Sumes Dewan tells the story of Astra Infra to illustrate how innovative structures may overcome the hurdles associated with acquiring land

I n March 2005, significant liberalizations to India’s real estate sector were set forth by the Ministry of Commerce and Industry in Press Note 2. Although a number of important restrictions remain in place, the guidelines permit 100% foreign direct investment (FDI) under the automatic route in townships of over 50,000 square metres, serviced housing projects of at least 100,000 square metres, and built-up infrastructure and construction development projects covering a minimum of 500,000 square metres.

The move opened the doors to an influx of FDI in Indian real estate and ushered in new technologies that have enhanced the efficiency of the country’s construction industry. But despite the reforms, real estate investors face significant challenges, perhaps none more acute than the initial acquisition of land.

A township in Punjab

Take the hypothetical example of Astra Infra, a foreign real estate company seeking to invest in India. The company is fictitious, but the story of Astra’s struggle to acquire land for its development, and the regulatory hurdles it must clear as part of that process, is indicative of the challenges faced – and solutions found – by many real-life property investors.

Astra Infra is seeking to develop a township in the northern state of Punjab. It has identified a suitable block of 460 acres (1.8 million square metres) of agricultural land and is keen to move ahead with the acquisition. However, two significant challenges stand in its path.

The first relates to Press Note 2, which states that a foreign investor is only permitted to acquire commercial land for a township project.

The fact that Astra Infra’s prospective land has an agricultural classification is therefore a serious setback to the company and highlights the importance of investigating how specific parcels of land are classified by the state government.

The second challenge facing Astra Infra is that the land in question is not a unified block, but a fragmented collection of smallholdings with many different owners.

Fragmented ownership

In spite of these challenges, Astra Infra is optimistic about the prospects for its development and is keen to explore all available legal strategies that may enable it to move forward.

On the advice of an Indian law firm, it has decided to initiate the process by tackling the classification of the land it seeks to acquire. Currently, the land is designated for agricultural use and development is prohibited (as is the acquisition of the land by a foreign entity). Astra must therefore apply to the state government for a reclassification.

In doing so, the fragmented ownership of land immediately becomes a problem. For any reclassification to be considered by state authorities, the prospective developer is required to submit detailed construction plans relating to a unified property. Astra Infra is therefore faced with the arduous task of tracking down all of the individual landowners.

India lacks a central land registry, making it extremely difficult to identify the owners of rural properties. Furthermore, many of the country’s agricultural holdings have no clear land titles. Astra Infra therefore engages a law firm to carry out an extensive title search and to review the revenue records of the fragmented plots of land. The task is complex: revenue records are kept by different people in each local village and many of them have to be translated from regional languages into English before they can be examined by lawyers.

Once the landowners have been identified, Astra Infra must find a way of consolidating the fragmented properties into a single block of land. It decides to do this by creating an intermediary company called Tech-Build Realtors. The new company is incorporated in India and its shares are held by Indian residents.

A land consolidation firm called Landmass is hired to communicate with the landowners and secure their consent to the plan. Landmass also structures and executes an agreement enabling Tech-Build Realtors to purchase the entire parcel of land from the various smallholders and consolidate it into a single block under unified ownership.

The execution of legally binding agreements between the landowners and Landmass, and in turn between Landmass and Tech-Build Realtors is a crucial step that minimizes the chances of any of the original landowners raising legal issues at a later date.

Unfavourable classification

One major hurdle has been overcome, but the issue of land classification has yet to be resolved. Any change in land designation is typically awarded to the purchaser, not the original owners of the property. As the new acquirer, it is therefore the responsibility of Tech-Build Realtors to apply to the state government for a change of land use certificate (CLU).

As part of the application, Tech-Build Realtors is required to submit comprehensive development plans to the state government along with a detailed breakdown of how the land will be divided between commercial and residential uses. It is also required to justify the compliance of its development plans with Press Note 2 and various regional laws.

In reaching a decision, the state authority considers the manner in which the land is to be used and the potential impact of the change on the local economy and local communities. Tech-Build Realtors cooperates fully with the state government during this process, and after three months a favourable decision is granted.

With the land consolidated into a unified block and a CLU obtained from the Punjab state government, Astra Infra is ready to move forward to the next stage in its plans. However, there is still a significant problem: Despite spending several months of management time on the project and investing a significant amount of money in professional fees and administration, Astra Infra is no closer to owning the land itself.

To make matters worse, what started out as a fragmented collection of smallholdings with a land use designation that prohibited development, is now a unified plot with a classification that makes it ripe for investment. Has Astra Infra inadvertently created an attractive takeover target for one of its competitors? After all, despite its considerable investment, it is not yet a shareholder in Tech-Build Realtors.

Fortunately, Astra Infra has provisions in place to protect Tech-Build Realtors from unwanted advances and to ensure that its owners don’t renege on their obligation to transfer the project to Astra. A share purchase agreement, executed when Tech-Build Realtors was established, gives Astra Infra the right to purchase 100% of Tech-Build’s shares at a pre-determined price within a 12-month period. And this period may be extended indefinitely if Astra Infra deems it necessary.

Once the share purchase agreement is exercised, Tech-Build Realtors – and its assets, including the consolidated land with the new designation – becomes a wholly owned subsidiary of Astra Infra.

Not for the fainthearted

The entire process, from identifying the land to finally purchasing the shares of Tech-Build has taken Astra Infra more than 10 months. The initial four months were spent selecting the land and tracking down the different owners, while the rest of the time was spent implementing the structure of the deal, acquiring the land, obtaining the reclassification and ultimately purchasing the shares of the intermediary company. Had Astra Infra fallen at any of these hurdles, the whole process may have collapsed.

Successfully executing deals through this structure therefore requires a great deal of patience as well as meticulous planning and a commitment to addressing the challenges that are inherent in India’s fragmented real estate market. Indeed, only after clearing the hurdles associated with land acquisition can real estate developers move forward to the process of seeking approvals for their developments.

Nevertheless, the recent growth in India’s real estate market bears testament to the attractiveness of the sector. And for the increasing number of international property developers that are eying investments in India, the difficulties in acquiring land pale into insignificance when weighted against the long term opportunities that now exist.

Sumes Dewan is a partner at KR Chawla & Co, a full service law firm in New Delhi. He may be contacted at sdewan@krcco.com. The companies and events described in this article are fictitious.