Role of Private Equity in the Construction Industry

By: Divya Tandon

What is Private Equity Investment?

Private Equity is one of the methods of financing an entity wherein capital is invested by private set of investors into a business in return for equity in the company wherein the capital is invested.

Private Equity investors are generally leveraged buyout funds, growth equity funds, venture capital funds, real estate investment funds, special debt funds or individuals having high net worth etc.

Private Equity Investors provide funding to the companies they invest in which help in meeting the capital requirements of the companies for funding their projects, pay off existing debts, solidifying the balance sheet, launching new projects etc.

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Due to huge size of investment, private equity investors often get involved in the functioning of the company and have a significant control and decision making rights in the company they invest in. The Private equity investors uses their enormous experience and skills to manage and improve the operations and revenue of the investee company over a period of time. The intent of the private equity investors is to improve the worth of the company so that they can later sell their stake for more than it was when they bought it thereby making profit.

Importance of Private Equity in the Construction/Real estate industry

The construction companies/firms require huge funds for their projects. Most companies/firms are not self-sufficient to fund their projects on their own. Hence, they look for alternative investment options to fund their projects. The construction companies can approach the banks for availing loans, look for joint venture partners, find suitable individual investors willing to invest in the form of equity or debt or private equity firms willing to invest in the company.  Since, huge funds are required by construction companies, most of the times the companies adopts more than one of the investment options to fund their projects.

Earlier, private equity investors used to avoid investment in construction industry due to certain inherent risks.  However, in recent years investment by Private Equity investors has gained momentum. The enactment of Real Estate (Regulation and Development) Act, 2016 (“RERA Act”) which has come into force with effect from May, 2017 has also made developers more accountable as their acts are now regulated by the RERA Authority. The RERA Act is more stringent as compared to previous legislation which has been brought to eradicate the problems that were inherent in the real estate sector. The RERA Act ensures transparency with respect to real estate transactions. Heavy penalties are imposed on the developers for violation of the provisions of the RERA Act or the terms and conditions of the agreement executed with the customers. Hence, RERA has brought in positive transformation in the real estate sector and boosted the confidence of private equity investors to invest in this sector.

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Besides the enactment of RERA Act, various other government policies and schemes have led to surge in investor interest in the real estate sector including foreign investors. Some of the policies of the government which has boosted private equity investment in construction industry are easing of FDI regulations, Housing for All, Affordable Rental Housing Complex Scheme, Credit Linked Subsidy Scheme (CLSS) to name a few.

Private Equity firms often fund real estate companies and provide financial support in development of real estate projects. Private equity investment provides the required liquidity to the company for its projects and provide support in launching new projects or to complete the pending projects. After enactment of RERA, the developers prefer completing their projects as per the agreed timelines to avoid payment of interest on the amounts paid by the customers. But due to liquidity crunch, sometimes the developers struggle with the available capital to complete the ongoing projects and provide possession to the customers. In such a scenario, the private equity investors come to the aid of the construction companies to provide last stage funding. Thus, the demand for funds in the last stages of completion of projects have risen. The last stage funding is also favorable for the private equity investors as it is comparatively less risky as during the last stages of construction generally necessary approvals are in place and construction is on the verge of completion. However, the private equity investors should ensure proper due diligence to understand the reason for the project being stalled. If the project is stalled only due to financial crunch, the investment by the private equity investors can help in reviving and completing the project and provide benefit to the investors by maximizing their value. On the other hand if the project where the private equity investor is considering to invest is stalled due to some third party dispute or pending litigations then the funding by private equity investors may not solve the problem and the project may not be completed as per the estimated timelines. This may result in the investment of private equity investors getting stuck.

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“Post the liquidity crisis in NBFCs in Q4 2018, private equity players including the domestic ones have become increasingly active once again and are expected to bridge the funding gap”[1]

In recent years, private equity investors are funding some major projects. The investment by private equity investors is not only in residential projects, but also in commercial and retail projects.  Due to the private equity investment, some of the stalled projects have been able to see the light of the day and have been completed, providing much needed relief to the customers who had invested in such projects.

Depending on the size of investment, the private equity investors get involved in the decision making process. The level of influence depends on the stake invested. They provide their inputs through out the development process and act as strategic partners.

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Impact of Covid-19 on the private equity investment in the construction industry

Due to the outbreak of the global pandemic Novel Corona Virus – COVID-19 in March, 2020, the current financial markets, trade, commerce and thereby business continuity is facing an unprecedented situation due to lockdown imposed by the central and state governments from time to time to curtail the spread of the deadly virus. This pandemic has paralyzed and destroyed the very economic fabric of the entire world including India.  Both the Central Government as well as State Governments had placed severe restrictions and implemented various remedial measures in an all-out effort to halt the spread of the virus.

The impact of the Covid-19 is thus a calamity and the adverse consequences on the Real Estate Industry is serious and has impacted the business severely. As a fall out of the above, there is total disruption in the supply–chain of materials, shutdown of construction activities due to huge shortage of construction materials in the market on supply–chain issues due to import restrictions, global manufacturing, shutdown of materials, heavy escalation in prices of materials etc. The site labourers had returned back to their native homes/villages due to the fear of contracting the virus due to which construction sites had either substantially slowed down or had come to a grinding halt. Since the real estate as an Industry being the most labour intensive, being extremely reliant on hundreds of materials coming from everywhere in projects and reliance on stable financial inflows into the projects; all these either being slowed / unavailable / stalled in most projects, severely affected current ongoing projects of the most real estate developers. The sale of residential/commercial premises had also been affected due to liquidity crunch in the market.

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It is also learnt that across the real estate industry, almost 60% – 65% of flat purchasers are defaulting in paying their due instalments to the companies towards the flats booked by them thereby further adversely affecting the business of the construction firms. The developers however on the other hand are without any respite/remedy in terms of payment of instalments towards huge loans taken from banks as well as payment of taxes and premiums to the various departments of the Government. Under these facts and circumstances, where on the one hand the payments are not being made by customers/purchasers, the construction work being affected and standstill due to the supply chain being disrupted and the workers unable to come to work, whereas the developers having to make payments towards service of finance loans, taxes, premiums etc. entire real industry is under the grave stress.

The outbreak of the Covid-19 and the forced lockdown (by the competent Government/Authorities) pursuant thereto, was a sudden setback to real estate sector which was already going through a rough patch due to low demand. Thus the construction industry is facing challenging times due to the drastic impact of the pandemic. The real estate industry is facing financial crunch to launch new projects and also to finish ongoing projects. Though, the restrictions have been relaxed by the governments, the impact of the Covid-19 and lockdown will be felt for months to come. Many construction companies are on the verge of bankruptcy. In such a scenario, private equity investors can come to the rescue of the severely hit real estate entities/firms.

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In recent times many private equity investors are in negotiation talks with construction companies to provide much-needed funding for their projects.

Recent trends

“Indian real estate attracted U$ 5 billion institutional investments in 2020, equivalent to 93% of transactions recorded in the previous year. Investments from private equity (PE) players and VC funds reached US$ 4.06 billion in 2020. The real estate segment attracted private equity investments worth Rs. 23,946 crore (US$ 3,241 million) across 19 deals in Q4 FY21. Investments in the sector grew 16x compared with Rs. 1,470 crore (US$ 199 million) in Q4 FY20. In value terms, these investments were 80% of that in 2020 and 48% of 2019, according to a report by Knight Frank”[2]

As per the reports from the property consultant, Savills India “Private equity investment inflows into the Indian real estate sector stood at $2.7 billion during the first half of 2021 as investors’ confidence remained intact despite the pandemic-induced slowdown. This inflow is equivalent to 41 per cent of the investment that the sector saw in the entire year of 2020. However, in the second quarter of 2021, Indian real estate market saw an investment of $865 million, a 54 per cent decline from the previous quarter.”[3]

As per Colliers’ report Investments Turbocharged with Focus on Alternate Assets Classes “Despite COVID-19, the total expected private equity inflows in the Indian real estate sector is expected to touch $5 billion in 2021, a 4.1 percent increase from 2020” [4]

As per ICRA estimates, Indian firms are expected to raise more than Rs. 3.5 trillion (US$ 48 billion) through infrastructure and real estate investment trusts in 2022, as compared with raised funds worth US$ 29 billion to date.[5]

According to the data released by Department for Promotion of Industry and Internal Trade Policy (DPIIT), construction is the third-largest sector in terms of FDI inflow. FDI in the sector (including construction development & activities) stood at US$ 50.8 billion between April 2000 and March 2021.[6]

Thus it can be seen from the above that the private equity investors both domestic and foreign have gained confidence in the Indian construction industry and have joined hands with some of the major construction companies to boost the growth of the sector.

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[1] As per the report of Savills on Private Equity in Indian Real estate