Don't mistake infrastructure for glitzy malls

Well I am not surprised at all after reading this. In fact, I’ve already said what I had to. Here and here.

“PE funds and analysts have become far more cautious in evaluating real estate investments in India. One of the analysts said that some of the funds are tightening norms for valuations after the slowdown and at least 30 per cent of the deals are taking a much longer time to go through because of valuation issues.”

All things that go up will have to come down. That is law of gravity. Imagine real estate prices going up without adequate supporting infrastructure. Say, proportionate expansion of road area or power and water supply? Ask Chennai residents. They've proved that humans don’t need natural drinking water to survive. Their life can be threatened only if the bottled water supply stops. One lash of rain and the city is flooded and the next few days are spent clearing the slush and choked drains. Soon many other cities will follow suit.

What is the point in putting up millions of square feet of glitzy malls and complexes if there are no decent roads leading to them? This is the bane of our city dwellers. Bombay was the pioneer that led this brand of mindless development and other cities haven’t learned from its travails. Bangalore, Chennai, Kolkata, Hyderabad, Cochin are all developing fast on the roadsides. But road area available remains just the same. Naturally less people would like to visit such places, much less choose to occupy. Fewer will invest. So how do you expect the prices to keep going up?

Town planners will have to work overtime. May be, one can try out PPP route to salvation. Infrastructure companies should be entrusted with the task of developing large townships and no individual developer should be allowed to develop in fractions. The system of build a block first, then dig the road to lay water and sewer pipes and dig again to lay power/data cable should stop. Major slices of Municipal budgets getting wasted on humungous pensions for past employees should stop. Spend it on better planning and efficient execution. That, if anything, would stabilize property prices - not liquidity, not a booming stock market or a surge in demand fueled by higher disposable income with people, because all this can dry up. What is constant is easier access, navigable road network and a peaceful enjoyment of the premises with enough water to drink and power to run your essential gadgets - in the kitchen, at least.

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Indian infrastructure. Big numbers, high hopes!

Realty sector is getting hot; yet again

While the housing sector experiences a slump with investors vanishing from the market and end users finding rising interest rates a major hurdle to buy their dream homes, the broader realty infrastructure sector remains hot. Leading PE funds such as Blackstone, 3i, ICICI Venture, Axis have all raised major rounds focused on Indian infrastructure sector.

Why this rush towards Indian real estate and infrastructure?

According to estimates from ICICI Securities, the Indian real estate market is worth $57 billion, and is expected to grow at a compounded annual rate of 13% to touch $105 billion by 2012. This would require investments worth $85 billion across the residential, commercial, retail and hospitality sectors. On infrastructure, the Indian government has forecast the need to spend $492 billion over the 11th five-year plan ending 2012.

As such, the investment climate for this sector has been hot, and funds, both domestic and global, have been queuing up for a slice of the action. Did you say liquidity crisis...?

No wonder I am finding myself in a funny kinda’ situation.

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Get your skin in the game

So I read this McKinsey report.

During the past two years, the flood of money into infrastructure funds has been an astonishing $130 billion. Take into account leverage, a billion dollars of equity funding could, in some situations, pay for up to $10 billion in projects. "Where will all the money go?” It asks. I am tempted to add an extension – “[with shrinking margins]”. The need for infrastructure investments in the emerging markets at present is about $1 trillion. I am at ground zero here in India. I can share a few insights.

PE funds here need a new approach – different from typical value creation through financial engineering and rising user demand. So far, they have acted less aggressively to improve operations; indeed, many financial investors still leave such issues to contractors and focus their governance efforts on financial metrics. This model is broken; it’s so yesterday.

So what should PE fund managers do today? I suggest -

a) Lay down norms of good governance. It helps assess risk in a structured way, avoiding unwarranted focus on a single category, such as technical delivery or regulatory compliance.

b) Brief project owners about the complexities by way of foot note to RFP itself. When they see reason, they might even expand their allocated budget. If you’d quoted thin, you’ll come to grief later.

c) Build alliances with Infrastructure specialists. Get some strategic skin in the game. Here’s the twin upside - a better chance of winning traditional deals and turn them around; and the ability to bid for operationally complex and less competitive projects. That’s how you learn to walk away from overpriced deals.

I quote an example. Macquarie and Ferrovial’s co-investment in the UK’s Bristol International Airport, for example, involved upgrading signage systems; renewing check-in, baggage reclaim, and catering facilities; rerouting foot traffic; and installing all-weather landing equipment. The investors also rejuvenated the airport’s retail offering, strengthened the management and sales teams, and even tweaked the system for booking parking spaces. In the four years after the acquisition, the number of passengers using the airport doubled—as did its EBITDA.

I find financial engineering can help PE returns only up to a point. With strategic competence added in, you can man up before the whole world, not just LPs. What do you think…?

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