What's holding up foreign funds?

To invest or not to invest' is no longer the dilemma facing the foreign funds waiting to plough money into the Indian real estate sector.

With annualised returns far exceeding that of the developed markets and the equity markets, Indian real estate on Thursday is considered a sound investment. And yet the promised money is not flowing in.

One of the biggest reasons is the ambiguities in rules governing the entry and exit of foreign funds. Another is the availability of land and projects which can absorb the kind of money that a foreign fund or developer would like to bring in, with issues like corporate governance and transparency bring up the rear, say analysts.

On the entry front, 100 per cent FDI is allowed on the automatic route into developments spread over a 50,000 sq ft or 25 acre threshold. Any fund wanting to invest in India through the foreign venture capital investor route has to go through the Securities and Exchange Board of India, which in turn checks with the RBI.

Once approved the fund can then either invest directly in a development, which meets the FDI rule or invest in a domestic fund, which in turn may invest in a basket of developments.

As many as 75 applications are pending with the RBI currently, according to industry sources.

But the real issues are with the exit route say analysts. With no exit policy in sight, most of the funds which were supposed to head to the Indian shores seem to be playing the waiting game.

Of the $3 billion that was supposed to head towards India by 2006 end, very little has come in. Analysts estimate that actual inflows could be in the range of $ 400-500 million.

Says Anil Harish of the law firm DM Harish & Co, "While it is not holding back investors, the absence of a clearly defined exit policy for foreign investors is certainly worrying. And the government seems to be in no hurry to work out an exit policy."

The options that FVCI investors have include transfer of shares to a third party (FVCI investors are not subject to entry and exit price restrictions), winding up of the ventrue capital undertaking, buy back of shares by the VC undertaking, reduction of capital of the VC firm, redemption of preferential shares or exit by IPO.

In the absence of a clear policy, most investors may end up preferring winding up the company or reducing the capital to pull out their money, says Harish.

Another issue is the availability of land. Most of the land in India is classified as agricultural land, which foreign investors cannot invest in directly.

"Also, in a city like Mumbai where the returns on investment are the highest, it is difficult to find large chunks of land. And if you do they fall under Urban Land Ceiling Act. Clear land titles are another problem," points out Harish.

The issue in corporate governance and deal structuring will also play a large role in the entry of FDI, says Ashwin Ramesh, principal, Primary Real Estate Advisory.

"Here we are dealing with differences in business cultures. International investors expect certain basic practices that Indian firms may not be following. But this is changing rapidly as most of the big firms are now adopting international standards.

"When a foreign investor comes in to invest, he expects certain safeguard to ensure that the Indian developer takes as much of the risk as he does; that the Indian devleoper walks out with the profits while he still figuring out ways to take his money back," says Ramesh.

Ramesh points out that most investors seek clauses like veto rights on certain matters, non-compete clauses, indemnification against third party claims, liquidation events, tag along and drag along where if one partner sells his equity, the other will automatically be a part of the deal.

"Unless these issues are resolved, the inverstor hesitates to sign on the dotted line," says Ramesh.