FDI in Real Estate: unlocking potential

Despite the overhaul that the sector has seen over the last decade and a half, there are still places where the law remains ambiguous

Real estate is a pivotal sector in the Indian economy, and is reported to be the second highest employment generator, after agriculture. The combination of its multitude of stakeholders, and its affiliations with various other sectors such as infrastructure creates a multiplier effect on its impact on the economy.

Historically, real estate has been one of the most carefully protected sectors, fortified by heavy regulations and policies which significantly restricted foreign investment. This protection was intended to prevent speculation in the sector, and even today speculative real estate business is prohibited under the foreign direct investment regime. Fortunately, over the last decade and a half, the government has strategically taken steps to relax the Foreign Direct Investment (FDI) norms, gradually allowing for more investment and growth.

Monumental change

It was a trailblazing Press Note issued in 2005 (PN.2/2005) which opened up the formerly off-limit options to FDI, subject to certain conditions. Essentially a distinction was drawn

Vivek Chandy, Joint Managing Partner, JSA

between real estate and construction development, setting in motion the liberalization in this sector. Under PN.2/2005, 100% FDI under the automatic route was permitted in townships, housing, built-up infrastructure and construction-development projects (which would include, but not be restricted to, housing, commercial premises, hotels, resorts, hospitals, educational institutions, recreational facilities, city and regional level infrastructure), under specific terms. Needless to say, this decision created a sizeable and transformative portal into investment in the real estate sector.

There were obligations on minimum size of development, period within which capitalization was to be infused, and certain lock-in requirements which have since been relaxed. In the present regime, the following points need to be borne in mind.

–  Transfer of stake from one non-resident to another non-resident without repatriation of investment is neither to be subjected to any lock-in period nor to any government approval. This is because there is no outflow of the FDI.

–  The Indian investee company will only be allowed to sell developed plots. Under the policy, developed plots will be those in which all trunk infrastructure has been provided. In general, selling undeveloped land is still not permitted.

–  100% FDI is now permitted under the automatic route in completed projects for operation of townships, malls/ shopping complexes and business centres.

Grey Areas

Despite the overhaul that the sector has seen over the last decade and a half, there are still places where the law remains ambiguous. Completed assets are an area of untapped possibilities for FDI, and the consolidation of policy on this matter is what is needed to harness this potential. The existing policy mentioned above, is generally interpreted conservatively, and the view taken is that under the construction development sector unless the FDI came in when the real estate asset was being developed, it is not permitted to be infused into a company with completed assets. At present the exceptions to this are “townships, malls/shopping complexes and business centres”, all of which are open to 100% FDI, with conditions. Aside from this, foreign investment can also be made in industrial parks and infrastructure, however in most instances the projects qualify as construction development projects. Recent amendments by way of press note 1 of 2022 clarify that earning of rental income from real estate assets will not be treated as “real estate business”, but it is still not clear whether foreign investors can invest in companies holding completed assets which do not fall within the stated exceptions in the policy applicable to the construction development sector.

The term “business centre” is said to mean a project “where multiplicity of businesses of same or different nature are being carried out from a particular building” – a definition which leaves far too much room for interpretation and therefore, confusion. Furthermore, the existing policy allows foreign investments in completed assets provided that the intent is only to earn rental income, and does not amount to transfer. Although this is a welcome move, it seems to contradict the intent of the law to limit foreign investment in completed assets and is therefore interpreted to mean that if an entity receives foreign investment to develop a project, the entity can then lease out all or part of the project without being considered to engage in “real estate business”. If the government were to make their stance on the matter clear, the opportunities for capitalization would be endless.

Over the past couple of years there have been discussions on the possibility of liberalizing the FDI policy in the real estate sector further, possibly an attempt to placate the chaos wreaked by the pandemic on the real estate market. A restructuring of FDI policy is apparently in the offing, and the DPIIT is expected to present these changes soon. It is being suggested that a relaxation will include 100% FDI in completed RERA registered projects with over one hundred apartments, and other such hopefully progressive changes.

The positive effect of such a change would be twofold.

For the developers:

This move would allow builders to fully exit developed assets and break ground on new projects, with the cash in hand to properly address their buyers’ requirements. They would also be able to complete pending projects that were stalled due to insufficient funding, and monetize previously unsold inventory. The liquidation of their current holdings would allow for the

recirculation of cash, consequently reviving the market itself. Essentially the respite of new investment could be the key to overcoming the financial hurdles created by the pandemic.

For the investors:

Many foreign investors are interested in forward purchase contracts, and in such contracts, it is important for the investor to acquire the asset once it is completed and possibly even let out to tenants. Giving investors what they want will only attract more of them, and the value of their investments will provide the economy with a much-needed lift. The government should cash in on the increasing demand from international investors and concentrate on attracting more FDI. In addition to the overall economic boost, the supply of affordable housing (a key area of focus for the government in the past two budgets) will rise to meet demand for the same.

Conclusion

The government has made great strides in the liberalization of FDI in real estate over the past sixteen years, and the time has come to take this a step further. The easing and consolidation of regulatory requirements for completed assets would be advantageous for all parties – and time is of the essence. Swift implementation would expedite the benefits not only in the real estate sector, but all allied industries. Regulatory coherence paired with consistent efforts to make the sector more favorable towards investment will elevate the real estate market in India, and open up boundless opportunities.

Authored by: 
Vivek Chandy, Joint Managing Partner, JSA

Disclaimer: The views expressed in this article are those of the author and do not necessarily reflect the views of ET Edge Insights, its management, or its members

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