Foreign Investments in Real Estate

(2) After 1995 there is unprecedented rise in real estate
prices year after year. Now a new trend has emerged amongst the class of
developers of specialising in different categories, such as construction
projects for residential complexes, commercial spaces, hospitality i.e.,
hotels, industrial parks, malls and similar projects.

(3) To regulate the development projects, the regulating
authorities issued two Press Notes. But even these Press Notes excluded certain
categories from its purview e.g., Press Note 2 does not deal with
industrial park developments, which comes under automatic route. Similar
position exists in cases of development of warehousing, hotels, etc.

(4) As regards regulating the provisions applicable to
foreign investment in real estate developments, the speaker said that there are
four or five segments available to foreign investors who are either NRIs or
foreign venture capital investors or foreign institutional investors. For each
of these categories there are different norms.

(5) Regulations prohibit participation of foreigners in real
estate business as traders per se. However, real estate business does not
include development of townships, construction of residential and commercial
premises, roads, etc.

(6) On following two dates viz. 6th July 1991 and 3rd
March 2005, drastic changes were introduced in regulations which have made the
real estate business an attractive proportion to foreign investors. From 12th
January 2005 the permission of Govt. hitherto required for foreign investors was
done away with. As per Press Note No. 2, hundred percent investment in
development projects of townships, hotels and roads was allowed to non-resident
investors subject to the following conditions :

(a) For development of housing project, investment in land
acquisition of minimum 10 hectares which is equal to 25 acres, will be the
precondition. The question that needs consideration is whether a 100% subsidiary
Co. of a foreign company can acquire agricultural land for development. The
answer is that if the law of the State in which such agricultural land is
situated, permits such acquisition, then such company can purchase agricultural
land provided it takes steps to convert agricultural land into non-agricultural
land and uses it for development of building and not for purposes of
agriculture.

(b) Capitalisation norms and restrictions :

A foreigner making investment through a subsidiary in India
will be obliged to invest at least 10 million dollars. If investment is made
with Indian joint venture partner, then capital contribution will be 5 million
dollars. The investment should be within 6 months from commencement with lock-in
period of 3 years from date of investment.

(c) What constitutes joint venture :

The ratio of investment in such joint venture need not be
equal. The foreign investors can have dominating percentage. As regards period
of six months from commencement, Press Note No. 2 provides that the date should
be counted from the date when agreement to subscribe shares is entered into
between co-venturers. The minimum prescribed amount of 5 million is to be
brought in within six months. The condition of lock-in period of 3 years applies
to minimum investment and not to additional investment over and above minimum
investment.

(d) Time period for completion of project :

At least 50% of the project has to be completed within five
years from the date from which all the clearances are obtained. The investor
will not be permitted to sell undeveloped plot. It means that before effecting
any sale, he must have completed development of plot by carrying out
construction of roads, water supply lines, drainage, water storage and related
facilities. It means, the investor must develop 10 hectares of project plot
before effecting sale.

(7) The speaker then observed that the boom in real estate
trade is attributable to excess liquidity in the economy. Many foreign investors
find that they are suffering cash crunch though the lock-in period is yet not
over. For making the development project viable, they have already invested
funds over, say, 25 crores plus Stamp Duty @ 1% and if at that stage any
disputes or difficult situation arises, then to meet the liquidity challenges
the only way is to dispose of their surplus investment over minimum by
transferring their shares or to liquidate holdings through buy back of shares or
to liquidate the company. In another situation if construction has already
started but if constructed area cannot be disposed of profitably, the investor
will face serious difficulty. Where development of land, say, of 10,000 sq.
meters is undertaken, then built-up area of 50,000 sq.mtrs. will be available
assuming FSI of 5. In the event response to constructed area is very poor, then
the loss may be much higher. The foreign investor has to keep in mind all such
situations.

8) The speaker then clarified that in the event the project fetches good profit, then dividend can be declared, subject to transfer of required percentage to reserves.

9) As regards companies in real estate, with huge capital investment of, say, 100 crores, the foreign borrowing for purchase of land is not permitted. Such borrowing’s are permitted only for financing construction work. As issue of shares at premium is possible, in such a case the capital base can propor-tionately be kept smaller. However, it is necessary to look into Reserve Bank guidelines. The amount of premium can be considered, for satisfying the condition of minimum capitalisation. External Commercial Borrowings (ECB) is not permitted. On
1-6-2008 the Government has put a bar on issue of non-convertible preference shares or non-convertible debentures. Debentures must be convertible and time frame for conversion has to be observed. But, if the company has committed to issue non-convertible debentures prior to 1st June 2008, then such company can continue with its commitment. In another situation if company wants to change over to convertible debentures, then Reserve Bank should be approached before taking such step.

10) Another aspect is satisfying valuation norms prescribed by the Controller of Capital Issues, pre-vailing up to 1992. Though this order was abolished, valuation rules prescribed by CCI regulations still continue.

11) As regards conversion of preference shares in equity shares, such conversion is treated as transfer for ascertaining capital gains liability of shareholder.

12) As regards conversion of debentures into shares, S. 47(10) of the Income-tax Act provides that the same will not be regarded as transfer. Transfer of shares by one foreign Co. to another foreign Co. requires no permission, nor is it governed by transfer pricing rules, nor by pricing guidelines. The same principle applies to transfer by one NRI to another NRI. Where transfer of shares is from person resident in India to non-resident, no approval is required. This however is subject to compliance of guidelines, set out in circular of RBI of October 2004 and pricing guidelines.

13) Any gift by a resident to a resident outside India needs RBI approval. Where there is a transfer by a person outside India to a resident in India, the repatriation of price realised above fair value will not be permitted to such non-resident.

14) Mr. Kapadia then stressed the need on the part of non-resident investor to give serious thought to structuring aspects of joint venture investment, by planning of route to be adopted, by studying the provisions of DTAA, and FEMA, whereby the tax effect can be minimised and his investment will be ideally tax effective and cost effective.

15) The speaker thereafter touched upon the various segments of real estate trade. It cannot just be restricted to conventional form of construction of buildings, but also takes into consideration other forms. The capital investment requirement and form of organisational set-up vary from each other. The few illustrations are:

a) Real estate management company needs to have minimum net worth of 5 crores.

b) There was one more category of O.CB., where 60% of holdings were owned by non-residents. Now, 50% of Directors of such real estate management company should be financing directors. The unit should invest in real estate projects of which 80% should be in completed projects and maximum up to 20% in incomplete project. Investment in vacant land is not permitted. These provisions at present are in a draft form till guidelines are notified.

c) The other avenues in real estate are development of service plots, residential or commercial premises, development of townships, investment in manufacture of building materials, investment in joint ventures, and similar other forms of organisation. In respect of many of the avenues there are no limiting or restrictive conditions like minimum capitalisation or lock-in period. The only requirement is the investor should be an NRI, a person of Indian origin. All these investments will be on repatriable basis.

d) As regards foreign venture capital investors fund, clause 5(5) of Foreign Venture Capital Fund Regulations of 1998 plays an important role. The constitution of a venture capital undertaking has to be a company whose shares are not listed on a recognised stock exchange in India and which should not be engaged in an indus-try specified in negative list. The advantage is lock-in restriction and pricing restriction are done away with.

16. Regulations  Re : Real  Estate  Mutual  Fund:

The only requirement is that management of such mutual fund shall have at least 5 years expertise in real estate trade. The investment should be in a specified real estate asset and not in incomplete projects or projects under construction. It must be located in India and in such city as may be specified. The property should not be subject matter of any litigation. At least 35% of net assets of the fund will have to be invested directly into real estate asset and therefore such mutual fund will not be equity-oriented mutual fund. Distribution made by mutual fund will be subject to dividend distribution tax. The investment can also be made in shares, debentures, mortgage-backed securities. The investment in these can be 75% and balance 25% in any securities. No real estate mutual fund can invest more than 25% of its capital in unlisted shares. The NAV of the real estate mutual fund shall be published every 90 days.

17. While concluding his talk, the speaker narrated a quotable quote of Pandit Jawaharlal Nehru on the eve of Independence in 1947. Hon. Panditji said, “The achievement which we celebrate today is a step of opening as an opportunity to the greatest triumph. We should be wise enough to grab this opportunity and accept the challenge of future”. This statement applies even today in current economic scenario.

The meeting terminated with a vote of thanks to the speaker.