Why Indian real estate is a classic bubble

Gaurav Dalmia founder and chairman of Landmark Holdings, an investor in India real estate projects, shares his views on India's real estate opportunity.
Landmark Holdings was an early financial investor in real estate projects in India in 2002. It is part of the Dalmia group, a diversified Indian business group with interests in cement, industrial ceramics, engineering, steel, agri-commodities, information technology and private equity. We speak to Gaurav Dalmia, founder and chairman about his views on the real estate opportunity.

What prompted you to focus on real estate investing?

We were benchmarking returns from our various alternative investment assets: private equity, technology venture capital and real estate. Our real estate IRR's stood out : 45%. To provide focus and a separate balance sheet, we started Landmark as an investment company. Today, we have twelve projects with a liquidation value of over $1.5 billion. All of these are joint ventures with leading and upcoming developers.

What kind of returns are you predicting going forward?

Landmark's IRR has been 80% or so, but that is an aberration since we have had a spectacular bull run in the last 4 years and we got carried by the tide. Over any 10 year period, we expect a 45% or so IRR. I must point out that in this business, IRRs are misleading, since we return the capital very quickly and a high IRR does not automatically translate into a high multiplier return. We have to constantly rotate capital in new deals to effectively translate this IRR into a multiplier return. In the last four years, a third party valuation report shows an eight times return on our investment.

What are your key investment parameters?

We invest in project specific special purpose vehicles, not in real estate companies. Our average investment is in the range of $10-15 million. Our time horizon is 5-7 years. Typically, we take a 50% equity stake in a venture, which gives us a real say in the project. Our most important investment criterion is the entrepreneur, someone who respects capital and with whom we have a 90% mental alignment. We prefer housing projects since housing stock is self liquidating and there are no exit risks, unlike in a commercial building or a shopping mall investment, though I think as REIT's etc come in, those exit risks will go away.

I must say that every real estate project resembles a startup. So, this is a far more hands on business as compared to private equity and since there is no PE (price earnings) expansion as in private equity, all returns are from the project; therefore this is more hard work than many financial investors might think.

What kind of investors did you target?

We invest our own capital and seek co-investments from sophisticated investors, who are playing for the long term and are not "turned on" because of the current euphoria. Our co-investors include a leading Indian conglomerate, a prominent US family office, a leading NRI group, a large real estate fund. The largest private property company in the UK has made two joint bids with us; one of them, in suburban Calcutta, which we just lost to DLF, who won it for $600 million. A mid-sized US hedge fund has also just given $70 million to us to co-invest and we have done three deals with this pool of capital. They have threatened to give us $200 million!

How much of the fund is invested?

We are almost fully invested from our own balance sheet at this stage. Our holding companyÆs balance sheet is unleveraged so we are considering a structured debt option. We are increasing our pool of capital via co-investment arrangements. Today, we have the firepower to invest $100 million in single deals and deploy $500 million or more if we see attractive deals.

What is next in this space?

Not a whole lot of brand new things. Our current portfolio is north India-centric and we want to move to other geographies. We also want to look at income creating assets as most of our current assets are housing related which self liquidate. Management is a huge constraint in this industry today, so we are being very careful about spreading ourselves too thin.

Real estate in India is being called the new bubble - what is your view?

It is a classic bubble, even though the real estate folks might not want to believe this. Like in the last days of the dot.com boom, developers tend to dismiss you and say ôyou donÆt get itö if you ask them tough questions.

If you look at the affordability levels in housing by comparing to income levels, most products, even in reasonably distant suburban markets, are outside the reach of middle class India. Most buyers are speculators and there is an enormous inventory build up.

In retail and office space, it is a similar story. As a joke, I tell people that the IT industry would be shocked to hear the amount of space the real estate community has planned for them in the next five years!

I also see huge implementation risks. So many projects run late because developers are stretched for capital or management. Asset inflation has forgiven these mistakes in the last three years. I am not sure this will be the case in the next three.

Then there are macro risks such as interest rates, which can affect both demand and capitalisation rates for rental yield assets.

There is too much money chasing real estate in India currently - what is your strategy to differentiate yourself in this demand-supply imbalance scenario?

I think there is less real money than is visible. There are many institutional aspirants who want to play. There are fewer concrete plans and even fewer effective efforts. Most capital that is actually there is informal high net worth capital, which is erratic. Our differentiation strategy is speed. We have made in-principle decisions on investments in a week and completed due diligence and made physical investment in three weeks. I would submit that this is not bubble bravery, it is domain knowledge.
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