Foreign Direct Investment:
Investing in Real Estate in India

Indian real estate has huge potential demand in almost every sector especially commercial, residential, retail, industrial, hospitality, healthcare etc.

Commercial office space requirement is led by the burgeoning outsourcing and Information Technology Industry. The leaders of the IT/ITES world have set up or are setting up their centers in India. Estimated demand from IT/ITES sector alone is expected to be 150mn sq.ft. of space across the major cities by 2010.

In residential sector there is housing shortage of 19.4 million units out of which 6.7 million are in urban India.

The increase in purchasing power and exposure to organized retail formats has redefined the consumption pattern. As a result the country has experienced mushrooming of retail projects across the cities.

The main growth thrust is coming due to favorable demographics, increasing purchasing power, existence of customer friendly banks & housing finance companies, professionalism in real estate and favorable reforms initiated by the government to attract global investors.

Foreign Investment (FDI) in Real Estate Sectors in India

Foreign Direct Investment is encouraged and permitted, subject to certain conditions,  in the following real estate sectors in India:

• Hotel Development

• Tourism

• Hospitality

• Township development

• Developing Commercial Real Estate

• Built-up infrastructure

• Housing and construction projects

• Building Resorts

• Building Hospitals

• Building Educational institutions

• Building Recreational facilities

• Infrastructure projects: regional and local level

• Special Economic Zones (SEZ's)

Conditions for Foreign Investment in Real Estate Sector in India

Foreign Direct Investment in some of the aforesaid areas (not all) is subject some conditions, some of which are as follows:

• Develop a minimum land area of 10 hectares for serviced housing plots, and a minimum built-up area of 50,000 sq m in case of construction projects. The policy does not clearly define ‘built-up’, though FSI (Floor Space Index)/FAR (Floor Area Ratio) could be used as a basis for the same.

• Fulfill the minimum capitalization norm of $10 million for a wholly-owned subsidiary and $5 million for JVs. The funds would have to be brought in within six months of commencement of business (which needs to be defined) of the subsidiary or JV.

• Complete at least 50% of the integrated project within five years from the date of obtaining all clearances.

• Do not sell undeveloped plots (with no infrastructural backup). Provide infrastructure and obtain the completion certificate from the concerned local body before disposal. This clause needs amendment because certificates are sometimes not issued for months on end, even years, an uncertainty which tends to raise project cost, often beyond viability.

• Do not repatriate original investment before three years from completion of minimum capitalization. Early exits require prior approval of the Foreign Investment and Promotion Board.

• Conform with all applicable local and state laws, and abide by all regulations and norms.
   

FDI in Real Estate in India

Previously, only NRI's and PIO's were allowed 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 (JV) company along with a local partner.

India fully opened FDI in real estate in 2005. However, norms issued later made a minimum capitalization of $10 million for wholly-owned subsidiaries and $5 million for joint ventures mandatory. The government also imposed a minimum area requirement. 

The department of industrial policy and promotion had in March 2005 allowed FDI in real estate in projects in a minimum area of 25 acres.

The finance ministry has allowed external commercial borrowing (ECB) in realty projects involving integrated townships of 25 acres or 50,000 sq m. However, the Reserve Bank of India has not yet notified it.

At present, the government allows FDI in real estate, but does not permit foreign institutional investment. It is, however, considering a proposal not to view FDI and FII as distinct investment flows while specifying an overall limit.

It is yet to permit foreign venture capital investors (FVCI) in the realty sector. To ensure that the concept of special economic zones (SEZs) did not distort the realty market, the RBI has classified lending to SEZs on par with commercial real estate, according it higher risk weight and provisioning.

The RBI allows ECB in real estate projects involving integrated townships of 100 acres or more. In real estate projects, a large portion of money is required for land acquisition, which is classified as working capital. But end-use restrictions like not allowing ECB money to be used for working capital take away its attractiveness.



 

Real Estate Laws in India

Investing in real estate in India require compliance with various laws which run into dozens, some of them more than 100 years old and some very new.  In addition to federal laws of India, there are many state laws governing real estate transactions and investment. The federal laws governing real estate include:

 Indian Transfer of Property Act

The Transfer of Property Act governs the transfer of property by various means. Sales, mortgages (other than by way of deposit of title deeds) and exchanges of immovable property are required to be registered by virtue of the Transfer of Property Act. Therefore, all the above documents must be in writing and registered.

Indian Registration Act, 1908

The purpose of this Act is the conservation of evidence, assurances, title, publication of documents and prevention of fraud. It details the formalities for registering an instrument. Instruments which require mandatory registration include:

(a) Instruments of gift of immovable property;
(b) other non-testamentary instruments which purport or operate to create, declare, assign, limit or extinguish, whether in present or in future, any right, title or interest, whether vested or contingent, to or in immovable property;
(c) non-testamentary instruments which acknowledge the receipt or payment of any consideration on account of instruments in (2) above.
(d) leases of immovable property from year to year, or for any term exceeding one year, or reserving a yearly rent

Sales, mortgages (other than by way of deposit of title deeds) and exchanges of immovable property are required to be registered by virtue of the Transfer of Property Act. Evidently, therefore, all the above documents have to be in writing.

Section 17 of the Act provides for optional registration. An unregistered document will not affect the property comprised in it, nor be received as evidence of any transaction affecting such property (except as evidence of a contract in a suit for specific performance or as evidence of part-performance under the Transfer of Property Act or as collateral), unless it has been registered. Thus the doctrine of part performance dealt with under Section 53 A of the Transfer of Property Act and the provision of Section 49 of the Registration Act (which provide that an unregistered document cannot be admissible as evidence in a court of law except as secondary evidence under the Indian Evidence Act) together protect the buyer in possession of an unregistered sale deed and cannot be dispossessed. The net effect has been that a large number of property transactions have been accomplished without proper registration. Further other instruments such as Agreement to Sell, General Power of Attorney and Will have been indiscriminately used to effect change of ownership.  Therefore, investors in real estate have to be careful in their due diligence.

Indian Urban Land (Ceiling And Regulation) Act, 1976

This legislation fixed a ceiling on the vacant urban land that a 'person' in urban agglomerations can acquire and hold. A person is defined to include an individual, a family, a firm, a company, or an association or body of individuals, whether incorporated or not. This ceiling limit ranges from 500-2,000 square meters. Excess vacant land is either to be surrendered to the Competent Authority appointed under the Act for a small compensation, or to be developed by its holder only for specified purposes. The Act provides for appropriate documents to show that the provisions of this Act are not attracted or should be produced to the Registering officer before registering instruments compulsorily registrable under the Registration Act.

This legislation was repealed by the federal government in 1999. The Repeal Act, however, shall not affect the vesting of the vacant land, which has already been taken possession by the State Government or any person duly authorized by the State Government in this regard under the provisions of Urban Land Act. The repeal of the Act, it is believed, has eliminated the large amount of litigation and released huge chunks of land into the market. However the repeal of the Act has not been carried out in all states. Initially the repeal Act was applicable in Haryana, Punjab and all the Union Territories. Subsequently, it has been adopted by the State Governments of Uttar Pradesh, Gujarat, Karnataka, Madhya Pradesh and Rajasthan. Andhra Pradesh, Assam, Bihar, Maharashtra, Orissa and West Bengal have not adopted the Repeal Act so far.

Stamp Duty

Stamp duty is required to be paid on all documents which are registered and the rate varies from state to state. With stamp duty rates of 13 per cent in Delhi, 14.5 per cent in Uttar Pradesh and 12.5 per cent in Haryana, India has perhaps one of the highest levels of stamp duty. Some states even have double stamp incidence, first on land and then on its development.

Rent Control Acts

Rent legislation in India has been in existence for a very long time. Rent control by the government initially came as a temporary measure to protect the exploitation of tenants by landlords after the Second World War. However these rent control acts became almost a permanent feature. Rent legislation provides payment of fair rent to landlords and protection of tenants against eviction. Besides, it effectively allows the tenant to alienate rented property.

Property Tax

Property tax is a levy charged by the municipal authorities for the upkeep of basic civic services in the city. In India it is the owners of property who are liable for the payment of municipal taxes. Generally, the property tax is levied on the basis of reasonable rent at which the property might be let from year to year. The reasonable rent can be actual rent if it is found to be fair and reasonable. In the case of properties not rented, the rental value is to be estimated on the basis of letting rates in the locality.

Foreign Funds Investors in India: RBI puts curbs on FII entry in real estate IPOs 

The foreign portfolio investment in real estate in India has come under regulatory glare. The Reserve Bank of India (RBI) has thrown in a caveat on FII subscription to public equity offerings by real estate companies. The RBI is of the opinion that such firms can sell their initial or follow-on public stock offerings to FIIs, only if the real estate projects being developed fulfill the conditions for foreign direct investment. The central bank, which has the last word on cross-border fund inflow, has indicated this to investment bankers and advisors of real estate firms planning to tap the capital market. One of the companies planning an issuance has already dropped the idea of marketing shares of its forthcoming equity issue to FIIs; while another firm has positioned itself as a construction company (one which doesn't own the land as distinct from a real estate company) to sidestep the restriction. The issue has boiled down to subtle differences between FII and FDI.

The facts are: real estate projects can attract FDI up to 100 percent, subject to certain conditions which were spelt out by the government in April '05. These conditions include minimum area to be developed, minimum capitalization, no repatriation of original investment before 3 years and ban on sell of under-developed plots. If a project meets these conditions, the concerned company can attract FII subscription up to 24 percent equity, and later revise it to the sectoral FDI cap, which is 100 percent in this case.

However, for a company not willing to meet the stringent project conditions, the FII route could be used to overcome the rules and bring in foreign investment. All the company needs to do is get FIIs that are registered with SEBI to invest in the IPO. This is what the RBI is possibly objecting to. Interestingly, the regulator is not averse to FIIs buying shares in the secondary market. In other words, even though FIIs cannot subscribe to a real estate firm's IPO (if the project concerned is non-FDI compliant), they can buy shares through a registered broker once the company gets listed.

Madaan & Co. believes that further clarifications are required by the RBI in order to clear the contradictions in various policies of the Government of India.

The foreign Investors should also be careful in investing in real estate in India.  A proper legal advice is highly recommended before investing in this sector. In a nutshell: INVESTORS BE WISE
 

For More details see FDI in India Sector wise Guide

SEBI Norms for Real Estate Mutual Funds

Securities and Exchange Board of India (SEBI) has issued guidelines on real estate mutual funds (REMFs). Once these investment vehicles see the light of the day, small investors will be able to participate in, and profit from, the real estate growth story.

The way the policy is evolving in India, initially REMFs will be allowed to invest in listed entities only. The next step will be to set up real estate investment trusts (REITs), which will be allowed to invest directly in real estate assets. This graduated approach is being followed to allow time for the market to mature, and so that public money is not put to undue risk..

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