The Indian Economy Is Entering A Dynamic Growth Phase

India has entered an era of dynamic growth because of sustained economic reforms since the early 1990s and the rapid growth of Indian IT and business process outsourcing (BPO), which have been among the key growth drivers. According to UBS forecasts, India’s potential growth rate is expected to increase to 6-7% over the medium term, compared with the 5-6% rate of the last two decades. Over the long term, India’s potential growth rate could be even higher, but not until key bottlenecks, such as inadequate physical infrastructure are overcome.

To achieve sustained & rapid economic development, massive investment will be required in physical infrastructure, such as modern business parks and urban townships, transport, ports, airports, communications, and utilities. India’s lack of adequate physical infrastructure is still a major impediment to economic development, and private sector investment has a major role to play in financing the construction of physical infrastructure.

Mobilizing private sector capital flows to finance India’s infrastructure needs will be one of the key challenges for India over the next 10-15 years. Prime Minister Manmohan Singh has recently estimated that India requires an investment of around US$ 150 billion in infrastructure over the next seven years to meet the nation’s needs, and the Indian government has set in motion processes through innovative public-private partnerships to realize this goal.

Strong Expansion In The Commercial Property Sector

Rapid expansion in Indian commerce and industry is already driving strong growth in the demand for commercial real estate developments, including office parks, commercial office buildings, shopping malls and urban townships.

The rapid growth in IT and business process outsourcing to India in the last three years has resulted in a sharp increase in the demand for office space in India’s largest cities, with around 5 million square meters of office space projected to be required for this industry alone over the next 3 years. In 2004, around 1 million square meters of office space was taken up, almost double the figure for 2002. Indian commercial yields remain high compared to other major industrial nations, at around 9-11% for prime office space in the major cities. In the residential sector, there is a severe capacity shortage in residential housing, with an estimated housing shortage of 20 million residential units. In addition, the rapid development of mortgage financing products will result in an accelerating growth in the demand for residential housing.

Mumbai, New Delhi, Bangalore, Hyderabad and Chennai are the leading outsourcing hubs of India, and have experienced a particularly strong demand for commercial space in the suburbs with modern business parks and quality office developments. This has put an upward pressure on the commercial prices and rents in these suburbs, despite continued high levels of new development activity, with land values in some new development areas of Bangalore up by 25-30% in the last twelve months.

The Role of REITs

Large-scale private sector financing is required to fund the development of commercial and residential infrastructure, and India’s financial markets will need to become increasingly sophisticated in order to facilitate the rapid development of modern commercial office, retail and residential infrastructure. India has outgrown the old model, whereby developers often raised financing through personal channels. Large scale, world-class commercial property and urban townships development across the many large cities of India will require more sophisticated financing mechanisms, including tapping capital markets.

Liberalization measures have been introduced to facilitate such private sector financing. Since April 2004, both Indian and foreign venture capital funds have been

permitted to invest in real estate, and the permitted scope of foreign investment has been widened to include residential, commercial and shopping malls. Furthermore, in February 2005, the Indian government decided to allow foreign direct investment of up to 100 percent under the automatic route in townships, housing, built-up infrastructure and construction development projects, in order to catalyze investment in the vital infrastructure sector of the economy. This will permit foreign investment in the residential and commercial developments as well as hotels, hospitals, educational institutions, and urban infrastructure.

A number of Singaporean and Malaysian companies are already active in the development of integrated townships that met earlier foreign investment criteria, and the recent liberalization measures have triggered a significant increase in the foreign joint venture investments in the Indian real estate market.

In India, the issue of whether to allow REIT-type real estate mutual funds has been under consideration for some years, although the government has had concerns about the nature of the Indian market, including the rates of stamp duties, which are very high by international standards. The mutual funds industry has shown considerable interest in launching REIT-type real estate investment vehicles for retail and institutional investors, and there has been a detailed scrutiny of the potential options for launching such vehicles.

There are various reasons that would help to create the necessary framework for an efficient market for the listed real estate vehicles. For example, the Association of Mutual Funds of India Sub-Committee Report on real estate mutual funds recommended that the property title system be overhauled to improve efficiency, by computerizing all land records, with the modernization of rental laws still required in some states. The AMFI Sub-Committee also reviewed the international experience with REITs and stressed the importance of providing an appropriate tax regime for REITs.

Once the appropriate groundwork has been laid, the introduction of REIT-type investment vehicles is expected to significantly increase private sector funding for real estate development in India, by tapping finance from a wide range of institutional investors in India and abroad, using both domestic and international securities markets. Improved integration between the capital markets and the real estate markets also plays a role in strengthening the depth of the financial system, by the reducing reliance of the real estate industry on bank finance.

Conclusion

India’s real estate industry has a crucial role to play in India’s economic development, by creating the necessary commercial and residential property infrastructure that is vital for the industrial development and in attracting private sector investment into commercial & residential property. Many countries worldwide have utilized REITs to improve the financial sophistication of their domestic real estate industries, and REIT-type investment vehicles have the potential to open up significant new domestic and international financing flows for India’s economic development.