Debt & dash of equity is realty’s new cocktail

Blame it on a welter of scams plaguing the sector or overheating of the economy, but private equity’s (PE’s) way of seeing real estate is undergoing a transformation.

PE players, who are expected to pump in $1 billion into the realty sector in 2011 are no more interested in buying mere equity of realty firms. Instead, they are opting for structured deals that combine debt and equity.

In a structured PE deal, the investor gets a minimum assured return against the debt component, while holding a portion of the investment as equity.

“It is not that structural finance is a new phenomenon but by the end of 2011 there would be about $ 1 billion worth of structured deals in real estate, as PE players want to play safe. No two deals are similar and it is entirely based on several possibilities,” said Sandeep Kotak, business head, real estate, Kotak Mahindra Bank.

In most cases, a company’s earnings is being considered while finalising the deal, with an option of converting debt to equity at a later stage. Many deals are also happening in mid-level realty firms with an option of conversion or “put “options (to sell at a specified price), said an industry expert.

“Volumes in real estate have gone down, which directly reflects on a company’s topline. In this scenario, not much PE activities are happening and investors are opting for structured deals at the SPV (special purpose vehicle) level,” said Uday Dharamadhikari, CEO, Usha Breco Realty, a Mumbai real estate firm focused on affordable housing.

“There is a huge gap as far as valuations are concerned between developers and PE players, as the yardstick for measuring the same is different for both. Although, at least on paper, PE players have an upper hand,” said a PE player who recently invested in a project in the National Capital Region. At a time when raising liquidity through the capital market is almost closed and banks are taking a cautious approach towards realty firms due to recent scams, PE remains the only option, though developers too are adopting a cautious approach towards structured deals.