Sundaram Alternative Opportunities Series – High Yield Secured Real Estate Fund IV

• Demonetization, RERA compliance, GST impact and associated costs – project & entity level impact
• COVID-19 and associated business disruptions, key–man issues, slowing sales, price corrections cross micro markets
• Operating discipline and efficiency of developers determining impact on sales, timing, cash flows
• Cost escalations and project delays due to lockdown
• NBFCs granting loans and advances in the real estate sector are to ensure that project approvals relating to a project have been obtained. Hence, NBFCs cannot engage in direct land acquisition funding. Such regulatory arbitrage is advantageous to AIFs
• Banking scandals negative impact on money supply to the sector directly & indirectly
• Government focus on affordable homes – lower cost capital focused away from mid-market and premium housing projects in key urban metros / cities

India Real Estate evolution through the last decade

• 2012-2013 : Supply beats demand, speculation
• 2014-2016 : RE financing overload and deteriorating credit metrics Vs high stock levels & stagnant prices => impending sales decline
• 2017-2020 : Capital supply issues with NBFC debacle, RERA, demonetization, GST (VAT) disruptions
• 2019-2023 : Capital values fall, sector consolidation, COVID-19 impact adding to developer liquidity issues
• 2023-2026 : New deal opportunities (clean–up of stress work-in-progress), readjustment of inventory supply, new financiers coming in (last mile, resurgence of re–finance, growth capital across RE asset classes)

Bank scandals, NBFC ALM issues opening-up non–bank / alternate asset financing to large private capital; several overseas funds setting up shop in India => indicative of free–pricing of alternate credit / private  financing yields in the country in the next 5–10 years

Private capital pools (both Indian & foreign) such as AIF funds, prop capital, overseas funds, SPACs, etc. have started to make in–roads; early stages of credit, price & risk–reward buckets; loosening of FPI debt limits,  introduction of IBC, evolution of bond markets => stronger

Real Estate capital demand split over the past 4 years

• Sector transforming from rescue (over the last 5–6 years) to growth – relatively low inventory levels in most micro-markets, high sales absorptions, upscaling demand from customers & post COVID-19 ‘home needs’
• More growth-oriented funding needs since 2021 (refer chart)
• Greater capital supply – NBFCs re-starting to participate in construction finance after a 5-year lull; ~USD 5 bn new private money via larger funds (Kotak, HDFC & large offshore players) looking to back growth at higher rates
• Emergence of Tier II builders alongside expansion of resi-formats across plotted, Co-living, custom villas, Eco Homes, etc.
• Significant Govt. investment planned into social infrastructure across metros and semi-urban cities – creating new demand pockets

RE capital breakdowns

• RE lending (by banks, NBFCs & HFCs) estimated at
  • ~$90 bn as of 2019
  •  Banks: 35–40%
  •  HFCs: 35–40%
  •  NBFCs & Private Credit Pool: 20–30%

• Funds (equity & credit) estimated at an additional
  • ~$20–25

• RE exposure of banks on a steady decline since 2014 when NPA recognition norms became stricter
• RE lending of NBFCs on a decline post the 2018 ILFS crisis – with several large players (Piramal, Edelweiss, India Bulls, DHFL) winding down of RE portfolios

New local players (HDFC, Kotak, SWAMIH) and offshore players (Apollo, Brookfield, Ares, etc.) focused mainly on last mile / portfolio rescue de

• ~99% of credit to Grade A & Grade B developers – largely name lending
• When the sector turned 2017–18 onwards – 22% of loans under moderate stress (~$20 bn) & ~16% (i.e., $15 bn) severely stressed; MMR & NCR ~91% of severely stressed loans; Aggregate new capital est. Against $35 bn of rescue is estimated at ~$5 bn

Derived net liquidity needed (post NAV adjustments & restructuring) estimated at ~$5 bn annually over the next 4–5 years.

• Long-term outlook for the residential sector is bright as we expect the economy to stand steady along with softening of global headwinds so that RBI can eventually reduce the policy rate creating positive ripples. RBI has already paused the repo rate hike in its last Monetary Policy Committee (MPC) meet.
• Most office markets around the world have been grappling with the adverse impact of a slowdown in economic activity caused by unrelenting inflation and the threat of a looming recession. India’s undercurrent of economic stability and growth is also reflected in the relatively stable occupier activity seen in the Indian office market.
• Logistics industry is transforming, and organized sector is growing at a faster pace, hence warehousing markets are expected to be on the rise with a CAGR of 10%

Until IL&FS crisis in September 2018

• Sizeable overseas capital pools and portfolios of HFCs / NBFCs / Stressed Funds @20–25% IRRs (INR)
• Opportunity for attractive returns from a secured debt perspective
• Co–investing likely to emerge as a new form of investing

• Transactions can generate 17–20%* gross returns in Indian rupee (INR)
• Project completion / construction financing to get secured high yield returns & selective LAP (completed inventory financing) at discounts to current market value
• Rescue financing to de–stress project / enterprise cash flows & attractive real estate pools – next 12-24 month investment opportunity

• Predatory Pricing due to enhanced liquidity in the market/ Equity deal structures couched as debt.
• Inflation remained high at 5% – reducing lender’s margin of safety as the cost of construction materials has risen dramatically, including key input materials such as cement and steel, due to shortage and a surge in fuel prices.
• Recessionary fears and slowdown in IT/ drying up of VC capital for overvalued Tech poses risks to ÏT Cities”
• Political instability (state elections in Telangana in CY 23, Maharashtra in CY 24) can lead to delay in project approvals, demand/supply issues etc.
• RBI has hiked repo rates by 250 bps in FY23 – this could impact residential sales to some extent, particularly in the affordable segment in short-term. The increase in cost of borrowing will have a direct impact on home buyers, leading to higher EMIs and lower affordability

• Despite the high cost of borrowings and adverse effects of inflation; rise in GDP per capita, larger disposable incomes, growing urbanization and a need for a better standard of living likely to fuel growth in the sector
• A slew of regulatory changes over the last 5 years (RERA, GST, IBC etc.) have substantially mitigated historical “governance” issues & rapidly transforming the sector to “organized”
• Govt & private investments in social infrastructure, healthcare, education creating new pockets of demand across urban, semi-urban and Tier II locations

Indicative model portfolio 

• Active pipeline & co–investor build across deal categories already underway
• SHF will continue to be a tactical joint investment partner to SAA RE funds aside of being the principal sponsor of the funds
• Augmenting platform capabilities to enhance scale & related risk management processes
• Focus will remain South micro markets alongside select Mumbai & Pune market deals

TRACK RECORD & CAPABILITIES

• One of the earliest entrants in the industry with ~25 years of history
• First in the industry to launch a fund in the midcap space
• Strong in-house research team
• Investment Philosophy – Bottom-up stock selection / Buy & Hold
• Flagship Fund – Sundaram Midcap Fund has been a consistent outperformer with a CAGR of ~23% since its inception 20 years ago

CUSTOMERS

• Managed over 5.6 million customer folios since inception.
• 1.9 million active customer folios.

DISTRIBUTION FOOTPRINT

• Over 50,000 empanelled distributors
• 94 branches across India; with International offices in Singapore and Dubai

High yield credit – robust execution platform

HY RE Credit

• Experienced & dedicated team
• Conservative credit policy; hands on IC
• Senior / secured deals; ~2x covers, priority cash flows
• Executed across project finance, bridge, rescue & last mile deals
• Set up fund structures catering to onshore & offshore capital
• Focused market presence (brokers, law firms, valuers & asset monitors)
• Intensive monitoring / credit culture
• Strong / resourceful sponsor group

Sponsors and its affiliates

• Committed ~30-35% of overall AUM / deployment (via Sponsor commitments, additional joint investments, via group companies); real ‘skin in the game’
• Senior group management hands-on at the Investment Committee (IC) from an accountability perspective

Scale

• ~INR 2000 crs. On Mar. 23; deployed over INR 2000 crs.
• Over 150 investors to date across HNI, Family Offices & institutions
• No presence in 2017 to a preferred RE financier in its target markets
• In addition to RE credit, launched a corporate credit fund in 2022 (~INR 600 crs. to date; ongoing fund raise)
• New credit products under launch across Impact, Listed Bonds etc.

Hands on Investment Committee (IC) that drives the business

Credit model reflects Sundaram conservativeness

• Matrix model devised for Real Estate / asset–backed credit that combines risk, pricing, UW rules & asset monitoring practices
• Unanimous IC recommendation – consensus approach
• Process-driven approach – fact–based decisions
• No, inter–fund conflicts Active oversight by the IC
• Investment Team operates within parameters – institutionalized business
• Pre–agreed UW policy – control over portfolio quality

Institutionalized underwriting approach 

• Core Investment focus: Solving for project cashflow mismatches; Construction funding; Select incremental approvals that add to security value
• Cash flow sweep: All project cash swept into escrow accounts. Only permitted uses are to service our debt and invest in our project; Significant incentive for developer to play ball
• Sole senior secured creditor or sole creditor
• Mid- to late-stage profitable projects: No pre-approval entry; brownfield focus. Engage at the enterprise level to stay abreast of overall credit
• Focus on climate + ESG (CESG): Built into underwriting and documentation; Transition CESG to a compliance
• requirement; Incentivize borrowers to invest into CESG positive infrastructure
• Provide comfort on future financing: A key to stay aligned on projects

Rigorous monitoring process 

Consistent, granular, relationship & process oriented approach to monitoring deals. The process involves periodic monitoring of investments and comprises escrow balance monitoring, sales and cost monitoring, construction progress monitoring and debt obligation follow-up

Escrow balance monitoring

• Daily monitoring of escrow balances for all investments.

Sales and cost monitoring

• Monthly sales management information system (“MIS”) and cost details obtained from investee companies.
• Sales and cost data compared with our underwritten business plan.

Construction progress monitoring

• Quarterly site visits for all projects.
• Site visits primarily involve the following;
  • Assessment of construction progress
  • Management discussions on historical and future cash flows

Follow-up on debt obligation

• Investment team regularly assesses the sufficiency of escrow balances to meet service debt obligations.
• Timely follow-up with investee companies performed by investment and operations teams.

The main investment objective of the Fund is to undertake activities of a Category II AIF and invest in high yielding debentures and mezzanine securities (including equities), of Indian entities involved with real asset industries that may include (but not limited to) real estate (residential, commercial, retail), logistics (warehouses, supply chain facilities,  data centers, etc.), hotels (including hostels, resorts) and healthcare facilities (hospitals, senior care homes, etc.). The investments will predominantly be backed by real estate. The instruments will be secured by monetizable assets, related cash flow streams and corporate guarantees, etc.

The Fund’s investments will mainly focus on de–stressing / de–bottlenecking identified assets / corporate situations via a combination of refinancing existing financiers, last mile funding, rescue financing, acquiring distressed assets and restructuring them with the goal of realizing value and cash from such businesses and companies.

DEAL STRUCTURE

Senior secured debt structure with mortgage of assets, escrow of cash flows from active projects, guarantees, share pledges, powerful operational covenants, Board / Step–in rights

OPPORTUNITY TYPES

• Rescue Financing
• Term outs (Refinancing + Working Capital)
• Pure growth (Securitize existing cash flows to fund new project acquisitions / land)

CREDIT FRAMEWORK

• Bilateral transactions with targeted developers:
• Senior secured NCD instruments – amortizing structure from self–liquidating RE projects
• 3–5 year deal tenors (avg. maturity 2–4 years)
• Deal sizes – USD 10–25 mn.

DEAL STRUCTURE

Senior secured debt structure with mortgage of RE project / assets, escrow of corporate cash flows, promoter guarantees, share pledges, strong operational covenants, financial guarantees (E.g.: bank guarantees, FD  escrows, etc.)

OPPORTUNITY TYPES

• Enterprise liquidity
• Term outs (Refinancing + Working Capital)
• Pure growth (Securitize existing cash flows to fund new project acquisitions / land)

CREDIT FRAMEWORK

• Bilateral transactions with targeted developers:
• Senior secured NCD instruments – amortizing / annual redemption structure from self–liquidating projects / assets
• 2–3 year tenors (avg maturity 1.5–2 years)
• Deal sizes – USD 10–25 mn

DEAL STRUCTURE

Senior secured debt structure with mortgage of assets, escrow of cash flows from active projects, guarantees, share pledges, strong operational covenants, Board / Step–in rights

OPPORTUNITY TYPES

• Rescue Financing
• Term outs (Refinancing + Working Capital)
• Pure growth (Securitize existing cash flows to fund new project acquisitions / land)

CREDIT FRAMEWORK

• Bilateral transactions with targeted developers:
• Senior secured NCD instruments – amortizing structure from unencumbered RE projects
• 3–5 year deal tenors (avg maturity 2–4 years)
• Deal sizes – USD 10–25 mn

DEAL STRUCTURE

Senior secured debt structure with mortgage of promoter assets, escrow of corporate cash flows, senior on the cash waterfall, promoter guarantees, share pledges of operating entities, strong operational covenants, Board seats

OPPORTUNITY TYPES

• Enterprise liquidity
• Term outs (Refinancing + Working Capital)
• Pure growth (Securitize existing cash flows to fund new project acquisitions / land)

CREDIT FRAMEWORK

• Bilateral transactions with targeted developers:
• Senior secured NCD instruments – amortizing structure from corporate cash flows / operating infra / commercial / logistics / healthcare projects
• 3–5 year deal tenors (avg maturity 2–4 years)
• Deal sizes – USD 10–25 mn

DEAL STRUCTURE

Senior secured debt structure with mortgage of promoter assets, escrow of corporate cash flows, senior on the cash waterfall, promoter guarantees, share pledges of operating entities, strong operational covenants, Board seats

OPPORTUNITY TYPES

• Enterprise liquidity
• Term outs (Refinancing + Working Capital)
• Pure growth (Securitize existing cash flows to fund new project acquisitions / land)

CREDIT FRAMEWORK

• Bilateral transactions with targeted developers:
• Senior secured NCD instruments – amortizing structure from corporate cash flows / operating infra / commercial / logistics / healthcare projects
• 3–5 year deal tenors (avg maturity 2–4 years)
• Deal sizes – USD 10–25 mn

• Est. $40–50 bn invested into RE by Banks / NBFCs / HFCs
• NBFCs negatively impacted by: Bankruptcies (IL&FS) ; Credit concerns (DHFL, India Bulls); Debt MF redemptions (lenders to NBFCs); Bank scandals (PNB, others)
• Largest providers to Real Estate funding stopped doing active business in mid 2018 which coincided with RERA implementation
• ALM issues across most Real Estate focused NBFCs – compelled to create liquidity by selling down assets / portfolios
• Possible to purchase single assets / portfolios from Real Estate lenders at attractive returns (e.g.,: DHFL Bombay Dyeing trade)