Federation of Indian Chambers of Commerce & Industry

Survey Report

On

Foreign Direct Investment In Real Estate

INTRODUCTION:

The size of the real estate industry in India is estimated by FICCI, to be around
US$ 12 billion. This figure is growing at a pace of 30% for the last few years.
Almost 80 % of real estate developed in India, is residential space and the rest
comprise office, shopping malls, hotels and hospitals. This double-digit growth is
mainly attributed to the off-shoring business, including high-end technology
consulting, call centres and software programming houses which in 2003-04, is
estimated to have accounted for more than 10 million square feet of real estate
development. This is the ideal time to invest in the country as policy makers have
begun to emphasize on developing adequate infrastructure for the country. Real
estate companies would also do well to maximize their own performance and
operational efficiency.

For every Indian rupee invested in the construction of houses in India, INR 0.78 is
added to the gross domestic product. The real estate sector is also subservient to
the development of over 250 other ancillary industries. A study by a rating agency
ICRA shows that the construction industry ranks 3rd among the 14 major sectors in
terms of direct, indirect and induced effects in all sectors of the economy. After
agriculture, the real estate sector is the second largest employment generator in
India

The sustained demand from the Information Technology sector also affected the
urban landscape in India. As per estimates, there is demand for 66 million square
feet of IT space over the next five years. Several multinational companies continue
to move their operations to India to take advantage of lower costs of skilled
manpower and logistics. With human resources being the key element in this
industry, the hiring and housing of people, both at their work place and home
assume great importance and therefore the need to create space for people to work
and live, which in turn triggers the development of other related infrastructure.

The predominant trend has been to set up world-class business centres, often
campus-style establishments, bearing a distinctive corporate stamp. So distinct are
some of these locations that they are being termed as the "temples of modern
India" by the local press. This is just an indication of the extent of real estate
development taking place. Indian and international real estate majors also
envisage a major boom in the hotel project developments over the next five years.
During the last five years, major chains such as the Orchid, Marriott, Holiday Inn
etc have either tied up with local developers of property or they have started
planning for their own real estate.

Though the real estate sector in India is proclaimed to be the most promising sector
today, it is still hugely plagued by market uncertainties and inhibitions. This is
manifested by an abysmally low mortgage penetration. In India the mortgage to
GDP ratio is about 2%. This compares to a mortgage to GDP ratio of over 51% in
USA. However, even if one were to benchmark with more comparable
counterparts, the ratio ranges between 15-20% for South East Asian countries.
Thus the penetration level of mortgages is miniscule when compared with the
shortage of housing units. The real estate market in India predominantly continues
to remain unorganized, fairly fragmented, mostly characterized by small players
with a local presence.

Foreign Direct Investment (FDI) in Real Estate

The decision to liberalise the FDI norms in the construction sector is perhaps the
most significant economic policy decision taken by the Union Government. Until
now, only Non-Resident Indians (NRIs) and Persons of Indian Origin (PIOs) were
permitted to invest in the housing and the real estate sectors. Foreign investors
other than NRIs were allowed to invest only in development of integrated
townships and settlements either through a wholly owned subsidiary or through a
joint venture company in India along with a local partner. However, the guidelines

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prescribed via Press Note 2 (2005) series issued by Ministry of Commerce &
Industry, have further opened out FDI in townships, housing, built-up
infrastructure and construction-development projects. Major conglomerates are
taking initiative and are wooing internationals firms in order to line up investments
for major projects

FDI in Real Estate in India

Share of FDI Share of real

GDP FDI in GDP estate in FDI
2003
INDIA 600.6 3.11 0.20% 4.5% (0.14)
CHINA 1,417,000 57 0.004% 18.3% (10.43)
2004
INDIA 650 3.75 0.57% 10.6% (0.4)
CHINA 1,533,194 60.63 0.004% 21.78%(13.21)
2005 (estimated)
INDIA 692.25 15 2.10% 10-20% (1.5-3.75)
CHINA 1,672,714.65 68.6 0.004% 30 (20.5%)
All figures are in US $ billions

Source: Chesterton Meghraj Property Consultants (P) Ltd.

FDI IN REAL ESTATE: Guidelines

The Department of Industrial Policy and Promotion (DIPP) vide Press Note
No. 2 (2005) permitted FDI up to 100% under automatic route 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 facilities, such as roads and bridges, transit systems et
al), subject to the following guidelines:

1.The minimum area to be developed under each project would be as follows:

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 o In case of development of serviced housing plots, a minimum land area of
10 hectares.
o In case of construction development projects, a minimum built-up area of
50,000 sq.mts.
o In case of a combination of the above two projects, any one of the above two
conditions would suffice.

2. The minimum capitalization norm shall be US$ 10 million for a wholly

owned subsidiary and US$ 5 million for joint ventures with Indian partner/s.
The funds would have to be brought in within six months of commencement of
business of the company.

3 Original investment cannot be repatriated before a period of three years

from completion of minimum capitalization. However, the investor may be
permitted to exit earlier with prior approval of the government through the
FIPB.

4 Development of at least 50% of the integrated project within a period of

five years from the date of obtaining all statutory clearances, has to be
completed. The investor would not be permitted to sell underdeveloped plots
(underdeveloped connotes, where roads, water supply, street lighting, drainage,
sewerage and other conveniences as applicable under prescribed regulations,
have not been made available). The investor must provide this infrastructure
and obtain the completion certificate from the concerned local body/service
agency before being allowed to dispose of the serviced housing plots.

5 The project shall conform to the norms and standards, including land use
requirements and provision of community amenities and common facilities as
laid down in the applicable building control regulations, by-laws, rules and
other regulations of the State Govt./Municipal/Local Body concerned.

6 The investor shall be responsible for obtaining all necessary approvals,

including those of the building/ layout plans, developing internal and peripheral
areas and other infrastructure facilities, payment of development, external
development and other charges and complying with all other requirements as
prescribed under applicable rules/bye-laws/regulations of the State
Government/Municipal Body/ Local Body concerned.

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7 The State Government/ Municipal/ Local Body concerned, which approves
the building/ development plans, will monitor the developer’s compliance to
the above conditions.

QUESTIONNAIRE BASED SURVEY:

In view of the challenges and potentials of FDI in the emerging sector, FICCI
conducted a survey to ascertain the response of the Indian developers on the
revised FDI guidelines.

Analysis of Responses:
Minimum Area stipulation of 10 hectares for development of serviced housing
plots

Majority of domestic investors i.e., 73.33% feel that the reduction of minimum
area stipulation from 100 acres (approx. 40.5 hectares) to 10 hectares would go a
long way in boosting FDI in the real estate sector. 26.6% view that the limit
should be further lowered to 5 hectares in general and 2 hectares for Joint Ventures
(JVs)..

Minimum Built-up Area Stipulation of 50,000 sqmts in case of construction

development projects

The policy does not clearly define the scope of built up area, thus leaving it open
to an ambiguous interpretation. Most of the respondents feel that the definition of
“built-up area” is inadequate and does not clearly imply whether it is inclusive of
basement, common areas, service areas, lifts, balcony etc. The developers’ feel that
the measure of built-up area should be based on the FSI (Floor Space Index) / FAR
(Floor Area Ratio) as specified and approved by a competent local planning
authority of the State or more aptly a common definition to be adopted by all the
states. However, 63.5% feel that the stipulation of 50,000 sqmts is appropriate and
does not need any revision. Others view that the stipulation should be further
reduced to 10,000 to 25,000 sqmts.

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 % of Builders Agreeing with the Min. Area and
Min. Built-Up Area Stipulations

73.33
63.5
Percentage

Min. Area Stipulation- 10hectares Min Built-up Area-50,000sqmts

Minimum capitalization for Joint Ventures (JVs) to be US$ 5 mn:

Most domestic developers hold the view that there is ambiguity in the clause
pertaining to “6 months within commencement of business”. Here the problem
arises when the FDI is brought in an existing company which is operational for
more than six months before the date of signing agreement with FDI partner,
which date should be considered as date of commencement of business of the
company? The Government should clearly spell out the implication of the term
‘commencement of business’. It needs to be clarified that the ‘date of
commencement of business’ is the date on which the joint venture agreement or
joint development arrangement or any other form of agreement for development
activities in India is signed by the foreign investor or the date of incorporation of a
company, as the case may be. This ambiguity must be clarified in subsequent
legislations or administrative notices.

However, 76.6% of the domestic developers feel that the minimum capitalization
norm of US$ 5 mn for JVs is appropriate and does not need revision. Others feel
that the minimum capitalization norm should be between US$ 2-3mn. The present
FDI policy on the construction-development sector requires a minimum
capitalization of US$ 5 million where the project is undertaken in joint venture
with an Indian partner. This has resulted in ambiguities on whether FDI of US$ 5

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million is in relation to a single foreign investor or is it the total contribution of
multiple foreign investors investing in the project in India.

Minimum Capitalization for Wholly Owned Subsidiary to be US$ 10 mn:

Most of the domestic developers, i. e. 86.6% feel that the minimum capitalization
norm for wholly owned subsidiary is appropriate at US$ 10 mn, however others
are of the opinion that the minimum norm should be raised to between US$ 15-20
mn.

% Builders Agreeing with Minimum Capitalization

Norm

100

90
86.6
80
76.6
70
Percentage

60

50

40

30

20

10

Min. Capitalization for Wholly Owned Min. Capitalization for JVs-US$ 5 mn

Susidiaries-US$10mn

Completion of the project:

76.6% of domestic investors agree with the clause that 50% of the project should
be completed within 5 years of obtaining all statutory clearances. In the case of
large projects that are going to be developed in phases, the provision should allow
the builder the flexibility of developing the different phases only when he
perceives the demand for the project

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Sale Of Underdeveloped Plots By The Developers:

Majority of domestic developers, i.e. 86.6% feel the need of amendment of the
clause pertaing to sale of underdeveloped plots, whereby the developer has to
obtain the completion certificate from the concerned local body/service agency
before disposing the serviced housing plots. Completion certificates are sometimes
not issued for months, sometimes running into years. If sale is not allowed after
sanction of the scheme, investments involved in completion of the project will be
extremely high and will make many projects unviable. The present position
therefore needs to be amended to permit sale after sanction of the project is
received.

Monitoring Agency:

The State Govt/ Local / Municipal bodies as the monitoring agency to oversee the
development of the project in accordance to the established norms was accepted by
60% of domestic developers and investors. Rest 40% feel that a regulatory body
set up for the purpose or a Central nodal agency should take upon the
responsibility to monitor and regulate this sector.

Guidelines Concerning Repatriation of Capital:

As of now, there is no specific guideline pertaining to exit route and repatriation of

capital, except the lock-in period of three years. Investors are to seek the approval
of FIPB, for repatriation of capital before three years. However, ironically, only
50% of domestic developers feel the need for a detailed guideline relating to the
exit route. 40% are of the opinion that clearer guidelines should be brought out
with respect to repatriation concerned with JVs.

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 Need for detailed guidelines relating to
repatriation of capital

40%
Guidelines for JVs

Yes
50%

No
10%

Advantages of FDI:

According to the respondents the greatest benefit of FDI in the real estate sector
would be towards making the sector more organized. The second most important
contribution will be increased professionalism followed by creation of healthy and
competitive market environment for both domestic and foreign players and
bringing in superior technology.

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 Ranking of Advantages of FDI

Organize the
Sector

Create More
Professionalism

Induce Healthy
Competition

Bring Superior
Technology

0 1 2 3 4 5

Cumbersome and time consuming sanctioning process has been inhibiting

developers to come to this country. It is high time that the government took
measures to ensure that the sanctioning process and other formalities are
simplified. Foreign investors would invest in the country only when they are
assured that they will maximize profits and minimize costs within a short period of
time. When they face undue delays in obtaining several clearances from multiple
windows, their opportunity cost rises manifold, straightaway discouraging
investment. It was suggested that to encourage FDI, all required clearances should
be received within 60 days.

There has been a demand from the foreign investors for access to a consolidated
document that clearly specifies all the clearances required with details on all the
concerned agencies and the procedures, so that they are clear on the legal requisites
before they make a commitment on the funds.

Edge of FDI over Domestic Developers:

An amazing 80% of domestic developers feel that foreign investors have an edge
over domestic developers in making available huge funds for big projects, bringing
in international quality construction techniques, best designs and models that is
often lacking in domestic counterparts.

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 Edge of FDI Over Domestic Investors

Make Available
Huge Funds

International
Quality and
Construction Tech.

Best Designs

0 1 2 3 4

MEASURES TO BOOST REAL ESTATE SECTOR

To provide congenial investment atmosphere to foreign direct investors, the

following should be focused upon:

There is a need to completely overhaul the union and state legal system
governing various aspects of real estate. Many of these laws date back to the
19th century. This is admittedly not an easy task since land is a state subject in
India. For instance, under the Rent Control Act, tenants continue to pay the
same rent fixed in 1947. This has discouraged fresh investment in housing for
rental purposes and the poor collection from the obsolete rental values make
repairs and maintenance unviable for the landlords, thereby resulting in the
dilapidated condition of many buildings.

There is also an urgent need to reduce stamp duties, which in some states are as
high as 10-13 per cent. This results in a massive understatement of the proceeds
of a sale. Reduction and rationalization of stamp duties will ensure greater
compliance and enhance revenues for the government. Stamp duty is
extremely high and must be rationalized and brought down to 2 to 3 % as per
global practice.

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Sustained initiatives by the Central and State Government towards
legal/regulatory reforms have been taken with a view to create an enabling
environment. Initiatives like Repeal of Urban Land Ceiling & Regulation Act,
1976, formulating Model Rent Control Legislation, Model Apartment
Ownership Legislation and the Model Property Regulation Bill for States to
adopt subject to local variations. Several States have already adopted these
measures. Other states should be urged to expedite their adoption.

There is need to open up more avenues to facilitate long-term finance for

the housing sector. Permitting real estate mutual funds would, through the
pooling in of resources, allow individuals with small amounts of cash to take
advantage of the returns available from the real estate market.

Computerizing land records and circulation of and access to this database,

would be one of the most useful features of reform in this country.

Like the IT, banking and insurance sectors, the real estate sector too should
have certain specialized institutions and vocational courses for professionals.
This will go a long way in shaping the real estate scene in the country.

Foreign design and consultancy companies should be encouraged to set up

offices in the country to introduce world class designs and technology.

Allow FDI in shopping malls & retail business.

Public-Private partnership (PPP) in housing & infrastructure development is

imperative for rapid growth and must be encouraged and facilitated. FDI in PPP
and Group Housing Schemes should be encouraged to give a fillip to the
concept of housing for the Economically Weaker Section.

The government should increase land supply, through faster release of

government land and through improving the turnaround time required for land
clearances.

Each state must identify / prepare / offer FDI projects for ease of entry.

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