Myth #6 : Private Equity investment reduces the risk for Real Estate Developer

(Category: Finance)

(also published in CNBCTV18.com )

In general, equity partners normally reduce the risk for promoters but do PE investors in real estate do the same?

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One of the key expectations from any equity investor is that he would reduce the risk for the promoter. So does the entry of a private equity investor reduce the risk for the developer?

By definition, equity investment can reduce the risk for the promoter if it can reduce the promoter’s loss in adverse market conditions. A developer’s risk, therefore, can come down only when the investor not just participates in the upside but also shares the developer’s loss.

Most PE investments in India, however, are in the form of Structured Debt. Such structures have a minimum guaranteed return to the PE Investor. This guaranteed payout is independent of the profits from the project. With PE investors not sharing developer’s loss, a PE investment transaction obviously does not result in the reduction of the risk for the developer. 

The value, therefore, that the PE funds bring to the table is not risk mitigation but benefits like deferment of interest payment which is not offered by banks and NBFCs (Non-Banking Finance Companies). And since PE investment is treated as quasi-equity, it enhances the developer’s potential to raise debt from banks/NBFCs. 

Therefore, for projects that are bankable, PE investment generally does not offer a Risk-Return trade-off to developers. But those who want to make their projects bankable, Private Equity is a good bet. But it comes with its own costs.