India's real estate sector is seeing record bond sales as developers tap demand from yield-hungry private credit funds to replace other sources of funding.
Banks, mutual funds and non-banking lenders have shown decreasing appetite to finance the property sector due to tightening regulations and general risk aversion, but bond investors are filling the gap.
The total bond volume in the housing, construction and real estate sector is expected to pass last year's high of Rs574bn (US$6.8bn) amid an upturn in the industry and the rapid growth of private credit funds looking to deploy capital in high-yielding investments. Total bond volume for the sector in the first 11 months of this year was Rs500bn, according to Prime Database.
"We do expect bond issuances by real estate and construction companies to touch an all-time high this year as private credit [assets under management] for real estate are also near all-time highs," said Saurabh Rungta managing director at Avendus Wealth Management. "We expect this trend to continue even next year."
Among the recent deals, Century Joint Developments, rated C by Acuite Ratings, issued Rs8.5bn four-year bonds, according to data from National Securities Depository. The bonds were sold with a coupon of 10% and an all-in yield of 22% to Ares SSG Capital Management, according to market sources. A spokesperson for Ares SSG declined to comment.
The residential, commercial and retail builder and developer sold the high-yield notes to refinance bonds.
Acuite said the company faced liquidity constraints because of delays in project construction and had deferred repaying its bonds.
Other real estate developers that printed high-yield bonds this year include Prestige Projects, Kalpataru Projects International, Provident Housing, Suruchi Properties, Shreshta Infra Projects, Prateek Realtors, Pharande Township, and Purva Good Earth Properties, with their combined volume totalling US$666m, according to an EY private credit note. The developers raised mostly high-yield bonds to fund greenfield residential projects in Indian cities and refinance debt.
Pool of private credit
The growing pool of private credit in India is supporting demand for these issues. Real estate funds had 8% of their Asia Pacific-focused AUM, equivalent to US$21.2bn, deployed in India at the end of March, up from US$20.3bn in 2021, according to Preqin.
Nearly 27% of private credit investments in India in the first half were in the real estate sector, according to EY. The growth has been supported by the government's decision to tax capital gains from debt funds, cutting returns and prompting investors to search for yield elsewhere.
"Family offices and high-net-worth investors are now looking at private credit and real estate strategies for higher post-tax returns – in double digits – with an intent to beat inflation," said Rungta. "Ever since the tax arbitrage has been removed, money which was going into fixed-income funds – due to indexation benefit – is now getting reallocated to private credit funds, including real estate."
Before the tax change, investor flows were skewed towards debt funds as capital gains on debt mutual funds held for more than three years were indexed for inflation and benefited from the long-term capital gains rate of 20%.
Conversely, banks face constraints in lending to the real estate sector and many have less appetite. Banks are not allowed to lend to projects that do not have full regulatory approval, to fund land acquisition, or finance developments that have stalled, and face restrictions on uses of proceeds, such as funding controlling shareholders' equity in project development companies, according to market experts.
"Banks have tightened balance sheets and want to have less exposure to real estate as a strategy and the issuers have no option but to look for more expensive private credit exposure," said Manisha Shroff, partner in DCM, banking and finance at law firm Khaitan & Co. "Private credit also offers flexibility in repayment terms, back-ended repayment structures and more flexibility."
Since 2019, non-banking financial companies have practically stopped lending to the sector after Infrastructure Leasing & Financial Services defaulted in 2018. NBFCs were big lenders to IL&FS and suffered heavy writedowns.
Mutual funds have also stopped lending to high-yield credits, including in the real estate sector, following tightened regulations after Franklin Templeton shut six debt schemes in April 2020 because of severe redemption pressure amid the pandemic.
Improving credit metrics
Even though many institutions are not keen to lend to property developers, the outlook for the industry is improving.
Urbanisation and growing preference for larger homes with more privacy and better facilities, especially since more people started working from home following the pandemic, have spurred demand for property. "The boom in the equity market has led to wealth creation in the country, which has resulted in additional demand for real estate in terms of owning more than one home by the HNIs," Rungta said.
That has helped the biggest property companies to reduce their debt.
"The key listed real estate developers have achieved aggregate pre-sales of Rs1trn in FY24, a year-on-year increase of 36%," said Divyesh Shah, director at rating agency Care. "This resulted in increased collections which doubled to Rs670bn in FY24 ... from Rs300bn in FY19. Developers effectively used these collections to manage their debt, thus reducing gross indebtedness."
The biggest real estate companies have also deleveraged through equity fundraising, commercial asset sales and spinning off properties into real estate investment trusts. New business development will largely take the form of joint projects, diversification into warehousing and hospitality, or entering new cities, Shah said.
Developers that are borrowing at yields in the mid-to-high teens are giving security against things like escrow accounts for cashflows and sometimes even corporate or personal guarantees, Rungta said.
For example, the Century bonds are secured against equity and convertible securities.
While hot demand and supportive policy initiatives are positive for the real estate sector, some are concerned that the rush of high-yield bond issues could lead to lower underwriting standards.
"The risk will emanate from multiple funds chasing the same deals, which could lead to aggressive pricing, relaxing the covenants to beat competition and lowering the underwriting norms," said a chief investment officer at a private credit fund.
Rungta agreed. "Lenders are not doing much due diligence, and the security pool is not as tight as it should have been."