taken. There has to be 25% (minimum)
Margin between the amount of loan and collateral
property. Constructed site should be fully insured
against fire, riots and other damages according to
Bank’s clause.
 Delivery of Credit

 The credit/quasi credit requirement of a

Builder by way of cash credit/short term
loans/overdraft linked to each specific
project for a maximum period covering the
period of construction plus 12 months will
be considered on merit. Loan amount is not
given to the builder/promoter in lump sum
manner, the extension of loan will be in
phases depending upon the progress of work
as certified by Chartered
Engineer/Architects.
 Repayment

 Repayment is to be made in pre decided

instalments after completion of the
project and sale of the flats as decided
earlier. It is prohibited to use sales
realizations of one Project in another
Project. Loan amount has to be paid
before and then builder can use the left
amount in other projects.
 Specific Terms
 Raising money abroad and Masala Bonds
 Leverage
 Credit Scores
 FDIs/FIIs
◦ India is ranked fourth in developing Asia for FDI
inflows as per the World Investment Report 2016
by the United Nations Indian real estate has
attracted $32 billion in private equity so far. The
global capital flow into Indian real estate in 2016
stood at $5.7 billion.