The New Real Estate Capital Stack: Equity, Private Credit, REITs and Structured Finance

by Dr. Amit Goenka, Chairman & MD of Nisus Finance

With India’s urban population expected to reach 900 million by its centennial year of independence, the country’s real estate sector is projected to reach a market size of between USD 5-7 trillion by 2047. That said, given the sector’s capital-intensive nature, financing this growth will require India’s real estate financing ecosystem to mature beyond traditional bank lending and promoter-led equity infusion. Accordingly, the current real estate capital stack has evolved to include banks, housing finance companies (HFCs), non-banking finance companies (NBFCs), alternative investment funds (AIFs), real estate investment trusts (REITs), private equity (PE) funds and institutional investors. While each capital provider is playing a distinct role within the overall financing ecosystem, the capital stack itself is transforming into a more diversified, efficient and disciplined structure that is built around tighter underwriting.

Understanding The Real Estate Capital Lifecycle
While the real estate capital lifecycle can be broken into five distinct stages- land acquisition, early-stage development, construction, inventory and last-mile funding- there is an increasing need for turnaround capital for stressed assets and more stable capital for lease rental discounting (LRD) as well. Banks, NBFCs and HFCs make up the bulk of the lender pool for most of these stages, AIFs are increasingly joining them in funding land acquisition and other high-risk development stages. With the RBI restricting banks from funding land acquisitions and approvals, developers are increasingly relying on AIFs, PE capital and to some extent NBFCs, especially since the latter can only fund approved projects from 2022 onwards. As a result of these factors, the Indian real estate sector has been increasingly diversifying its funding sources and is currently in a long-term capital expansion cycle that should see rising institutional investor participation over the coming decade. AIFs, PE and REITs are not only bridging the credit gap faced by developers today, but are also delivering structured finance by using customised multi-layered debt and equity arrangements to fund large-scale real estate projects. Similarly, asset reconstruction companies (ARCs) are stepping in to fulfil the growing need for refinancing of stressed assets and unlocking value through sale or completion of stuck projects.

Why Developers Are Preferring a Diversified Capital Stack
Even though some of the above sources of capital come with a higher interest expense, developers are increasingly preferring a diversified capital stack as it gives them more flexibility, while also reducing dependence on a single funding source. Thus, instead of financing a project almost entirely with bank debt or equity, developers are combining several sources such as senior debt, mezzanine or structured debt, preferred equity and institutional or private capital where traditional lenders are constrained. This approach is helping developers in achieving better capital efficiency while distributing risk across different capital providers. It also gives them greater flexibility and enables them to achieve faster project execution; in turn positively impacting cash flows across a portfolio of different projects. In fact, by diversifying their funding sources and employing rather complex capital stacks, developers are now able to create the right combination of cost, leverage, risk, control and return expectations; benefitting all stakeholders and leading to greater maturity of the overall real estate financing ecosystem as well.

Creating New Investment Opportunities with Disciplined Underwriting
As developers increasingly adopt a more layered capital stack to fund their projects, it is creating new opportunities for institutional and alternative investment platforms, while making risk assessment, cash-flow visibility and disciplined underwriting increasingly important in determining sustainable real estate returns. As these investors occupy different positions in the overall capital stack, they will ostensibly have different risk, return and control requirements. This is where investment platforms like REITs come in, filling in gaps with specialised capital either to recycle investments or provide fresh capital for promising projects. Similarly, private credit platforms will largely focus on providing senior/structure capital while PE platforms could position themselves as development equity providers to capture higher upsides on the capital employed. As a result of this institutionalisation of the real estate capital stack, developers can tap into different capital pools with each providers pursuing more disciplined underwriting while addressing credit gaps across different stages of the real estate lifecycle from acquisition and development to refinancing and asset monetisation.