India, once celebrated for its spicy curry, mysterious Maharajas and bejeweled elephants, is transforming from an exotic locale to the next frontier for American commercial real estate investment. Already the growing economy has displaced the U.S. as the second most favored investment destination after China, according to a recent study by consultant A.T. Kearney & Co.

Although most projects are not yet off the ground, there are several dealmakers in India scouting around for development opportunities. In fact, nearly one year after India modified regulations to make it easier for foreigners to directly invest in Indian real estate, many U.S.-based institutional and private real estate investors such as New York-based Tishman Speyer Properties L.P., GE Commercial Finance Real Estate and First Wall Street Capital International have established joint ventures or opportunity funds to develop office, hotel and residential projects.

While the rewards could be handsome, these firms are taking on significant risks when they invest in an emerging market. Specifically, the real estate market in India is not as transparent as it is in the United States, construction quality is substandard compared to other countries, and bureaucracy and corruption can endanger new projects and create roadblocks to obtaining approvals.

“Despite the risks of an emerging market, we think India is a spectacular opportunity — one of the great opportunities in this time in history,” says Katherine Farley, senior managing director of emerging markets and global corporate marketing for Tishman Speyer.

The U.S. company has put together a joint venture with Bangalore, India-based ICICI Venture Funds Management Co., India's largest private equity firm and a unit of ICICI Bank Ltd. The partnership plans to invest $600 million in India's real estate market including office, multifamily and retail, with each company contributing roughly $300 million.

Meanwhile, GE Commercial Finance Real Estate has invested $63 million in a fund sponsored by Singapore-based Ascendas Pte Ltd. The fund, which Ascendas kicked off by contributing two IT parks in Bangalore and Hyderabad, plans to acquire and develop roughly $500 million in information technology parks over the next seven years.

Tishman, GE Commercial Finance Real Estate and other U.S. investors are attracted to India because of the insatiable demand for office, residential and hotel space. The seemingly endless demand, coupled with little or no supply of quality assets, has boosted internal rates of return for new development projects to more than 20%, according to industry experts.

Encouraging foreign investment

Real estate investment is expected to capture about 18% to 20% of all the money that is coming to India this year from outside its borders. In 2005, total investment dollars flowing into India from other countries reached $8 billion, up from $4.7 billion in 2004, according to PricewaterhouseCoopers.

The consultant forecasts that foreign investors will sink $1.2 billion into Indian real estate over the next 12 months, with foreign investment into the real estate sector alone reaching $7 billion to $8 billion per year by 2009. Overall, real estate investment is expected to grow from $12 billion annually today to $50 billion in just five years.

The bulk of development opportunity available to foreign investors is in the office, residential and hotel sectors, according to Anuj Puri, managing director of Trammell Crow Meghraj. The investment hot spots today include the tech-driven cities of Bangalore, Hyderabad and Mumbai in the southern part of the country, and Delhi in the northern region.

Tishman Speyer, for example, is actively pursuing deals in southern India and has started to look for opportunities in Chennai on the eastern coast of India and in the northern India cities of Calcutta and Delhi, according to Farley.

“India has very attractive real estate potential because, from an economic perspective, it is a high-growth market,” says Jonathan Kern, global chief investment officer for GE Commercial Finance Real Estate. The institutional investor picked India as an investment locale over other emerging markets such as Brazil, China and Russia.

Kern says that the changes in India's foreign investment policy encouraged GE Commercial Finance Real Estate's participation in the fund. Moreover, he points to India's outstanding economic, employment and population growth as incentives to invest in the country. “Ascendas is just the beginning for us,” Kern says of the fund. “We expect to be in India permanently, and we expect that our growth will parallel India's growth.”

Beyond call centers

Without question, India's growth has been impressive over the past several years, with the economy expanding at a rate of 7% to 8% annually and no significant slowdown in sight for another 10 years or so. Based on historic and projected GDP growth, India, along with China, will account for almost 50% of the global economy by 2045, according to Ernst & Young.

India, already the fourth largest economy in the world measured in terms of purchasing power, is closely tied to the United States in more ways than one, notes Arsh Chaudhry, managing director of client solutions for Cushman & Wakefield.

India, like the United States, is a democracy governed by similar property laws and regulations, which is a strong selling point with real estate investors. “I'm more comfortable investing in India because there are laws that protect the American investor,” says Glenn Myles, CEO of First Wall Street Capital International. “I'm not ready for China yet because the government still controls everything.” Myles is referring to China's communist regime and its policies pertaining to real estate.

Moreover, India is an English speaking country when it comes to business, offering an additional level of comfort and familiarity to U.S. investors. Along those lines, investors are reassured by the fact that so many U.S. companies already have a presence in India, according to Chaudhry.

Long recognized as a locale for call center operations, India is establishing itself as a true knowledge center, he contends. Roughly 25% of all Fortune 500 companies including Eli Lilly, General Electric, and Hewlett Packard have set up research and development facilities in India. Additionally, Microsoft recently announced that it would add 3,000 new jobs to India, while JP Morgan Chase plans to hire an additional 4,500 Indians.

“The connections with Corporate America are a big plus, because U.S. investors can tap into the relationships they have at home and carry those into India,” Chaudhry notes. In fact, demand for office space from multinational companies has grown from an estimated 3.9 million sq. ft. in 1988 to more than 16 million sq. ft. in 2005, according to Cushman & Wakefield. Over the next two years, demand is expected to grow 14.5% annually to just over 20 million sq. ft. per year.

“Here in India, you can take on the development risk, but because the office buildings are already pre-leased to the gigantic multinational companies, you end up with core properties at opportunistic returns,” says Noble Carpenter, a senior leader in Jones Lang LaSalle Inc.'s capital markets group. Investors can expect net operating income to increase a minimum of 10% annually based on increasing rental rates.

Although 80% of the demand for office space is created by the IT sector, other industries such as banking and financial services, biotechnology and pharmaceutical are growing.

Growing middle class

The expansion of new and existing companies is creating a growing middle class with significant buying power. Today, India boasts a population of more than 1 billion people and adds about 20 million people annually, according to Ernst & Young. To put that in perspective, India's annual population growth rate of 2% is equivalent to adding the entire population of Australia every year.

Roughly 200 million to 300 million of the country's population can be described as “middle class,” which translates into expanding levels of disposable income that can be spent on upgraded housing, entertainment and retail goods and services, according to Rajiv Sahni, a partner with Ernst & Young's real estate practice in India. India's middle class is defined by those who make $4,545 to $23,000 per year, reports the National Council for Applied Economic Research based in Delhi.

In fact, India's strong economic growth and growing middle class are collectively driving a change in cultural values, Chaudhry notes. “In a traditional Indian home, a lot of people stay with their extended families, but today a lot of young people are buying their own homes,” he says, adding that industry experts have estimated that India suffers from a shortfall of 20 million homes in major metro areas. The housing shortage translates into an investment of $325 billion to $350 billion just for residential development alone.

“If you asked Jesse James the reason he robbed banks, he would have said he did it because that's where the money is. For commercial real estate, the money is where the people are,” Myles says.

Local partners open doors

Instead of trying to break into the Indian development market alone, First Wall Street Capital International recently established a joint venture with London-based Global Emerging Markets to build as much as $500 million worth of residential condominium/hotel product in Mumbai and Delhi, two of India's largest metropolitan areas. The joint-venture entity has already put land under contract and is in the process of finalizing an agreement with a luxury hotel brand for the projects.

Most, if not all, foreign investment is taking on local partners, primarily because Indian developers often have a construction pipeline that is already filled with projects, says Alex Darragh, managing director of Trammell Crow Co.'s international operations.

First Wall Street Capital is relying on Global Emerging Markets for local market expertise building apartments in India, Myles says. “We're using local partners because they're familiar with the approval process,” he explains.

Similar to the development challenges in the U.S., land assembly is the number one difficulty in India, and a lot of these Indian partners might already have land banks, allowing U.S. investors to compress the development time frame, according to Avnish Singh, a director in Jones Lang LaSalle's India office.

“There is still a strong element in bureaucracy involved, and it's always good to have a local partner so you can hit the ground running,” he says.

But finding the right partner for Indian investment can be challenging, Singh believes. He says that most top-tier Indian real estate developers have very robust balance sheets and don't need U.S. capital to make their projects work. “A U.S. investor might have to partner with a second- or third-tier developer to get the returns they want,” he explains, adding that blue-chip names such as GE may find the process less difficult.

GE Commercial Finance Real Estate, for its part, plans to do most of its investing in India with local real estate partners, Kern says. A foreign investor may also choose to partner with a non-real estate company. Tishman, for example, chose a bank for its partner. “We never even considered going to India alone because our assumption going in was that we'd be much more effective with a partner,” Farley says. “We really needed the Indian piece [of the puzzle], and when we want to speak to the chief minister of any state, it's very easy to get their ear because of the relationships they have with our partner ICICI.”

Infrastructure issues

By aligning themselves with partners, foreign investors are hoping to mitigate some of the risks involved in developing in India. Investment transparency, government corruption, a sluggish regulatory environment and the decaying and inadequate infrastructure are particular concerns of many U.S.-based investors.

“Nothing is right today in terms of infrastructure,” says Sahni of Ernst & Young, referring to the country's antiquated airports, roads and utilities such as electricity and sewer. “It will require billions of dollars to get our infrastructure to a level that compares to China.”

India's infrastructure isn't the only laggard — the business community lags behind most countries when it comes to financial reporting. “Getting basic information in India is very difficult,” contends Dennis Yeskey, the leader of real estate capital markets practice for Deloitte & Touche LLP. This lack of transparency in financial reporting makes it hard for foreign investors to conduct their due diligence and maintain a close eye on their money, and Indian firms are just now assuming a higher level of corporate governance.

Moreover, industry experts say that India's land records and rent control regulations need to be overhauled, particularly because land ownership in major cities and the suburbs has been extremely fragmented and title insurance is not yet available in India.

The biggest issue, observers say, is corruption. “India is bureaucratic and there are a lot of poor government officials, making the country ripe for corruption and payoffs,” Yeskey says. This is especially true of ground-up development, which requires many licenses or approvals from various government authorities. “We are very careful (about corruption),” Farley says. “We realize that it means that we may not get business because we have a zero-tolerance policy for it.”

For most U.S. investors, these risks don't outweigh the rewards. “A lot of people tell us that India is not an easy place to set up a business or an easy place to build, but the advantages it offers offset the problems, and India offers a dramatically attractive opportunity,” says David Gialanella, executive vice president of CB Richard Ellis.

Kern agrees: “We realize that India, like every emerging market, poses some risk. But, as long as the regulations and the laws enable foreign investment, we're excited and we plan to grow there.”

Jennifer Popovec is a Dallas-based writer.

INDIA'S VITAL SIGNS

Current Population: 1.02 billion

Demographics: 50% of population is under age 25; 75% is under 40

Population Growth Rate: 2%, or 20 million annually

Economic Growth: 6% to 8% annually

Real Estate Investment: $50 billion in additional investment by 2010

Labor Force 500 million and growing by 15 million annually

Source: Ernst & Young, The Associated Chambers of Commerce and Industry of India

FOREIGN REAL ESTATE INVESTMENT IN INDIA: REFORMS IN GOVERNMENT REGULATIONS
Previously Today
All foreign real estate investment national government approval National government approval is no required longer needed
Foreign investors were not allowed to buy existing buildings No change
Ground-up development was restricted to technology parks, hospitality, and special enterprise zones Ground-up development is allowed in all commercial real estate, plus residential real estate
Ground-up development was restricted to projects with a minimum of 100 contiguous acres Ground-up development is allowed for projects with a minimum of 25 acres, or 538,000 sq. ft.
Minimum investment of $5 million for joint ventures, and $10 million for independent companies No change
Source: Knight & Frank