I overview of the market

India has undertaken significant structural reforms and the result is evident in improved rankings by 23 positions in the World Bank's ease of doing business index, and by 129 ranks in the ease of dealing with construction permits index.2

The overall economic outlook for the country is positive. The IMF has projected the GDP growth of India in 2019–2020 to be in the range of 7.3 per cent.3 The real estate sector is of considerable significance in the Indian economy as it contributed approximately 7 per cent to the Indian gross domestic product (GDP) in 2017 and is expected to contribute about 13 per cent by 2025.4

FDI equity inflows in the construction development sector stood at US$29.41 billion during the period April 2000 to December 2018.5 The private equity and venture capital investments in the sector reached US$4.47 billion in 2018, an improvement over the figures for private equity and debt investments for 2017 (US$4.18 billion) for the same period. Real estate was one of the top five sectors that private equity investment was made to in 2018.6

II Recent Market Activity

The Indian real estate sector has witnessed high growth in recent times with a rise in demand for office, residential spaces and logistic warehouses. Salient reported on the activity in this sector, including the following:7

  1. In May 2019, private equity firm Warburg Pincus formed an investment platform with Mumbai developer Runwal Group with a total corpus of US$1 billion to develop shopping malls.
  2. In March–April 2019, Embassy Office Parks, India's first real estate investment trust (REIT) went public. Embassy Office Parks is backed by global private equity Blackstone and Bengaluru based developer Embassy. With this event, India joins the list of elite countries like the US, Singapore, and the UK, where REIT units are publicly traded.
  3. In November 2018, Warburg Pincus-backed logistics developer ESR Group and German asset manager Allianz Real Estate, announced a joint platform to invest around US$1 billion in the logistics sector.
  4. In May 2018, Blackstone Group acquired One Indiabulls in Chennai from Indiabulls Real Estate for approximately US$136.9 million.
  5. Around 5.1 million square feet of retail space became operational in seven Indian cities in 2018.
  6. Warehousing space in eight Indian cities increased 22 per cent year on year in 2018 to 169 million square feet.
  7. Real estate players and investors are increasing their focus on co-working and co-living spaces, with co-working space across seven cities increasing sharply in 2018 (up to September), reaching 3.44 million square feet, compared to 1.11 million square feet for the same period in 2017.
  8. The government has taken an aggressive stance to promote affordable housing in the country, with measures including financial assistance of 2 trillion rupees (US$29 billion), lower borrowing rates, tax concessions and increased private investment.

III Real estate entities and platforms

Asset classes in the Indian real estate sector include standalone commercial (comprising business parks, special economic zones, hotels, hospitality, shopping centres, etc.), residential assets or a combination of both in mixed-use projects. Developers have also in the recent past focused on the development of full-fledged townships that cater to a wide variety of investors and customers.

Assets in the Indian real estate market are mostly aggregated at the local level. Development entities either buy from these aggregators or enter into development arrangements with land owners. Large project requirements are also met through government-assisted acquisitions. Land is usually held through multiple special purpose vehicles (SPVs) holding real estate assets.

Multilevel holding structures are typically used for reasons of consolidation, corporatisation, ease of unbundling, ring-fencing project-specific risks, itemised scalability and future potential to list holding companies for fundraising.

Typically, investments are held though corporate entities and SPVs, and in businesses without a foreign investment element, through partnership firms and limited liability partnerships driven primarily by tax benefits, low compliance, and ease of setting up and winding up.


Avenues for fundraising in the real estate sector are fairly skewed as a result of regulatory hurdles and lack of confidence in developers given the manner in which the sector has been operated over the years.

i Issues under various modes of financing

Bank debt

Under the domestic banking laws, scheduled commercial banks are restricted from lending for acquisitions of land. Further, a promoter's contribution towards the equity capital of a company needs to be brought in from the promoter's own resources, and the banks are not permitted to grant advances for the acquisition of shares of other companies. With bank funding for land and the acquisition of SPVs ruled out, construction development finance is essentially the only area for which bank funding is available, which is more often than not the second step in a real estate transaction. Such restrictions, however, do not apply to non-banking financial companies, which had been active in this segment, but may have become more circumspect pursuant to the recent liquidity crunch.

External commercial borrowing

Recently, the Reserve Bank of India (RBI) consolidated all the erstwhile foreign exchange regulations governing the borrowing and lending in foreign currency or Indian rupees between persons resident in India and outside under the Foreign Exchange Management (Borrowing and Lending) Regulations, 2018. These regulations have further eased the process for accessing overseas funds, however proceeds of external commercial borrowing (ECB) can still not be used for real estate activities. Construction and development of industrial parks, integrated townships, SEZ purchase, long term leasing of industrial land as part of the modernisation of expansion of existing units or any activity under the 'infrastructure sector' are not classified as real estate activity.

Public fundraising

From a public markets point of view, the track record of publicly traded real estate companies is less than good. However, given the positive response to India's first REIT by both institutional as well as retail investors, public fund raising through REIT platforms is likely to gain more momentum.

Funding through bids

Since the introduction of the Insolvency and Bankruptcy Code, 2016 (IBC) the real estate sector has also seen investments being undertaken through a bidding process, with the winning bidder's plan for resolution of the insolvency of the asset receiving judicial sanction. Recent amendments to the IBC envisage exemptions for testing the connected persons (as defined in the IBC) of pure play financial entities against each of the qualifying parameters. Further, in February 2019, RBI also permitted resolution applicants from raising ECB to repay rupee term loans of the corporate debtor, with prior approval of the RBI. The legal regime is evolving towards greater participation by financial investors in the resolution process.

Setting up REITs

The foreign exchange regulations have been amended to permit non-residents to invest in REITs, including by way of a swap of capital instruments held in an SPV (which holds the assets) for REIT units, thereby clearing a significant hurdle in setting up a REIT with non-resident PE investors. However, the swap of non-convertible debt instruments for REIT units still requires approval of the RBI and could therefore continue to be a hurdle in case of investments made through debt instruments.

Investment conditions

Under the current regulatory framework, at least 80 per cent of the value of a REIT's assets must be invested in completed rent-generating assets. The remaining 20 per cent is permitted to be invested in properties that are under construction or completed, but not for rent-generating purposes. While the general 80:20 classification is in line with the intent of providing more liquidity and ensuring minimal risk in the hands of a unitholder, REITs are also intended to be a means of revitalising the cash-strapped market for real estate assets, especially under-construction properties. Practically as well, in the case of large office parks that are not substantially complete, or in the case of SPVs operating multiple office parks with some being under development, the under-construction component may need to be carved out to comply with the existing norms. The process might involve regulatory hurdles and significant transaction restructuring costs.

Further, in instances where the manager or sponsor of a REIT is foreign-owned or controlled, the REIT would be deemed to be a foreign-owned and controlled entity, and all downstream investments by the REIT would be required to comply with foreign exchange regulations. Given that real estate is a significantly regulated sector, this could restrict the funding and investment options available to the REIT.

Multiple SPV structures

The REIT regulations permit up to two-layer SPV structures to be held by the REIT. Therefore, the requirement of complying with this requirement in cases where assets are held through multilevel structures involves significant restructuring of existing holdings.


While specific types of development-related activities are permitted, generally speaking, FDI is not permitted in real estate business (dealing in immovable property with the intent of earning profits), the construction of farmhouses and trading in transferable development rights. Exceptions to this are investments in construction development projects and the earning of rent or income from projects through the leasing of property (without transfer of the same). However, in 2018 it was clarified that FDI is permitted in real estate broking services.

The equity investment regime has come a long way since the sector's liberalisation in 2005. Under the 2005 regime, stringent entry conditions such as a minimum capitalisation (US$10 million for wholly owned subsidiaries and US$5 million for joint ventures) and minimum area requirements (10 hectares for development of serviced housing plots and 50,000 square metres for construction development projects) had made projects below a certain size inaccessible to investors. Exits were available only after the expiry of a lock-in of three years or upon completion of the project, which meant that if a project did not take off for reasons of litigation or lack of consumer interest, the non-resident investor would have to sit out for three years. There was also regulatory ambiguity with FDI being meant only for greenfield projects and not for brownfield or existing under-construction projects. Exits from projects prior to a period of three years (even through a stake sale between non-residents without repatriation) required the approval of the Foreign Investment Promotion Board (FIPB),8 which was not very forthcoming given the sensitivities around the sector.

In a significant overhaul in 2014, the present government eased the minimum area requirements, and minimum capitalisation conditions were made applicable from the commencement of the project; however, subsequent tranches of investment could only be brought in until the expiry of 10 years from the commencement of the project. The three-year lock in was done away with, and exits were made possible on completion of trunk infrastructure (roads, water supply, street lighting, drainage and sewage). While the easing of entry conditions did help, the greenfield–brownfield ambiguity continued and exits remained an issue, specifically for stalled or litigation-affected projects. The only way out for projects with no trunk infrastructure was by approval of the FIPB. Transfers between non-residents during the lock-in period were specifically brought into the approval route. As a positive measure, for the first time, investments in the operation and maintenance of completed projects such as shopping centres and business centres were permitted. Thus, the FDI regime in construction development until November 2015 was marred by exit issues.

In November 2015, the government did away with most of the entry conditions for investment into a project. Investment can now be brought in for each phase separately, a dispensation that has significantly aided developers in obtaining phase-wise funding from different investors. Although investments by non-residents continue to be locked in for a period of three years, exits are permitted if trunk infrastructure in a project is completed. Exits are no longer linked to absolute transfer restrictions, but are linked to repatriation of funds outside, which means that non-resident investors are permitted to divest stakes to other non-residents without a repatriation of funds, even during the lock-in period, without the requirement of obtaining any approvals from authorities in India. In addition, special economic zones and hospitals, where these sectoral conditions relating to FDI do not apply, and industrial parks (where there is a different regime of commercial projects), investments are now permitted in completed projects for the operation and maintenance of townships, shopping centres and complexes and business centres, subject to a lock-in of three years. Investments under the FDI route have to comply with pricing guidelines, which prescribe a fair market value cap (determined based on internationally accepted pricing methodology) for exits and restrict non-resident investors from agreeing on assured returns on their investments. With significant liberalisation in the FDI regime, it is expected that deal activity in this sector will continue to increase.

In the case of industrial parks, while investments are permitted under the automatic route, 66 per cent of the allocable area in the project is required to be dedicated to industrial activity (a specified set of activities), with the park required to have a minimum of 10 units and no single unit occupying more than 50 per cent of the allocable area. Industrial park investments have to continually undertake compliance analysis and keep only a defined tenant base, which on a practical level is sometimes arduous.

Investment through listed non-convertible debentures

The market is seeing a rise in the prominence of investments through listed and unlisted non-convertible debentures (NCDs) subscribed by foreign portfolio investors (FPIs) and non-banking financial companies. From 2017 to 2018, the corporate bond market has raised about 5,990 billion rupees across 2,706 issues through private placement of NCDs.9 Under the Indian foreign exchange regulations, FPIs registered with SEBI are permitted to invest in listed or unlisted NCDs (subject to minimum residual maturity of one year, exposure (of a FPI and its related entities) to not more than 50 per cent of a single issue. There are end-use restrictions on investment in real estate business, capital market and the purchase of land, and conditions imposed by under the regulatory laws for such security). In February 2019, RBI relaxed the requirement of an FPI having exposure to not more than 20 per cent of the corporate bonds of a single issuer (or its related entities). This, as an investment route, is separate from the FDI regime, and consequently, sectoral caps and conditions, pricing and restrictions on assured returns as applicable to FDI are not applicable to such investments.

RBI has recently on 1 March 2019, introduced a separate channel, called the 'Voluntary Retention Route' (VRR) for FPIs to invest in debt markets. Broadly, investments through the route have relaxations from certain regulatory norms (including the minimum maturity period, limit of 50 per cent exposure to a single FPI by a corporate debtor), subject to the FPI retaining a minimum percentage of its investments for a period. FPIs can choose to participate in this route, for which limits are made available through tap or auction.

In summary, with traditional debt funding through scheduled commercial banks and external commercial borrowings being in short supply, sentiment for publicly traded real estate companies being weak and REITs still in their infancy, investments (both equity and debt) in the real estate sector continue to be dominated by private equity investors.

ii Impact of the Real Estate (Regulation and Development) Act 2016 (RERDA)

A revolutionary change in recent times was the introduction of the RERDA, which seeks to protect home owner interests, ensure efficiency in property transactions, improve the accountability of developers and boost transparency in the sector, all of which have been lacking for a long time. RERDA prescribes registration of residential real estate projects, disclosures in relation thereto, and imposes restrictions on promoters and developers from changing building plans, or misusing the funds collected from allottees.

While the RERDA is intended to provide investors with much-required developer accountability and transparency, from the perspective of real estate companies, the regulatory burden and compliance costs have significantly increased, with certain conditions, such as the depositing of 70 per cent of funds, posing practical challenges. More importantly, as the implementation of RERDA is left to the discretion of the states, clear disparities have emerged between states, with regions such as Maharashtra and Haryana setting the benchmark in the industry.

V Transactions – Structuring concerns

i Equity structures

Traditionally, the real estate sector has been highly regulated for foreign investment. Discouraging speculative activities on land has been a major theme of the regulators. Therefore, foreign debt was highly restrictive and equity also came with conditions related to, inter alia, development milestones and lock-ins.

With FDI conditionalities now significantly liberalised, transactions in the construction development space have more or less become automatic in the truest sense of the word. A lot of acquisition activity is now seen in the acquisition of completed assets. Management of commercial assets as a separate business skill has been gaining ground, amply supported by technology and best global practices. India's FDI policy now specifically recognises foreign equity investment for the purposes of operation and maintenance of completed assets. The country has also seen significant restructuring activity in the sector from the point of view of making real estate spaces more marketable commodities: consolidating assets, segregating marketable assets, restructuring for raising finance, tax structuring, court-based mergers, demergers, conversion of LLPs into companies, restructuring partnership interests to permit investments and capital reduction, inter alia, have been used to achieve this end.

For investments in completed assets that are part of larger projects, over and above the 'undertaking' test from a taxation standpoint, from an FDI perspective, the asset being hived off should independently qualify as a completed project.

Significant structuring continues to be adopted around promoted structures and profit-sharing arrangements to incentivise developers. It is not uncommon in commercial projects to have asset or property management and development management arrangements with affiliates aimed as cash-outs to developers. Indemnity or holdbacks, escrow structures, representations and warranties and tax considerations (typically around capital gains and withholding taxes), inter alia, are sector-agnostic, and would apply to real estate investments and exits as well. Many investors who picked up significant stakes in the 2007–2008 bull run are now in exit mode. Owing to limited fund life and other constitutional concerns, PE funds are reluctant to give standard representations at the time of exit. While warranty insurance is slowly gaining traction in India, it comes with its own problems of high premium costs and wide exclusions (including all information known to investors, taking away from them the traditional knowledge exclusion despite their diligence).

ii Debt and structured debt

Investors are now looking at debt investments to gain an upside for their businesses by structuring returns based on business performance or project-based conditions. Being debt, there is downside protection of the principal. Given the fundamental jurisprudence of debt being an absolute obligation to repay, absorbing downside risks remains tricky. Structures with PE investors investing in nominal equity along with private debt were common; however these have not been very prevalent in the last year due to the 50 per cent cap on FPI investment in each issue of debentures. These structures permitted investors to exercise control through affirmative voting rights, obtain a board seat as equity holders and receive assured return on their investments as creditors. This not only helps bridge the gap in a company's capital structure; it is also commercially viable for investors, as it occupies a place between senior debt and equity in terms of security, returns and influence. There are instances where investments are purely into debt but where veto matters are shaped as negative consent rights, which are standard in the lending arena.

NCDs usually earn mid to high yields through various combinations of a cash coupon coupled with a redemption premium, cash flow or profit-linked coupons, market-linked returns obtained through exposure on exchange-traded derivatives, or equity-like components such as warrants or convertibles.

The slowdown in the real estate market, lack of funding for land acquisitions, defaulting developers and the downgrading of their ratings have led to the sector being highly leveraged. Consequently, developers are now relying on private debt either as fresh debt or by way of refinancing an existing debt. With a high-risk appetite, PE players have shown interest and have invested in the NCDs of such companies. However, owing to the risks involved in such investments, such as delays in the completion of projects, projects under litigation and a general slackening of market demand for real estate, interest rates are substantially higher than those found in other sectors. To insulate themselves from the risk associated with such investments, private debt investors typically collateralise their investment by security cover depending on the developer's credit rating, and personal and corporate guarantees. Securing collateral for non-residential/ FPI investors is subject to the regulatory restrictions. The trend in securing a high return and easy exit is evidenced by way of redemption premium.

iii International taxation

In recent years, India has actively accelerated changes in the international taxation regime to accord compliance with the OECD Base Erosion and Profit Shifting (BEPS) Action Plans. Accordingly, India has undertaken introduction of several anti-avoidance measures in its domestic tax regime as well as in its bilateral Double Taxation Avoidance Agreements (DTAAs) with other nations.

In 2016 India entered into various protocols with the governments of Mauritius,10 Singapore11 and Cyprus to revise its DTAAs with these countries, to provide for source-based taxation of capital gains arising from an alienation of shares instead of a residence-based taxation with a view to preventing double non-taxation, curb revenue loss and check the menace of black money through an automatic exchange of information. However, the investments made prior to 1 April 2017 (i.e., shares acquired before 1 April 2017, including preference shares acquired before 1 April 2017, which may convert later) would continue to be taxed based on the principle of residence-based taxation (this is subject to a limitation of benefits clause in the India Mauritius and India Singapore DTAAs).

Significant other changes have been brought into Indian domestic tax legislation such as the Income Tax Act, 1961 (IT Act). Subsequent to the introduction of the concept of a place of effective management (POEM) for the determination of the residential status of the company, the government has issued final guiding principles for determination of POEM. Thus, foreign companies having a POEM in India, could be regarded as Indian tax residents, and shall be liable to pay taxes in India on their global income and may not be entitled to any DTAA benefits. Given the same, PE funds should ensure that the POEM is outside India and for this purpose, all major decisions relating to the investment and divestment of Indian securities should be taken outside India, and their fund managers should be located outside India.

Furthermore, the provisions of General Anti Avoidance Rules (GAAR) became effective from financial year 2017 to 2018 onwards. By virtue of GAAR, Indian tax authorities have been empowered to declare any arrangement or transaction to be an impermissible arrangement or transaction if they are of the view that the main purpose of carrying out the said arrangement or transaction is, inter alia, for the purposes of availing a tax benefit. Considering the wide ambit of GAAR, a number of legitimate business transactions could come within its purview unless the taxpayer is able to establish its commercial substance before the Indian tax authorities. The threshold limit for the invocation of GAAR is 30 million rupees. However, GAAR provisions are not applicable to income from the transfer of investments made before 1 April 2017.

Another significant expansion of the scope of business connection, in line with BEPS Action Plan 7, has also been introduced in India. Previously, a non-resident was said to have a business connection in India if there was a person in India acting on behalf of the non-resident, who, among other attributes, had the authority to conclude contracts in India. However, as per the expanded scope, habitual conclusion of contracts or playing a principal role leading to conclusion of such contract would also result in the non-resident having a business connection in India.

iv Goods and service tax (GST)

Generally, developers prefer joint development agreements as it supports their capital-light business strategy. Under the GST regime, while the government has exempted transfer of development rights for residential projects, such transactions in commercial real estate attract GST at the rate of 18 per cent per annum payable by the developer. Developers are increasingly structuring their rights for tax optimisation.

v Taxation of REITs

Under the Income Tax Act 1961, REITs are accorded a pass-through status for interest income received by the REITs from an SPV and also for rental income earned by the REITs. However, a REIT is required to withhold tax at appropriate rates, whose credit can be claimed by the unitholders against their final tax liability payable on the income earned from the REIT.

Where the assets in a REIT are held by an SPV, dividend distribution tax (DDT) of approximately 20 per cent would be applicable to distributions made to the REIT, making the structure tax-inefficient. However, no DDT is required to be paid for distributions made by SPVs that are 100 per cent REIT-owned (or co-owned with a minimum mandated holding by the co-owner under law), and such dividend received by the REIT and its unitholders shall not be taxable in the hands of the REIT or its unitholders. While these are welcome steps, given that the exemption is limited to only 100 per cent REIT-owned SPVs, the benefits would not trickle down to joint ventures.

Certain other issues that still require addressing from an industry standpoint include the fact that the tax deferral scheme made available to sponsors on the transfer of SPV shares to a REIT has not been extended to the direct transfer of assets and transfers of interest in LLPs; and that the holding period of REIT units has not been brought on a par with other listed securities at one year for availing of long-term capital gains benefits.

vi Conclusion

The real estate sector is slowly but steadily picking itself up from the lows of 2009 and 2010. Large platform deals and consolidation are an indication of growing confidence in the market by investors and developers. Greater number of listings on the REIT platform should bring further liquidity for investors and developers, and boost the real estate sector in India.

Use of technology is increasing in operation and maintenance of commercial and residential projects. Adoption of newer philosophies of co-living and co-working spaces, and student accommodation are steadily changing the landscape of the real estate sector.

Furthermore, the recently concluded general elections in May 2019, have given a clear mandate to the ruling party (Bharatiya Janata Party), and the real estate industry is expected to sustain momentum and growth, with further reforms on the anvil.


1 Cyril Shroff is managing partner, and Reeba Chacko and Nagavalli G are partners at Cyril Amarchand Mangaldas. Tax inputs from S R Patnaik and Mekhla Anand, partners in the tax practice. They were assisted by Trayosha Darapuneni and Harish S, principal associates in the corporate practice.

3 IBEF Presentation on Real Estate, accessible at https://www.ibef.org/download/real-estate-mar-2019.pdf.

4 Same as above.

5 PwC presentation on Deals in India: Annual review and outlook for 2019, accessible at https://www.pwc.in/assets/pdfs/publications/2018/deals-in-india.pdf.

6 IBEF Presentation on Real Estate, accessible at https://www.ibef.org/download/real-estate-mar-2019.pdf.

7 The FIPB has since been abolished.

9 Protocol amending the Agreement between the Government of Republic of India and the Government of Republic of Mauritius for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income and capital gains and for the encouragement of mutual trade and investment, signed on 10 May 2016.

10 Third Protocol amending the Agreement between the Government of India and the Government of Republic of Singapore for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income, signed on 30 December 2016.

11 A revised Agreement between the Government of Republic of India and Government of Republic of Cyprus for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to taxes on income, along with its Protocol, was signed on 18 November 2016.