Real estate is one of the sectors which has always been watched closely by regulators and private equity investors. Foreign direct investment (FDI) is not permitted in any entity which is engaged or proposes to engage in real estate business. However, FDI up to 100% is allowed under the automatic route in construction-development projects. Recently, the Department of Industrial Policy and Promotion revised the regulations with respect to FDI in this sector by amending the FDI policy.
Though a clear definition of “construction-development projects” has not been provided, the revised policy illustrates that the following will be included as construction-development projects: (i) development of townships; and (ii) construction of residential/commercial premises, roads or bridges, hotels, resorts, hospitals, educational institutions, recreational facilities, city and regional infrastructure and townships.
Though the entry route is automatic, several conditions must be fulfilled. The key conditions can be broadly classified as: (i) minimum area requirement; (ii) minimum capitalization; and (iii) minimum lock-in. Apart from these, there are a few other conditions, such as conforming to laws (including local laws) relating to construction and development activities, and investee companies being allowed to sell only developed plots.
Minimum area requirement
Projects to be carried out by the Indian company in which FDI is proposed must fulfil the minimum area requirement. In the case of construction-development projects, a minimum floor area of 20,000 square metres must be developed. However, in the case of a development of a serviced plot, there is no minimum land area requirement.
The minimum area requirement is a “project-specific requirement”, which means that each of the projects undertaken by such an Indian company must comply with the minimum area requirement. If any project housed in the Indian company is not able to meet this requirement, the company will not be eligible to use the automatic route. Therefore, most real estate companies generally house each of their projects in a separate special purpose vehicle (SPV), controlled by an umbrella holding company. Proposed FDI is then brought into such SPVs rather than the holding company.
Another important condition is the minimum capitalization requirement. The requirement is to bring in at least US$5 million within six months of the commencement of the project. It is important to note that the minimum capitalization requirement is an “entity-specific requirement”, unlike the project-specific minimum area requirement. Therefore, the minimum capitalization is not required to be brought in by the foreign investor for each of the projects of the company (if several FDI-compliant projects are housed in the company).
The revised policy brings in clarity by defining the term “commencement of projects”. It is the date of approval of the building plan/layout by the relevant statutory authority.
Further, the lock-in requirement is now linked to completion of the project. The foreign investor is permitted to exit only on completion of the project or after the development of trunk infrastructure. However, a window for approval has been provided to foreign investors, with respect to: (i) transferring their stake to another non-resident investor before the completion of the project; or (ii) permitting repatriation of FDI. All such proposals will be considered by the Foreign Investment Promotion Board on a case-to-case basis and in view of the facts and circumstances of the case.
Flexibility has been provided with respect to subsequent investments by the foreign investor. Subsequent tranches of FDI can be brought up to 10 years from the commencement of the project or before completion of the project, whichever is earlier.
It appears that the government has tried to streamline the conditions for FDI in this sector. This is a welcome move. Apart from the large changes, there are some clarifications which are helpful too, e.g. (i) the Indian company is now responsible for obtaining all the necessary approvals for the construction and development, unlike the earlier policy where the foreign investor shared this obligation; (ii) 100% FDI under the automatic route is permitted in completed projects for the operation and management of townships, malls/shopping complexes and business centres.
It will be interesting to see how the market reacts to this in the coming years, especially how it affects the exit strategies of private equity players. Exit has not been easy, given the fluid and complex regulatory framework and different interpretations of the regulations.
Aakash Choubey is a partner and Abhishek Sinha is a principal associate at Khaitan & Co. The views of the authors are personal, and should not be considered as those of the firm.
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